Price review clauses have long been a feature of mid-to-long term LNG sale and purchase agreements ("LNG SPAs"). Changing market dynamics and recent price volatility has placed additional focus and pressure on these clauses, which have become increasingly detailed and heavily negotiated.
A novel approach; termination not arbitration: A new approach to price review that has started to emerge sees parties opting to include a termination right, exercisable by either party if they are unable to agree on a revised LNG price after a period of good faith price review negotiations, rather than allowing for the matter to be referred to arbitration.
Some of the factors driving this approach -
1. The emergence of new LNG buyers: The current market oversupply and 'buyer's market' conditions has been a key factor for some buyers in introducing LNG to their energy mix. If a revised LNG price exceeds what a buyer can pass through to gas customers, or otherwise afford to absorb, termination of the LNG SPA would limit its take-or-pay exposure. Sellers may also prefer termination, to re-sell the relevant LNG quantities and reduce the risk of take-or-pay enforcement and credit/payment issues.
2. Impact of arbitration on parties' relationship: Even if negotiations were not acrimonious, the parties' inability to reach a negotiated price review outcome may indicate commercial misalignment between the Parties. This could result in the relationship becoming strained if the parties are required to continue with the contract following a price review arbitration. The relationship impacts of continuing could be compounded if the LNG SPA provides for an arbitral process which lends itself to identifying a 'winner'.
3. Third party control over LNG price: Although the LNG SPA will outline parameters for the arbitral tribunal to apply in determining the revised LNG price, some parties may feel uncomfortable relinquishing control over the LNG price (particularly new buyers who are unfamiliar with LNG price review processes).
4. Costs of arbitration: Parties may wish to avoid incurring the costs and committing the time and internal resources associated with conducting and managing a price review arbitration.
Some potential issues with this approach -
1. Reduced incentive to reach a negotiated outcome: The desire to avoid arbitration proceedings (including the potential associated cost, time and internal resource commitments) may incentivise the parties to reach a negotiated outcome. Typically, parties will agree to extend negotiations or delay giving a notice of arbitration, in order to mutually agree a revised LNG price.
2. Risk of 'gaming': A party may misuse such price review provisions and initiate a price review in order to trigger an early termination, regardless of its view on the price. It is difficult to guard against this risk in drafting the relevant provisions. Termination in this context would be on a 'no-fault' basis and, subject to any obligation to negotiate in good faith and in accordance with the LNG SPA, the parties would not be obliged to reach agreement on a revised LNG price. This risk may be managed to an extent by contracting with an established, long-term relationship counterparty.
3. Short-term contracting issues: An early termination option could be useful for buyers, particularly in emerging markets, where long-term demand can be uncertain. However:
'Portfolio' sellers and LNG traders may be able to manage the effects of early termination by re-selling or trading the relevant quantities. However, where the seller is marketing LNG on a single-source basis to underpin an LNG project development, the early termination right may create bankability issues for project financing, and may not be acceptable to lenders.
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Image courtesy of Ashurst LLP
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