Long-Term LNG Agreements And Short-Term Volatility: Buyers Beware?

• Jurisdiction: United States,Federal
• Author: Mr Jeremy Richmond KC and William Mitchell
• Law Firm: Quadrant Chambers
• Published date: 24 April 2023

OVERVIEW

Even the most pessimistic buyer would have struggled to predict the price shock to commodity markets following the war in Ukraine. What if unforeseen market movement under a long-term sale and purchase agreement (SPA) creates an arbitrage opportunity for a party if it is willing to breach the agreement? Does the innocent buyer have adequate protection? Could it recover from the contract-breaking seller? Long-term SPAs commonly contain arbitration clauses. As such, these are all issues with which arbitral tribunals (and those who advise parties to arbitrations) commonly have to grapple in this market sector.

The first part of this article considers how standard contract clauses relating to pricing, damages and remedies may respond in such a scenario; and whether such conduct is likely to amount to a breach which could escape the scope of typical liquidated damages clauses. The second part of the article considers whether conduct by the contract breaker could also give rise to non-contractual causes of action for the innocent buyer against a contract-breaking seller in such circumstances - particularly in light of the developing jurisprudence on economic duress in English law.

Price reopeners

Where a price spike gives rise to an arbitrage possibility (where LNG is diverted from one market to another that offers a better return), a seller may be less likely to consider breaching the contract if it can revise the price via a price reopener clause. A reopener clause will usually identify a trigger, set out a procedure for adjustment negotiation and dispute resolution, and provide criteria for the pricing revision.

The trigger might be an objective benchmark, for example if the reference price moves more than a certain percentage. Often, a vaguer benchmark is preferred by the parties so that unforeseen circumstances are more likely to be caught, notwithstanding the increased likelihood of disputes.

For that reason, triggers are frequently pinned to whether market conditions have "substantially changed as compared to what it reasonably expected", or if the buyer cannot maintain a "reasonable marketing margin". Sometimes it is additionally required that the change has created hardship for one of the parties - in which case it is unlikely to be available to the seller in the situation considered here.

What will be a substantial change? In the well-known Gas Natural v Atlantic LNG arbitration, the tribunal concluded that "change" in the price reopener meant a meaningful departure from a parallel movement between the price formula and the market value of natural gas. This was the type of change the price reopener was intended to address...