The concept of price review
A number of long-term contracts for the sale and purchase of LNG contain price review provisions.
But commentators will remind us[1] that price review provisions are contrary to the principle of sanctity of contract, because a contract should be performed just as it reads, as that is what the parties to it have agreed, having taken into account the risks and liabilities of entering into that contract, over a period of time. In English law, for example, there is a general reluctance to amend the terms of a contract, once these are agreed.
That said, it is argued, shouldn’t the parties to a long-term contract for the sale and purchase of a commodity like LNG, also contain the right to adjust or amend the terms and conditions of the contract, if the circumstances justify this?
With that in mind, the parties may deal with the principle of sanctity of contract by virtue of a contractual mechanism, a mechanism in the contract itself, which will enable the parties to maintain the contractual ‘status quo’ even though the circumstances have changed during the lifetime of the contract.
The price review clause (not to be confused with the price adjustment clause) in, say, a long-term gas sales contract, is one such mechanism.
Unlike the price adjustment clause, price review provisions will be triggered only in the event that certain unexpected, unforeseen, or extraordinary events occur, and normally only at the request of one of the parties to the contract.
In some cases, the price review mechanism will function merely to return the parties to the ‘economic balance’ which existed when the contract was executed, and in other cases, the mechanism will permit the parties to amend the contract with little or no attention to the original economic bargain.
Not dissimilar to this, is what practitioners call ‘hardship’ clauses[2]: these will apply when unforeseen circumstances result in one of the parties suffering disadvantage or hardship, compared to the economic balance at the time of signing the contract.
Asian LNG price review clauses, past and present
Unlike the position in certain other parts of the world, where long-term gas contracts have typically included price review clauses, these clauses did not appear in most Asian long-term LNG contracts until the 1990s, which generally meant that a party asking to re-open an oil-linked contract price for LNG had to resort to other options of a contractual or non-contractual nature. Hardship provisions were a typical contractual basis for renegotiation of a contract price.[3]
There were also a range of non-contractual means used to review a contractual price provision.
Nevertheless, the outcome of these alternative options was generally less certain than that involving a price review procedure, triggered on the basis of a price review clause, which serves the specific purpose of adapting the contract price to market changes.
Under current market conditions, and looking to the immediate future, buyers are most likely to request price reviews, especially in the event that the gap between Asian spot and long-term LNG prices widens, and oil-linked contracts become untenable.
Conversely, where the price of oil falls through the floor, there will be a resulting tendency on the part of buyers, to demand a review of the gas or LNG price in a long-term sales contract.
Not surprisingly, Asian LNG contracts finalized in recent years typically do contain price review clauses.
That said though, it is not uncommon to see Asian price review clauses containing major omissions, contradictions, and other drafting flaws, which render them invalid or unworkable. As a consequence, the issue remains as to the enforceability of a price review clause in an Asian LNG contract.
Even in the event that the clause is well drafted, price review clauses in Asian LNG contracts as yet very rarely stipulate that the price review can be requested outside the regular price review periods, or ‘at any time’, subject to the occurrence of some specified circumstances, and the grounds for price review in Asian LNG contracts are generally very limited. Crucially, they are unlikely to include a ‘significant change in economic circumstances in the buyer’s market’ (as we see in most ‘European’ contracts).
Although some Asian price review clauses refer to ‘changes in economic circumstances’, these are either put in a broader geographic context than the buyer’s market, or remain detached from any particular market. Rather than on buyer’s market conditions, Asian price re-openers tend to focus on the comparison with the current import prices, or prices in the new long-term LNG contracts concluded in a specific geographic region.
In the Asian LNG context though, this may indeed be unsurprising, resulting from the historical capability of Asian buyers to pass through price increases to their customers.
That said, this may well change in the future, especially in light of the liberalization of Asian LNG markets, which will inevitably mean that the buyers will operate in a more competitive environment, restraining their ability to pass through the costs of LNG and maintain profitability at the expense of end-users.
Asian buyers can, therefore, be expected to build protection against price increases into renegotiated or newly drafted price review clauses.
The price review negotiations process
As regards the process of price review negotiations, in the Asian context this often takes place through ‘good faith discussions’, as the first step in the price review process, though the length of negotiations can often prove uncertain, and most good faith discussions involving Asian stakeholders have been protracted, with some taking many years to reach resolution.
In the Asian context, there is sometimes the involvement of the relevant government in price re-negotiations, and this can potentially lead to additional delays in the price review process.
I note, that some Asian LNG contracts make it clear that if no agreement is reached by the parties, the contract ‘shall remain in full force’ notwithstanding that the parties failed to agree on price adjustment.
I note further, that some Asian LNG contracts offer the parties the right to terminate the contract, if they are unable to agree on price adjustment.
Asian LNG contracts do not follow the European pattern of a strong preference for arbitration, to resolve contractual disputes between the parties.
[1] Oil, Gas & Energy Law Intelligence, vol. 18-Issue #03-May 2020. See also CMS Annual Review of Developments in English Oil and Gas Law, 2017 edition.
[2] International Chamber of Commerce, Force Majeure and Hardship Clauses, iccwbo.org/publication/icc-force majeure-and-hardship-clauses/. See also, Force Majeure and Hardship in International Sales Contracts, Ingeborg Schwenzer, (2008) 39 VUWLR, ojs.victoria.ac.nz.
[3] LNG Contract Adjustments in Difficult Times, Konstantin Christie, et al, Oil, Gas & Energy Law Intelligence, March 2020. See also, Oxford Institute for Energy Studies, July 2020, Scenarios for Asian long-term LNG Contracts before and after COVID-19.
This blog is for information purposes only. It is not intended to provide legal advice.
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