The global energy sector is changing significantly as liquefied natural gas (LNG) becomes increasingly important in meeting growing energy demands and addressing environmental concerns. Even before COVID-19, the natural gas markets underwent such rapid evolution that they disrupted established long-term supply contracts, leading to waves of LNG price arbitrations. While LNG price arbitrations may harbour uncertainties, arbitration continues to stand as the preferred method for resolving disputes. Parties can play a role in minimising uncertainty in LNG price arbitrations, primarily through careful contract drafting. This note dives into LNG price arbitrations, highlighting their background, the challenges they involve, and practical ways to mitigate against uncertainty in this ever-changing environment.
Background to LNG Price Arbitrations
LNG is recognised as a crucial energy source worldwide. It plays a significant role in meeting growing energy demands and reducing greenhouse gas emissions compared to other fossil fuels. LNG is a form of natural gas that has been cooled to approximately -162 degrees Celsius (-260 degrees Fahrenheit) at atmospheric pressure, which causes it to condense into a liquid state. LNG has several advantages over traditional natural gas including reduced volume, increased energy density, global market access and versatility.
Once liquefied, LNG is typically stored in insulated tanks before being transported via specialised LNG carriers, which are purpose-built ships equipped with cryogenic tanks. At its destination, LNG is regasified using heat exchangers, converting it back into its gaseous state before distribution.
Challenges Surrounding LNG Price Arbitrations
Traditionally, most LNG supply contracts were in the form of long-term sale and purchase agreements (SPAs), often with options for extension or renewal. However, fluctuating oil prices caused significant shifts in bargaining power between buyers and sellers in long-term oil-indexed gas sales agreements (GSAs).[1] Particularly in Asia, the increase in oil prices and the Fukushima nuclear accident created an unforeseen demand for LNG. This led to market participants wanting to rely on shorter-term contracts. Consequently, parties that had entered into long-term contracts sought to activate price review or re-opener clauses. These clauses allow for periodic renegotiation of the contract price in response to significant changes in the energy market affecting the gas value. As a result, there has been a notable increase in LNG price arbitrations.[2]
Most LNG price arbitrations are confidential. However, some public awards have triggered questions about the suitability of arbitration in this context. Some scholars have claimed an unpredictable outcome of LNG price disputes when referred to arbitration.[3] There have been some cases where arbitral tribunals have seemingly deviated from the terms agreed upon by the parties (and, in certain instances, from the arguments raised by the parties during arbitration) to impose their own preferred pricing structure.
In Atlantic LNG v. Natural Gas,[4] following the triggering by one of the parties of the price review clause, the tribunal delivered its final award in 2008 and decided to impose a dual pricing scheme that neither party had requested in its submissions or approved. Such an outcome was possible because of the ability left to arbitrators to reach a “fair and equitable revision” of the contract price.
The same approach was adopted by the arbitral tribunal in the Quintette Coal arbitration. At the request of the parties to fix several prices for the next five years, the arbitral tribunal adapted the contract price, primarily guided by the contractual requirement to “reach a fair and reasonable adjustment”. The award was challenged by the claimants, who argued that the arbitrator’s adaptation of the contract was beyond the parameters set out by the parties. However, the court found that the contract granted jurisdiction to the arbitral tribunal to interpret the parties’ will and rejected the challenge against the award.[5]
In ICC Case No. 12936,[6] the arbitral tribunal found that oral and tacit amendments made by the parties to their contract showed their intention to revise it and to waive the form requirement agreed upon. The parties’ practice could thus lead to a revision of the contract without following the stipulated contractual procedure.
How to Mitigate Against Uncertainty in LNG Price Arbitrations
Arbitration continues to be the preferred method for resolving LNG disputes. Instead of turning away from arbitration, parties should give more thought to the drafting of the pricing mechanism and arbitration clauses. This section outlines practical advice for reducing uncertainty in the context of LNG price arbitrations.
Limit the arbitral tribunal’s power: the more detailed the contractual provisions regarding price review, the narrower the tribunal’s authority to modify the contract. It is, therefore, recommended to clarify in the contract that the tribunal’s scope to depart from the contractual formula is very limited or non-existent.[7] Parties can also explicitly exclude the right for the arbitral tribunal to render an award based on subjective principles of justice, fairness, equity, and good conscience. If the tribunal then decides to adapt or modify the contract extensively, the parties can challenge the award on the grounds of the arbitral tribunal’s excess of authority.[8]
Include an arbitration clause covering price review disputes: parties who wish to settle price review disputes through arbitration should explicitly state so. It is recommended to include a provision stipulating that disputes arising out or in connection with the price review clause (or re-opened clause) should be referred to and finally settled by arbitration.[9]
Choose the right governing law: it is important to bear in mind that the choice of governing law may have an impact on the extent to which the tribunal can depart from contractual provisions. Choosing a governing law that does not consider hardship as a valid ground to amend the contract (for example, English law) is recommended. This will reduce the chances of the tribunal finding a legal justification for straying from contractual provisions.[10]
Consider using baseball arbitration to determine the contract price: to avoid the arbitral tribunal “splitting the baby”, the contract can provide that each party submits a final offer or proposal for the resolution of the dispute. The tribunal is then required to choose one of the final offers presented by the parties without any modification.[11]
Provide for the parties to bifurcate the proceedings: to reduce costs and encourage settlement, parties can agree upfront to bifurcate the issues in dispute. In this case, the tribunal would first determine whether the price review mechanism was appropriately triggered given the prevailing market conditions. In a second phase, the tribunal would assess the impact of the triggering event on the price.[12]
Provide for the possibility for the tribunal to indicate its preferred solution to the parties in a partial award: parties can agree that the arbitral tribunal shall determine what adjustments are required to the contract price formula to calculate the contract price in a partial award. The parties maintain the liberty to apply for a further award to determine the contract price in case of remaining disagreement.[13]
Select the right arbitrator(s): to reduce the risks of unexpected outcomes, choosing an arbitrator with extensive knowledge of the gas supply industry and its prices is recommended.[14]
Conclusion
With its emphasis on confidentiality, international enforceability, and the opportunity to choose tribunal members with relevant industry expertise, arbitration is very well-suited to address disputes arising from LNG price reviews. The recent increase in LNG price disputes serves not only as a warning to parties yet to face such disputes but also as a reminder of arbitration’s unique position – private, tailored and internationally enforceable – to resolve such conflicts.
[1] B. Holland and S. Sparling, LNG Arbitrations (Global Arbitration Review, 2022).
[2] C. Tevendale and C. Morgan, Avoiding unpredictable results in gas price disputes: helping tribunals to spot the best outcome (Thomson Reuters, 2017).
[3] C. Tevendale and C. Morgan, Avoiding unpredictable results in gas price disputes: helping tribunals to spot the best outcome (Thomson Reuters, 2017).
[4] Atlantic LNG Company of Trinidad and Tobago v. Gas Natural Aprovisionamientos SDG, S.A., Final Award, 17 January 2008.
[5] Quintette Coal Ltd. v. Nippon Steel Corporation, 1991 CanLII 5708 (BC CA).
[6] ICC Case No. 12936.
[7] S. Bieri, Arbitration Clauses in Gas Supply Agreements (Kluwer Arbitration Blog, 2014); E. Kaufman and S. Svinkovskaya, Gas and Liquefied Natural Gas Disputes in Latin America: Issues of Force Majeure, Hardship, and Price Reopeners (Kluwer Law International 2021), p. 138; P. Lorfing, Adaptation of Contracts by Arbitrators (Kluwer Law International 2018), p. 71.
[8] C. Tevendale and C. Morgan, Avoiding unpredictable results in gas price disputes: helping tribunals to spot the best outcome (Thomson Reuters, 2017).
[9] C. Tevendale and C. Morgan (assisting Practical Law Arbitration), Gas price disputes: arbitration clause with drafting notes (Thomson Reuters).
[10] C. Tevendale and C. Morgan, Avoiding unpredictable results in gas price disputes: helping tribunals to spot the best outcome (Thomson Reuters, 2017).
[11] S. Bieri, Arbitration Clauses in Gas Supply Agreements (Kluwer Arbitration Blog, 2014).
[12] C. Tevendale and C. Morgan, Avoiding unpredictable results in gas price disputes: helping tribunals to spot the best outcome (Thomson Reuters, 2017); C. Tevendale and C. Morgan (assisting Practical Law Arbitration), Gas price disputes: arbitration clause with drafting notes (Thomson Reuters).
[13] C. Tevendale and C. Morgan, Avoiding unpredictable results in gas price disputes: helping tribunals to spot the best outcome (Thomson Reuters, 2017); C. Tevendale and C. Morgan (assisting Practical Law Arbitration), Gas price disputes: arbitration clause with drafting notes (Thomson Reuters).
[14] Sandra De Vito Bieri, Arbitration Clauses in Gas Supply Agreements (Kluwer Arbitration Blog, 2014).