LNG price reviews in Asia: key insights from recent experience

Introduction

Price review clauses have for decades been a feature of long-term LNG sale and purchase agreements (SPAs) for delivery into Asian markets. That being said, Asia has not seen the same glut of gas price reviews and associated gas price arbitrations that Europe has experienced, particularly over the last decade or so. That dynamic is now changing. With traditional, non-adversarial attitudes to formal price review processes shifting in line with underlying market dynamics, we are seeing a noticeable spike in price review activity.

With all the above developments, we have shared our insights and tips on LNG price review processes in Asia and provided suggestions for the drafting of price review clauses in the latest issue of the Corporate Disputes Magazine. Here are our perspectives in detail:

While contractual provisions providing for price reviews – and the price review processes themselves – are confidential between the parties concerned, we are noticing a number of emerging trends.

A recurring theme in many of the price reviews with which we have been involved has been a lack of certainty as to what happens when the parties fail to agree on a new price. Many Asian LNG SPAs include provisions for negotiations on a new price, following the triggering of the price review, often after a set number of years from the date of first delivery, but fail to provide any explicit mechanism, such as arbitration, for resolving deadlock in those discussions. Whether such drafting is a result of conscious or unconscious decision making is unclear. What is apparent, however, is that such clauses have introduced significant uncertainty for the parties when negotiations break down.

A particularly vexed question has been whether parties can commence arbitration to resolve a deadlock in the absence of an explicit provision referring determination of the new price to arbitration. While every LNG SPA will turn on its own wording, in those circumstances parties may be unable simply to rely on the general wording of their arbitration clause on the basis that in such a situation there is merely a failure to reach agreement, not a ‘dispute’ for the purposes of the arbitration clause, or, put differently, that the parties agreed to resolve the new price themselves by way of negotiations, not arbitration. It may be that any arbitral tribunal simply does not have jurisdiction in respect of the matter.

This uncertainty has, in some cases, been compounded by the fact that the relevant negotiations are required by the terms of the LNG SPA to be conducted in ‘good faith’. Under English law, which commonly governs LNG SPAs in Asia, this is still a developing area. It is often unclear to what extent a party is under an obligation to negotiate ‘in good faith’ and what the implications may be if it can be shown not to have done so. It is also relevant that civil law contract regimes, and some common law ones, may impose an obligation to negotiate in good faith even if one is not expressly provided for in the LNG SPA.

Even assuming that such good faith obligations are enforceable, parties to price reviews have faced uncertainty as to what the term ‘good faith’ requires of them. At least under English law, the doctrine tends to be applied by the courts on an ad hoc basis in response to ‘demonstrated problems of unfairness’. This can mean that the obligations the doctrine imposes on parties may vary from case to case, making it difficult for parties to know what is expected of them when the price review process commences.

Finally, there is often a lack of specificity in how a new price is to be reached. In our experience, the typical approach to price review clauses in Asian LNG SPAs is to seek to align the contract price with prices which other buyers are paying, rather than the alternative approach, common to European contracts, of aiming to preserve the parties’ original bargain in light of changed economic circumstances. What has been striking in recent price review matters, however, is the lack of specificity in price review clauses around how alignment is to be achieved, and what contracts are to be used as comparators. Price review provisions which seek alignment with ‘comparable’ LNG SPAs, or which seek to bring prices in line with the ‘market price’, without any greater specificity around what those phrases entail, permits parties with clearly opposing objectives to take divergent positions, often scuppering the hopes of amicable agreement on a new price from the outset.

Lessons learned

It has become apparent from these experiences that a successful price review process starts with the drafting of the price review clause. Inclusion of a well-drafted clause in an LNG SPA can help minimise the issues in dispute as part of a price review discussion and reduce potential uncertainty as to the process and outcome.

While there are many different elements of a well-drafted price review clause, the specific issues identified in this article can and should be addressed by relatively straightforward drafting.

First, there should be a clear time limit for negotiations and a default mechanism for breaking the deadlock if the parties cannot agree. The clause should provide certainty as to how long the negotiation period should last, including both start and end dates. This will typically be at least six months, which allows enough time for the parties to gather data, employ experts and engage with each other in order to reach an amicable solution. It is equally important to then set out the consequences of any failure by the parties to reach an agreement within this time frame. Most commonly, this will be that the new price may be referred to and determined by way of final and binding arbitration.

Second, at least under English law contracts, the parties might consider whether they should simply provide for negotiations, without requiring these to be conducted in ‘good faith’. This will avoid the uncertainty inherent in such language while being unlikely to impact how negotiations are conducted in practice. Parties are incentivised to negotiate in good faith even without such language, given that they face the time and cost of arbitration if they fail to do so. We do, however, appreciate that, particularly from a commercial perspective, parties take comfort from seeing this language included.

Finally, rather than relying on vague and subjective terminology like ‘comparable contracts’, parties should consider defining the parameters for the reference contracts that may be included in the dataset for the benchmarking process. This can be a complex exercise and must be considered on a case-by-case basis; however, in our experience, the reference contracts may be defined by reference to factors such as: (i) term and quantity – contracts for supply of LNG with a term and for an annual contract quantity in line with the term and annual contract quantity of the contract being reviewed; (ii) markets – to account for geographical market factors, contracts for delivery into a key set of reference markets or a single market only; (iii) pricing – contracts with similar price structures, such as oil-indexed contracts only; (iv) delivery basis – contracts with the same delivery basis as the contract being reviewed, such as delivered ex-ship (DES), free on board (FOB), or with the price adjusted accordingly, for example for an FOB contract, adjusted for shipping costs to reflect a delivered price; (v) unconditional or binding – unconditional or binding LNG SPAs, rather than non-binding documents such as a memorandum of understanding or heads of agreement; (vi) agreed or revised within a defined period – contracts with prices which were agreed within a defined period prior to the initiation of the price review, whether under a new LNG SPA or revised through a price review under an existing LNG SPA within the defined time period; and (vii) delivery time frame – contracts with a particular delivery time frame, which might be backward-looking (meaning deliveries already taking place at the time of the price review), forward-looking (deliveries taking place in the next defined price period that is the subject of the price review) or a combination thereof.

It is hoped that clear and considered drafting of this type will assist parties involved in the next wave of price reviews to minimise uncertainty and, ultimately, achieve faster and cheaper resolution of price review disputes.