Price Reviews: Are Asian LNG Contract Terms Finally Changing?
Price review clauses
A price review clause offers the most straightforward way to request a revision of a contract price which, during the life of a long- term LNG supply contract, may become untenable to either party. While European LNG contracts have routinely included price review clauses since the 1960s, price reopeners did not feature in most Asian LNG contracts until the 1990s. In more recent Asian LNG contracts, price reopeners are becoming standard. Such a clause could read as follows:
- No earlier than after the first 10 Complete Contract Years, and within 6 months after the beginning of every 5 Consecutive Contract Years, a Party may give a Price Review Notice to the other Party to renegotiate the Contract Price.
- Following the issuance of the Price Review Notice, the Parties shall meet and discuss the matter in good faith with a view to agreeing what Price Adjustment (if any) is required. The then current levels and trends in the price of oil and gas in the Asia-Pacific region shall be the basis for good faith discussions.
- Any Price Adjustment agreed by the Parties shall take effect in respect of all Deliveries of LNG under this Agreement on or after the date of the Price Review Notice. Until any Price Adjustment has been agreed, the Contract Price shall be determined on a provisional basis under the formula prevailing prior to the Price Adjustment.
The three standard components of a price review clause—conditions for a price review, price review process, and price review methodology—are discussed in turn below.
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Conditions for a price review
Temporal triggers
Price reviews in Asian LNG contracts can typically be triggered after a set number of years from the date of first delivery and at regular intervals throughout the life of the contract. Most Asian LNG contracts from the 1990s provided for a price revision at intervals of five to ten years. Modern contracts tend to stipulate shorter price review periods, typically of four or five years.
Narrower price review intervals offer more flexibility to request a revision of the contract price. But Asian LNG contracts still very rarely stipulate that a price review can be requested outside the regular price review periods, or based on the occurrence of some specified circumstances. The limited availability of non-period reviews necessarily constrains the parties in their attempts to revise the price, ultimately forcing them to await the next time window to submit their request.
Limited role of downstream market conditions
Grounds for a price review are very limited in Asian LNG contracts. Most notably, they are unlikely to include a ‘significant change in economic circumstances in the buyer’s market’—the price review trigger mentioned most commonly in European contracts. This peculiarity of Asian LNG contracts derives from the historical capability of Asian buyers to pass through price increases to their customers. The lack of reference to the buyer’s market conditions is likely to change in the future, especially considering that liberalization of Asian LNG markets will inevitably mean that the buyers will operate in a more competitive environment limiting 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.
Price review process
Good faith discussions
Negotiations in the Asian context, often referred to as good faith discussions, are routinely the first step in a price review process. The contractual basis for good faith discussions is rather vague in most Asian LNG contracts. In particular, price review clauses like the example set out above often do not stipulate a negotiation period or recourse in the event of failed negotiations. The length, and prospects, of price review discussions can therefore prove uncertain and potentially discourage a price review request. Price review clauses stipulating strict time limits for good faith discussions, and specific actions in the event of their failure, should offer a more favourable, but still rare, setting for a price review process. These more detailed price review clauses, which are most likely to be found in newer contracts, typically provide for one of three options if negotiations do not lead to a new agreed price. First, some Asian LNG contracts state that the contract ‘shall remain in full force’ even if the parties fail to agree on a price adjustment. Second, some Asian LNG contracts offer both parties the right to terminate the contract if they are unable to agree on a price adjustment. The third, and in the long run arguably most important, alternative now being adopted in some recent Asian LNG contracts is for the price review mechanism to provide that in the event the parties fail to agree on a new price within a specific time frame, either party may submit the dispute to an external dispute settlement mechanism like arbitration or expert determination.
Arbitration
Arbitration is the preferred dispute resolution method in European long-term LNG and gas supply agreements. For a variety of reasons, including the traditional Asian preference for non-adversarial dispute resolution mechanisms, and the close-knit nature of the LNG sector, Asian LNG contracts have not adopted the European preference for arbitration and only required the parties to ‘meet and discuss’ the contract price. However, the attitude towards arbitration is now changing in Asia. The emergence of new players and the expansion of capital-intensive LNG projects, in particular, have led to a greater push towards price review clauses offering recourse to arbitration primarily as a means to hedge against the risk of protracted price review discussions. As a result, recent Asian LNG contracts increasingly provide for arbitration as the second step after good faith discussions have been conducted for a stipulated period of time.
As for the earlier Asian LNG contracts, the availability of recourse to price review arbitration is uncertain. In particular, the absence of an express right within the price review clause to refer a failure to agree on a new price to arbitration is likely to prevent arbitration in relation to the setting of the price.
Apart from contractual barriers, arbitration under an Asian LNG contract may also face practical impediments. For example, industry evidence suggests that some parties to Asian LNG contracts, especially state-owned companies, will never allow a dispute to reach the arbitration stage. As fittingly described by one party interviewed as part of OIES’s research, in such cases, arbitration effectively becomes a Damocles sword hanging over both parties’ heads to force a negotiated solution.
Expert determination
Expert evidence has always played a vital role in LNG price review arbitrations. Parties have traditionally built their cases, and arbitrators decided these cases, on multiple expert reports. Some contracts expressly require the submission of narrowly defined, mainly purely technical, questions for determination by an expert.
Determination by an expert (or panel of experts), as a separate dispute resolution process with the expert acting as an independent decision-maker, has never evolved into a full-fledged alternative to arbitration in price reviews arising from European contracts. In that regard, Asian LNG contracts seem to differ from their European counterparts. Industry input suggests that some Asian price review clauses submit the resolution of an entire price review dispute exclusively to an expert. Other Asian contracts provide for expert determination as one option. For example, a contract may stipulate that the parties may agree to refer any dispute to an expert for determination if they feel that, in view of the nature of the dispute, this will be more suitable than arbitration. In at least one case, the parties entered into a dispute resolution agreement that effectively replaced arbitration with expert determination for their price review.
Price review methodology
Most price review clauses in Asian LNG contracts offer very little guidance as to the factors that should be taken into account. Strikingly, some Asian LNG contracts (including the most recent) do not specify any instructions or parameters at all for the price review, potentially exposing the contract parties to the risk of undesirable results. The lack of guidance on methodology should not cause major problems as long as the decision on the price adjustment remains in the hands of the parties. But problems are likely to arise if informal good faith discussions fail. Parties contemplating recourse to a third-party dispute settlement, in particular, may feel uncomfortable leaving this vital decision to an external actor whose powers are not constrained in any tangible manner by the contract. In response to such concerns, a wide variety of measures can be adopted to limit the discretion of arbitrators or experts hearing a price review claim. Strategies which are, arguably, most suited for Asian LNG contracts are briefly discussed below.
Limits to the decision-making process
First, the parties can instruct arbitrators or experts as to how they should (or should not) arrive at their decision. To that end, they can specify factors, parameters, or evidence to be considered (or excluded) in a price review. The parties may also set a threshold on retroactivity and the relevant time perspective of the price review, and define, for example, the extent to which the future impact of a price change should be relevant.
Limits to structural changes to the price formula
In addition, or as an alternative, the parties may limit structural changes to their price formula. Parties to Asian LNG contracts, in particular, may be inclined to reserve wholesale structural changes to a limited set of circumstances. For example, they can allow for a change from an oil-indexed price to a hub-based price only in the event of a liquid gas hub being created in the buyer’s market. Furthermore, the parties can prohibit changes to specific components of the price formula, like slope or constant, or expressly exclude application of specific indexes like the Japan Korea Marker or Henry Hub.
Quantitative limits to the price revision
Finally, the parties may specify a range within which the contract price can be increased or decreased. To that end, the contract can refer to specific maximum and minimum figures, or an acceptable percentage change, or stipulate a gradual transition to a new price formula over a period of years. These or other quantitative limits can feature in isolation, or together with limits to the decision-making process or to the scope of structural changes to the price formula.
Risk of overly prescriptive limits
Although the limits to the powers of an external decision-maker may play an important role in protecting parties from the uncertainties of the price review, some of these limits may prove too prescriptive and limit arbitrators’ or experts’ ability to provide a commercially sound decision. It is therefore essential that any limits remain sufficiently flexible and facilitate, rather than compromise, a price review process.
An alternative to such limits, and theoretically preferable, would be careful due diligence preceding the choice of an external decision-maker. In particular, the parties entrusting an individual with the decision on the contract price should have confidence that that person is experienced and well versed in international gas markets and the intricacies of the LNG business and that the final outcome will be acceptable to them (and, ideally, reflect the market price). Arguably, the parties could be inclined to allow such an individual more discretion in determining the contract price. But the practical difficulty of this solution lies in the fact that the contract is typically drafted long before any person is considered for such an appointment. Indeed, a stronger emphasis on the issue of price review methodology at the time the contract is drafted may constructively inform the decision on the most suitable external dispute resolution mechanism to be incorporated into a price review clause under a particular contract.
Conclusions and outlook
The lack of price review clauses in Asian LNG contracts, and the limitations to existing clauses, have historically translated into a low number of revisions to prices under long-term contracts in the Asian markets. In the future, and possibly the near future, the number of LNG pricing disputes in Asia is likely to increase. As soon as Asian LNG buyers and sellers develop a more systematic approach to price reviews, this is likely to be reflected in the content of price review clauses. In general, price review clauses in newly drafted or renegotiated contracts can be expected to become more detailed and to stipulate more flexible terms for a price review.
Conditions for price reviews in new Asian LNG contracts are likely to involve shorter price review periods and to increasingly provide for non-temporal triggers. Downstream market conditions, in particular, are likely to become more relevant in future price reviews. The most significant changes to contract terms governing the price review process are likely to focus on post- negotiation options. For the sake of certainty and efficiency, these options are likely to be reduced to a binary choice between third-party dispute settlement and contract termination. Capitalizing on the lessons learned over several decades of price reviews in Europe, parties to Asian LNG contracts can be expected in the future to opt for arbitration. It can also be expected that expert determination will play a more significant role in Asia than it has in European price reviews. Contract terms governing price review methodology will likely continue to be determined on a case-by-case basis but to become more prescriptive.
An overarching question is whether changing price review clauses, which are likely to incentivize price reviews, will result in more comprehensive changes to Asian LNG contract terms. In particular, it remains to be seen whether price reviews will be limited to a case-specific revision of a price under a particular contract, or whether they will cumulatively trigger broader changes to price formation, contract duration, destination flexibility, or other fundamentals in Asian LNG contracts.
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