A Price Review Clause For a Buyer May Give Flexibility to LNG Sale and Purchase Contracts – Part I
In recent years, liquefied natural gas (LNG) prices have reflected the turbulence of global markets. Driven by complex factors like geopolitical events, increasing environmental regulations, and innovations in energy technology, these price shifts underscore the seismic business shifts buyers must navigate in the sector. Luckily, buyers can use a tool, in the form of a contractual mechanism, that can give them the power to recalibrate pricing in line with broader trends in the global energy market: a price review clause.
A price review clause in a LNG sale and purchase contract allows parties to renegotiate price terms in certain, agreed-to circumstances. Several high-profile buyers or operators have recently employed these clauses with success, such as the 2016 price revision between Petronet, India’s leading LNG importer, and RasGas of Qatar. This revision adjusted the terms of their 7.5 million Mtpa deal signed in 1999, reducing the price from around US$13 to US$6-7 per million BTU. The renegotiated price, now linked to crude oil index prices, also enabled Petronet to avoid a substantial penalty by committing to take and pay for all previously undelivered volumes over the remaining 25-year contract period ending in 2028. This renegotiation saved India billions on LNG prices over the contract term, demonstrating how price review clauses can maintain fair, mutually beneficial agreements in the LNG space.
Since 2013, the use of price review clauses has become increasingly prevalent in Asian markets. Petronas and South Korea’s KOGAS engaged in negotiations to significantly increase prices, reflecting the rising value of crude oil. Yemen LNG adapted its pricing with key buyers like KOGAS in response to the U.S. shale gas boom and Asian market demand shifts. Meanwhile, Sakhalin Energy’s renegotiation with KOGAS aimed to increase prices to reflect the increased cost of Brent crude. The Indonesian government successfully negotiated price increases with China, setting a precedent for similar discussions with South Korean buyers. Notably, KOGAS’s 2018 arbitration against the North West Shelf Joint Venture marked the first public instance of price review arbitration in an Asian LNG contract.
As market conditions continue to change, so too has the frequency of price reviews. Initially spanning every five to ten years in the 1990s, recent reviews in Asia have occurred approximately every four to five years, while Europe’s dealmakers typically employ a more frequent three-year review.
In this first part of a two-part series regarding price review clauses, I discuss whether these clauses are necessary in LNG sale and purchase contracts, and considerations buyers should keep in mind when drafting and negotiating a price review clause. In the second part of the series, I discuss best practices when negotiating new pricing during a price review.
Are price review clauses necessary in LNG sale and purchase contracts?
This uptick in price review negotiations is a logical response to market variability, particularly in the Asia-Pacific region. For buyers, especially those grappling with oversupply issues, renegotiating contract terms through price reviews is a prudent and strategic business move. The trend of doing so underscores the crucial role price review provisions play in long-term, take-or-pay contracts, particularly in markets lacking transparent, market-driven gas pricing.
That said, not every buyer will want to, or need to, include price review clauses in their natural LNG sale and purchase contracts. Many buyers have negotiated favorable LNG sale and purchase contracts without them. The decision to include one must depend on a buyer’s business objectives, along with industry conditions, geopolitical concerns, and other external factors, not because others have it in their contracts.
Considerations for drafting and negotiating a price review clause
Once a buyer has determined that it wants to include a price review clause in its LNG sale and purchase contracts, the first thing it must do is engaging the right experts to help draft the clause. Commercial pricing experts can provide an appropriate pricing comparison basis, while experienced legal counsel would handle drafting the overall contract and the price review clause itself. Though experts are already knowledgeable about the industry and best practices, that expertise will only be helpful to a buyer if those experts understand the buyer’s business objectives and its intent behind entering into the contract and for making use of the price review clause. For this reason, a buyer should ensure that it has shared its objectives and intent with the experts before they work on the price review clause.
With the help of an expert team, buyers should determine the event that will trigger the required price review. A triggering event can be linked to external factors like market price changes or a shift in the JKM Platts price. Or, the triggering event can be as simple as notice from one party to the other that they intend to initiate a price review.
Whatever the triggering event it is, a buyer should also consider how it will provide notice to the other party when a price review will begin. For example, a buyer may choose to reduce uncertainty in the contract by including a provision that a party may only issue notice commencing price review within 30 days of the date that party becomes aware of a triggering event. Limiting the window in which the parties may invoke price review encourages swift action instead of letting a potential price renegotiation hang over the parties like a dark cloud only one party is aware of.
A buyer may also opt to limit the time permitted for price review discussions. A provision limiting the time for discussion may be useful when parties have not completely disagreed as to the price and terms and have invested significant time in trying to reach an agreement. Whether limiting discussion time is right for a particular contract depends on the goals of the parties and their tolerance for uncertainty. In Asia, some contracts limit discussion time, while others don’t.
Price review clauses often include language requiring that the agreed-upon price be “reasonable,” “appropriate,” “equitable,” “fair,” or “justified.” Parties may use these terms as a strategy to expand the scope of contract price negotiations. The Petronet case is one such example of this strategy. Petronet reduced the price it pays RasGas for LNG by 50%, but also agreed to buy 50% more over the long term.
Sometimes, during the price review period, parties cannot agree on a new price. In anticipation of such case, a buyer should consider whether it wants to include concrete language requiring the parties to come to an agreement over a new price. A buyer may additionally account for a potential stalemate by opting for arbitration over vague language suggesting future negotiations or agreements “to negotiate,” and giving arbitrators the authority to change prices. Choice of governing law will matter as well. An explicit approach is particularly useful where parties may be under a regulatory duty to reach an agreement. Of course, apart from a buyer’s legal obligations, its primary concern should be the long-term success of the deal and how the contract plays into its overall business objectives. While definite terms for resolving a price review dispute are recommended, buyers should always consider when additional flexibility may benefit their business objectives.
A price review clause is an excellent risk mitigation tool, but sometimes a buyer will require something different. Instead of or addition to a price review provision, LNG sale and purchase contracts can incorporate clauses like a “take-or-pay” clause; a “take-and-pay” clauses where a party takes and pays for all LNG delivered; cancellation clauses permitting contract termination under certain conditions; cargo diversion allowing redirection of shipments to different buyers with a guarantee to cover lost profits; cargo swap provisions allowing parties to take cargo from nearer origins; or hardship clauses addressing unforeseen circumstances, each of which can significantly alter contractual obligations. These provisions serve to manage specific risks in LNG sale and purchase contracts, and may be more appropriate than a price review clause in certain circumstances, depending on the objectives of the buyers.