International Oil Trading: Physical & Paper: A 3 Day Course

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You are currently accessing Global Arbitration Review via your firmwide account. If you would like to login via a personal account, please use the link below. In the first edition of this book, the author illustrated his experience of gas price reviews and, in particular, the key factors required to properly run the process. It derived from the development of the first two rounds of price reviews that took place in continental Europe from to and that were all based mainly on the decoupling of the oil and market prices.

Rather than rising or falling at the same pace, as had usually happened before the first round of arbitrations, oil prices started to rocket in before beginning a rapid descent in autumn while gas market prices decreased.

This amplified the negative difference between the prices at which the gas could have been resold by buyers in the market and the contract sales price of the gas, which was indexed to oil prices.

A third round of price reviews commenced in in an environment of unusually low oil prices and resulted in a series of awards in favour of the buyers. The main reason is that the contract sales prices in the existing long-term sales and purchase contracts were disconnected to the market prices and such disconnection was obvious with the occurrence of the decoupling. As already explained in the previous publication [2] this situation predominantly related to continental Europe and Asia.

At the outset of the gas industry in Europe, there was a need to link the contract sales prices to competing fuels in the absence of liquidity in gas trading markets.

Following European gas market liberalisation and the subsequent creation of several gas trading hubs, where the gas prices reflect the market value of gas, this approach has become obsolete.

Changing the indexation element of the contract price from oil to gas market prices has become key. This has been recognised by industry [3] and regulatory bodies. Arbitrators deliberating on the change of the indexation formula of a long-term oil-linked gas sales and purchase contract do not face an easy task. It cannot be resolved in isolation without the assistance of the parties. The wording of the price review clauses in the existing long-term gas sales and purchase contracts entered into at the time of no gas-to-gas competition, which still predominate, form the basis for most of the problems.

These clauses were written in a very vague language and only thanks to the efforts of tribunals and practitioners has it been possible to identify a set of general rules of interpretation that constitute the basis for their enforcement. Nowadays these clauses appear to be outdated and unsuitable for the changing market. However, the tribunals in price review proceedings still have to interpret old clauses like the following:.

Each of the Parties shall be entitled to request a revision of the applicable Contract Sales Price, provided that the market of the country of final destination of the natural gas shall undergo changes of such nature and extent that would justify a revision of the Contract Sales Price to enable the Buyer to maintain a reasonable marketing margin assuming the application of the principles of sound marketing practices and efficient management by the Buyer.

The main task of the tribunal is that of revising the contract sales price. In the gas industry, a price review is usually based on four or sometimes three steps, whereby the failure of the claimant, seeking either a reduction or an increase in the applicable contract sales price, to pass any step would bring the process to an end.

The first step, namely to determine if the significant changes have occurred during the review period, would remain the same, as it is not affected by the request to change the indexation formula. The second step is to verify if, at the review date, such changes are not reflected in the contract sales price, and the third is to determine if the buyer is able to economically market the gas.

As with the first step, these steps are not affected by a price review request seeking a change in the indexation formula. Indeed, the test necessary to run the check on steps two and three, namely the delta of delta test, is based on the value of the contract sales price against the market value of the gas in the given market. They are a matter of fact.

It is a comparison between the contract sales price and the market prices at the beginning and at the end of the review period. They constitute the basis of the right of the claimant to have the contract sales price reviewed. The most important difference is around the last step, when the arbitrators and the parties have to run the market test to change the contract sales price to determine what is the appropriate level of the contract sales price at which the buyer is able to sell the gas in the market economically, namely its reasonable margin.

The obtainability test is a key factor in this process. The hub reference generally used in Europe is the TTF, though in some countries the increasing liquidity of the gas markets has created specific country hub prices. It could be argued that the change from oil-linked to hub-price indexation should be made by making reference to the obtainable prices in the relevant gas market disregarding the actual prices obtained by the buyer and its market segmentation.

If the indexation refers directly to the market, it could appear at first blush to be logical. However, even if the contract sales price is the hub price, the market segmentation and the prices obtained by the buyer are still relevant.

In fact, when the tribunal runs the market test, it should assume a contract sales price that would always entitle the buyer to obtain a reasonable margin on its own sales. To do so the tribunal should calculate the contract sales price based on the algebra calculations of the hub prices — in general the average monthly prices at the given hub of the month preceding the month of the day of the review date, adding or deducting the necessary value to the hub to arrive at the level that, at the review date, would allow the buyer to obtain a margin the tribunal deems appropriate.

The logic of revising the contact sales price following a request should not change depending on the nature of the request. The main question is how the tribunal should determine the revised contract sales price. There are two possibilities. The final result should be a contract sales price that would allow the buyer to sell the gas economically in the market taking into consideration its own market segmentation.

It could be argued that the end result would result in a major change in the structure of gas sales and purchase contracts as it would embed the principle of a potential guaranteed margin to the buyer. However, today this methodology is frequently used for sales of gas into end markets and it is also frequently used in the gas industry when seller and buyer agree to revise the contract sales price by changing indexation, or when they enter into a new sale and purchase contract.

It could well be said that this is the new trend in the industry. Changing only the indexation formula to the hub prices would have the effect of locking the contract sales price to the market prices but would not necessarily enable the seller to obtain the margin it deserves under the contract.

This would be the same as pretending that hedging the oil indexation formula basket products would be the solution to every price revision and to the fluctuation between contract sales prices and market prices. Obviously, this is not the case, as, in the gas industry, hedging the oil products of the indexation formula is far from being the right solution.

This second methodology relates to the scenario where the parties or the tribunal decide only to partly change the indexation formula from oil-linked products to the hub prices. In general, it can be said that for tribunals to decide if and how to change the indexation formula incorporating hub prices into the contract sales price is a very difficult task that could hardly be achieved without the full cooperation of the parties and their experts, who would play a role of paramount importance.

The tribunal should also consider appointing its own expert. With the change to hub-price indexation the contract price would automatically adjust to the price of the market, as such that it could be defined as an automatic adaptation clause.

In any gas price review proceeding, either party or both parties may request the switch from an oil-linked to a hub-price indexation formula, unless it is expressly prohibited by the contract. In fact the contract sales price is always the end result of the price review, and what really matters is the final result. Therefore the tribunal may review the contract sales price at it wishes to do. In the Atlantic LNG case the tribunal went even further.

It decided to change the indexation formula even though neither party had requested it. This approach has given rise to doubts that the award was ultra petita.

In other words the seller takes the risk of the decoupling between the contract sales price and the market price as the buyer must be able to sell the gas economically. Some may assume that also the volume risk taken by the buyer should be amended to reflect the increased risks taken by the seller with the hub prices indexation. The effect of such change would, however, result in a change of the very nature of such contracts, from take or pay to take and pay. Second, the switch to a full indexation to hub prices would also have the effect of dismantling the price review clause.

It would not be necessary to determine the market value as it would be that of the hub prices. The delta of delta methodology would become useless. One interesting issue would be if the market margins at the wholesalers would change during the review period. Assuming that the new formula is the hub price minus a certain value, if that value has diverged from the market value, the question is if a price review could be requested to change such deduction from the hub prices to align the contract sales price to market value, namely if the possibility of the buyer to economically market the gas would be assessed against the general trend of the other market players.

A new era for gas long-term sales and purchase contracts has begun. The system created in the s to trade gas long term with take-or-pay contracts is changing. The driving force of this change is the switch from oil-linked prices to hub prices. Inevitably, the existing format of gas long-term sales and purchase contracts is being profoundly reconsidered by the industry.

This seems to be the most fascinating question arising out of a decade of gas price reviews in continental Europe, which put enormous pressure on the oil-linked price formulae. This period has seen no less than three waves of price reviews, many of which have been resolved by arbitrations.

If in the first wave —it was not an impossible exercise for the buyers to demonstrate decoupling between oil and market prices and their consequent incapability to sell the gas economically. With the second wave the parties began to consider the resolution of the difficulties originating with the decoupling differently. With the final wave of price reviews begun init has become obvious that the most efficient way to restore the equilibrium of the contract without requiring periodically the intervention of the tribunals was to eliminate the oil-linked formulae and to replace them with a system incorporating an automatic adaptation of the contract sales price to the market prices.

The reasons justifying the replacement of oil-linked formulae with hub-price indexation are found in the liberalisation and the increased liquidity of the markets that created several trading hubs in continental Europe.

There is no need of referring to the gas to gas competition any more. However, this is not new for the United States and the United Kingdom, where this system has been in place for a long time. As has been noted: Increasingly the new generation of long-term gas contracts resemble the short-term and spot contracts as regards contract sales price and flexibility.

The future of price review clauses and of their application is becoming doubtful. The end result produced by this new trend would be the change in the nature of the gas sales and purchase contracts from a take or pay to a take and pay basis with all consequences arising therefrom.

D is the x. Changing the indexation formula Arbitrators deliberating on the change of the indexation formula of a long-term oil-linked gas sales and purchase contract do not face an easy task. However, the tribunals in price review proceedings still have to interpret old clauses like the following: The authority of the tribunal to change the indexation formula In any gas price review proceeding, either party or both parties may request the switch from an oil-linked to a hub-price indexation formula, unless it is expressly prohibited by the contract.

Conclusions A new era for gas long-term sales and purchase contracts has begun. Practical insight from experts on the ground Contact GIR co-publishing. GB

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