Long-term Contracts – What Price?

November 2016

International oil and gas companies have long had difficulty reconciling the long-term and high-cost investments demanded by the upstream oil and gas business with the shorter term thresholds and measures adopted by the equity and debt markets.  It is becoming apparent that these traditional, commercial tensions are being joined by legal tensions in the identification and application of the obligations, liabilities and rights of the parties over the long term of many of the agreements on which natural gas investments are made.

The risks of contractual obsolescence were limited in the relatively stable conditions of reliable state grants, settled geopolitics, an established community of participants and manageable petroleum prices. These benign conditions prevailed for many years and the international gas business grew.  The vast sums of money required were raised on the security of corporate covenants and enforceable common law contracts.  These commitments were underpinned by the secure revenues arising from sales to predictable markets at prices with manageable variations.  The parties satisfied themselves that the choice of a common law (usually the laws of England and Wales or New York) to govern their contractual arrangements meant that they could rely on the establishment and enforcement of rights, obligations and liabilities over time, in the context of adherence to the assumptions and projections adopted during the (often very lengthy) negotiations.

Even the most clairvoyant would be slow to claim foresight of the next twenty years or so.  But that is the notion adopted by the parties to some of the gas sector’s biggest commodity and money contracts.  Companies and states seek to foresee future events and provide specifically for them in their relationship at the time of entering into their long-term agreements: the process of “presentiation”.  In recent times, the changing circumstances of state participation, regulatory controls, market movements and gas price formation have come to falsify the parties’ assumptions and ideals.  The certainty and predictability required as at the date the agreement by the traditional theories of the common law have (perhaps inevitably) proved ill-suited to coping with these moving seas.

At times of relative commercial and regulatory calm, contracts cope, or parties make them cope within the bounds of available flexibilities.  As turbulence increases, coping recedes along with goodwill and commitment to the shared endeavour formed during the extended period of courtship, and happily pursued during the period of honeymoon.  Memory fades quickly of those matters where regard is to be had to acting consistent with the contract’s common purposes and the parties’ reasonable expectations.  A deaf ear is turned towards Benjamin Franklin’s admonition to keep your eyes wide open before marriage, half-shut afterwards.

It is not unusual for pressure to come to bear on those parts of agreements which are least able to resist that pressure.  These may be obligations expressed by reference to a measure of endeavours in circumstances where the parties recognised that they could not negotiate a commitment that would be absolute, but wished to establish one that was meaningful nevertheless.  Or they may be expressed in absolute terms, but with the consequences of breach being subject to relief.  Or they may be those parts of the contract where the parties never did make an agreement, but instead left matters over to be agreed or established at a later stage, satisfied that the agreement as signed represented a sufficient commitment to enable things to advance.  This is the arena of specific assurances of good faith and agreements to negotiate or to agree: matters easily dispensed with as unenforceable under many common law regimes.

Even in the harsh light of the law courts in London these matters are not so easily disregarded under long-term agreements where the parties have left aside for another day those matters which could not be addressed at the outset.  This might include the filling in of gaps, the establishing of operational matters or the variation of prices in the markets prevailing over time.  Even in these sterile conditions, the courts will be slow to defeat the intentions of businesses to create long term relationships, adaptable to changing circumstances, albeit within an apparently complete and enforceable single bargain of long duration.

English law is well-versed in the implication of terms into contractual arrangements so as to facilitate the initial intentions of the parties over time, rather than seeing related contracts fall as a result of arguments or positions of temporary self-interest.  Precedent shows the implication of duties to cooperate in the achievement of the purpose of the contract, and not to prevent the other party’s performance of the contract.   And these rules are more compelling still in the context of long-term relational agreements where continued performance by one party is likely to depend on the continued performance and fidelity of the other to the contract’s common purpose.

With contractual relationships of such extreme duration, there is an inevitability of discord and dispute over time.  Some regard is had to providing for these in the terms of the agreements.  But it is scant regard in comparison with that committed to the establishment of the commercial terms.  A party is most unlikely to be able to effect an ending of the relationship outside of the agreed terms, even if its temporary circumstances are dire.  These areas of discord may well relate not to matters of interpretation of the parties’ intentions at the time the agreement was made, but to re-setting their relationship in the light of changed circumstances or the occurrence of events the parties chose not to provide for at the outset.

To paraphrase Sir Christopher Staughton, it is not uncommon for businessmen to adopt language of deliberate equivocation in relation to matters they cannot agree, in order to achieve their main objective.  But those are likely to be the matters which will, necessarily, encounter scrutiny over time and in that case it is more than a little artificial to pursue the process prescribed by law of ascertaining the common intention of the parties from the terms and context of the relevant document.  The common intention at the time the contract was made was, in fact, that the terms would mean what an arbitral tribunal might, at that later time, decide that they mean.

In this case, the usual reference to arbitration practitioners versed in the resolution of general and past disputes might seem incongruous. Not unusually the parties are, in fact, seeking the facilitated re-setting of their commercial bargain for the coming years.  For some, the gooseberry of an arbitral tribunal is not conducive to re-creating the essence of courtship and the shared optimisation of re-building the parties’ enduring commercial relationship for the remainder of their contract.

If the parties are providing others with the power to re-set their relationship from time to time, then who will those others be?  Most usually under the arrangements of the international petroleum business, they will be appointed at the time of the difference or dispute.  They may be lawyers but they need not be.  Even if they are, they may not be lawyers qualified in the applicable governing law.  They may have little or no experience of the international gas business.  Although there seem to be no current moves towards the civil law notions of good faith in the negotiation, formation and performance of contracts by dint of public policy, there are noticeable trends of English law towards good faith in the performance and enforcement of certain contracts.  For some, English law is showing signs of openness towards the American idea of good faith contractual performance, albeit through the rather unusual route of Australian and Canadian jurisprudence.

If Einstein was correct that insanity is doing the same thing over and over again and expecting different results, then is it time to question why otherwise rational businesses in the petroleum sector continue to enter into long-term agreements without close regard for the inevitably changing circumstances of those agreements over time and without providing in greater detail at the outset for how periodic differences might best be resolved in the context of the continuation of their overall relationship?

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