Disputes, litigations and arbitration proceedings are common in the oil and gas industry, where multidecade, multibillion-dollar projects depend almost exclusively on long-term contracts and their interpretation and the entire value chain is used to outsourcing services to third parties.
The nature and risk profile of many oil and gas projects requires a complex contractual structure to make an undertaking commercially and financially viable. In many cases, the financial close of a project requires the developers to contractually align supply on one end and demand on the other. Multi-year contracts require producers to periodically deliver specific quantities of a hydrocarbon while the counterparties agree to take delivery of the quantity through a previously established price formula.
Many contracts are structured using take-or-pay clauses which when over-simplified, force the demand side of a contract to take delivery of any given shipment or pay for demand shortfalls. Generally, contracts include up as well as downside tolerances over any given period (usually yearly or over the life of the contract).
The industry is going through its latest crisis, with global energy demand falling at historic rates and hydrocarbon prices dropping sharply, both due the COVID-19 pandemic and producers reacting slowly and insufficiently to curtail global production. This is having a devastating impact on oil and gas companies and their financial situation, as business margins appear to be fading away and the situation continues to worsen quickly. Independents, international oil companies (IOC), majors and national oil companies (NOC) are suffering from the effects of a “double-whammy” crisis.
Many companies have already initiated substantial restructuring efforts, mostly by reducing capital expenditures (capex) and operating expenses (opex), shutting in wells to deal with decreased demand and refinancing outstanding debt maturities. According to our Capex Cut Tracker, NOCs have, on average, slashed capex guidance for 2020 by 24%, while IOCs and majors have done so by 29%, which is typically the first reaction in times of crisis.
As uncertainty regarding economic recovery persist and second waves of shutdowns loom, companies need to review and renegotiate current contracts to further reduce costs along the value chain: take or pay agreements on the supply and demand side, transportation service agreements, oilfield service contracts and supply contracts, as well as agreements with government entities, financial institutions and others. Most industry participants will be involved somehow, whether on the demand or supply side across industry segments. Infrastructure-heavy sectors such as oil and gas producers and midstream companies, liquefaction plants, vessel operators and refining and petrochemical complexes are being confronted with declarations of force majeure to reduce their counterparties’ exposures. In addition, oilfield services companies, suppliers and offshore support vessel and rig operators are expected to face contentious contract cancellations as part of cost-cutting measures.
Renegotiation decisions will involve many potential conflicts, litigations and disputes, most of which will be highly complex. Companies that are either initiating renegotiations or are on the receiving end can benefit from the assistance of an expert sector advisor. From the onset, it is critical that companies and their advisors follow a strategic approach by first analyzing the terms of the contract and developing a deep understanding of the local legislation that supports them to determine whether any renegotiation or cancelation has sound legal ground.
Generally, oil and gas contracts include clauses that contemplate the possibility of facing exceptional situations on which the renegotiation of some terms can be based, such as force majeure or hardship of material adverse change (MAC) circumstances. These clauses have specific nuances and goals and should be approached differently to reach the desired outcome, whether it is a temporary or definitive suspension, a renegotiation or limiting specific terms of the contract.
The goal of these renegotiations and potential contract disputes is to ensure that the contract is bilaterally fair and in line with the current market dynamics. Therefore, it is critical to have advisors that not only understand the legal framework, but also have a deep understanding of the industry in which dispute is taking place.
Our team has broad international experience and is uniquely qualified to assist with reviewing and renegotiating contracts in which a spike of dispute activity is expected. Example situations include:
- Operation and maintenance of above-surface facilities and plants,
- Transportation of crude oil, natural gas, refined products and liquefied natural gas;
- Feedstock agreements and offtakes of petrochemicals and refined products;
- Production and work commitments with NOCs and host governments; and
- Merger and/or share purchase agreements that are currently within the interim period.
Duff & Phelps offers an integrated solution by bringing together a diverse team of experts in contract disputes and litigation and in oil and gas financial advisory. Our approach is built upon thorough analyses, deep understanding of the circumstances and the evaluation of different scenarios to reach the desired outcome through a well-documented and compelling strategy. Our ultimate goal is to assist our clients to achieve their goals and generate value in every interaction.