The Guide

to Energy
Arbitrations - Sixth
Edition
The Guide to Energy
Arbitrations - Sixth
Edition
The energy industry nurtured and shaped what we now know as international arbitration, and,
for a host of reasons – resource nationalism, oil price drops, geopolitics, climate change,
sanctions and pandemics among them – it has remained one of the discipline’s biggest
clients.

The Guide to Energy Arbitrations, published by Global Arbitration Review, provides coherent
and comprehensive coverage of the most common, diLcult and unusual issues faced by
energy Brms, from some of the world’s leading authorities.

Generated: December 4, 2024

The information contained in this report is indicative only. (aw )usiness Research is not responsible
for any actions Cor lack thereof2 taken as a result of relying on or in any way using information contained
in this report and in no event shall be liable for any damages resulting from reliance on or use of this
information. 0opyright 6--4 E 6-6x (aw )usiness Research

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Contents
Preface

Publisher's note
David Samuels
(aw )usiness Research

Preface
J William Rowley KC

Overview

The Breadth and Complexity of the International Energy Industry

Doak Bishop, Eldy Quintanilla Roché, Sara McBrearty
Sing P Dpalding ((H

Part I: Investor-State Disputes in the Energy Sector

Taxation-Related ISDS
Anna Crevon-Tarassova, Asha Rajan, Xhilda Vocaj
qentons

Part II: Commercial Disputes in the Energy Sector

Construction Arbitrations Involving Energy Facilities

Doug Jones AO

Offshore Vessel Construction Disputes

James Brown, William Cecil, Andreas Dracoulis
Iaynes and )oone, ((H

LNG Arbitrations
Ben Holland, Steven Sparling
SP( Gates ((H

Upstream Oil and Gas Disputes

Abubakar Anafi, Chimezie Onuzulike, Fidelis Oguche, Owen Umeh
G Klias P 0o

Part III: Contractual Terms

The Evolution of Natural Gas Price Review Arbitrations
Stephen P Anway, George M von Mehren, Michelle Glassman Bock, Max Rockall
DFuire Hatton )oggs

Part IV: Procedural Issues in Energy Arbitrations

Expert Evidence
Joe Skilton, Abi Harris
Decretariat

Quantum: Valuing Pre-operational Assets

Bennet Berger, Jack Stirzaker
The )rattle Group Wnc
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Publisher's note
David Samuels
Law Business Research

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Global Arbitration Review is delighted to publish The Guide to Energy Arbitrations.

;or anyone new, GAR is the online home for international arbitration specialists. je tell them
all they need to know about everything that matters, in their chosen professional niche.

Throughout the year, we deliver pitchEperfect daily news, surveys and featuresM lively events
Cunder our GAR (ive banner2M and innovative tools and knowEhow products, such as the
Arbitrator Research Tool and its companion Hrimary Dources Carbitral awards from the GAR
archive2. And we continue to innovate with fresh pro'ects such as our Academy, where you
can learn the skills of international arbitration in the privacy of your oLce or home. K&plore
around www.globalarbitrationreview.com when you have a moment. Wt’s almost certain to
reward.

Thanks to our position at the heart of the international arbitration community, we sometimes
become aware of gaps in the literature, and have the connections to do something about that.
The Guide to Energy Arbitrations was the Brst – and remains one of the best – e&amples. Di&
editions on, and it’s 'ust as relevant as ever – possibly more.

Wf you Bnd this Guide useful, you may en'oy some of our other GAR Guides series. They
currently cover construction, mining, UPA disputes, WH, challenge and enforcement of
awards, investment treaty protections, telecoms, and aviation and space, not to mention the
speciBcs of advocacy, damages, and evidence as they all manifest in international arbitration.
je also have a citation manual weOre very proud of – é0WA CUniversal Citation in International
Arbitration2.

‘n behalf of the whole GAR team, W’d like to thank our editors – )ill Rowley, qoak )ishop and
Gordon Saiser – for the energy they’ve put into the pro'ect, and my colleagues in production
for the Nlan with which they’ve realised our collective idea.

qavid Damuels
Uay 6-6x

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David Samuels

https://www.lbresearch.com/

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Preface
W Killiam Rowley MC

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Kconomic and technological change witnessed over the past several decades have altered
the global economy profoundly. )usinesses, and particularly those involved in the energy
sector, responded to reduced trade barriers and advancement of technology through
international e&pansion, crossEborder investments, partnerships and 'oint ventures of every
description.

The resulting 3internationality’ of business and trade patterns alone would have been
suLcient to 'etEpropel the growth of international arbitration. )ut when coupled with the
uncertainties and distrust of 3foreign’ court systems and procedures, the stage was set
for a move to processes and institutions more suited to the resolution of a new world of
transEborder disputes.

1ot surprisingly, the concept and number of international commercial arbitrations have
grown enormously during the past 9- years. )olstered by the advantages of party autonomy
Cparticularly over access to a neutral forum and the ability to choose e&pert arbitrators2,
conBdentiality and relative speed, as well as near worldwide enforceability of awards, the
system is 5ourishing. And if a single industry sector can lay claim to parental responsibility
for the present universality of international arbitration as the goEto choice for the resolution
of commercial and investor–state disputes, it must be the energy business. Wt is the poster
boy of arbitral globalisation.

(ed by oil and gas, the energy sector is marked by enormously comple&, capitalEintensive
international deals and pro'ects, freFuently involving prominent parties and state interests.
Transactions and partnerships are often longEterm and involve 3foreign’ places and players.
Holitical instability and different cultural backgrounds characterise many of the sector’s
investments. Wn short, the energy sector is a natural incubator for disputes best suited to
resolution through international arbitrations. And despite recent international trade disputes,
Russia’s invasion of ékraine, deteriorating éD–0hina relations and the appearance in 6-/J
of the novel coronavirus, all of which have led to a degree of restructuring of crossEborder
investments and supply chains, there is no sign that this will diminish the popularity of Cand
need for2 international arbitration.

Wndeed, in the past z- years or so, following a rash of nationalisations in 1orth Africa, the
Gulf states and parts of (atin America, and the lessons learned in 3foreign courts’, there is
scarcely a ma'or energyEsector contract Cwhether oil, gas, electric, nuclear, wind or solar2 that
does not call for disputes to be resolved before an independent and neutral arbitral tribunal,
seated, where possible, in a neutral, arbitrationEfriendly place.

The e&perience and statistics of the ma'or arbitral institutions bear out the claim that
the energy sector has driven, and continues to account for, ma'or growth in international
arbitration. W0DWq is illustrative, where x6 per cent of its case load in 6-69 involved the
energy sector. At the (0WA, case statistics for 6-66 revealed that energy and resources, and
energyErelated commodities disputes accounted for over one third of the (0WA’s cases and
had the highest number of parties, both as claimants and respondents. )etween 6-6- and
6-66, the Dtockholm 0hamber of 0ommerce Arbitration Wnstitute saw its case load average
in energyErelated cases reach xx per cent.

Although much of the evidence of the energy sector’s arbitral demand is anecdotal, those
arbitrators who are known in the Beld report growing demand and a steady increase
in enFuiries as to availability. And having regard to the multifaceted fallout from a

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climateEchange driven energy transition policy, a revival of resource nationalism Cwhich

e&acerbates the natural tension between energy investors and host states2, an ongoing war
in ékraine and a world in which sanctions imperil contractual performance, the only realistic
e&pectation is for further reliance on arbitrators and arbitral institutions coping with the
disputes that are surfacing daily.

Another driver towards arbitration of energy disputes is the fact that the number of
substantive players in the sector is relatively limited. These parties will invariably have
multiple agreements, partnerships and 'oint ventures with each other at the same time,
many of which are longEterm. These dynamics call for disputes to be resolved by decision
makers who are known to and trusted by all, and whose decisions are Bnal. The simple
fact about business is that the economic uncertainty associated with an unresolved dispute
overhanging a longEterm partnership is often considered to be more problematic than getting
to its Fuick and deBnitive resolution, even if the resolution is unfavourable in the conte&t of
the particular deal.

Against this backdrop, when Gordon Saiser raised the Fuestion with me in the summer of
6-/x of producing a book that gathered together the thinking and recent e&periences of
some of the leading counsel in the sector, it resonated immediately. Gordon was also more
than pleased when W suggested that we might try to interest qoak )ishop as a partner in the
pro'ect. jith qoak’s acceptance of the challenge, we have tried, in the Brst Bve editions of
this guide, to produce coherent and comprehensive coverage of many of the most obvious,
recurring or new issues that are now faced by those who do business in the energy sector
and by their legal and e&pert advisers.

)efore agreeing to take on the role of general editor and devoting serious time to the
pro'ect, we needed to Bnd a publisher. )ecause of my longEstanding relationship with (aw
)usiness Research C()R2, the publisher of Global Arbitration Review CGAR2, we decided that
W should discuss the concept and structure of our proposed work with qavid Damuels, GAR’s
publisher, and Richard qavey, then managing director of ()R. To our delight, the shared view
was that the work could prove to be a valuable addition to the resource material available. ‘n
the assumption that we could persuade a suLcient number of those we had provisionally
identiBed as potential contributors, the pro'ect was under way.

Iaving taken on the task, my aim as general editor has been to achieve a substantive
Fuality consistent with The Guide to Energy Arbitrations being seen as an essential desktop
reference work in our Beld. To ensure the high Fuality of the content, W agreed to go forward
only if we could attract as contributors colleagues who were some of the internationally
recognised leaders in the Beld. The guide is now in its si&th edition, and qoak, Gordon and W
feel blessed to have been able to enlist the support of such an e&traordinarily capable list of
contributors over the years.

The si&th edition of The Guide to Energy Arbitrations has been e&panded with new chapters
on renewable energy arbitrations and damages. The remaining chapters have been updated
to re5ect developments since 6-66.

Wn future editions, we hope to Bll in important omissions, such as the changing dynamics
of investment cases under the Knergy 0harter TreatyM in'unctions against and the setting
aside of awardsM bribery and corruptionM sovereign immunity and enforcement issuesM force
majeure and contractual allocationsM issues arising related to sanctionsM and intellectual
property and insurance disputes in the energy sector.

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jithout the tireless efforts of the GARV()R team, this work not would have been completed
within the very tight schedule we allowed ourselves. qavid Damuels and W are greatly indebted
to them. ;inally, W am enormously grateful to qoris Iutton Dmith Cmy longEsuffering HA2, who
has managed endless correspondence with our contributors with skill, grace and patience.

W hope all my friends and colleagues who have helped with this pro'ect have saved us from
error – but it is W alone who should be charged with the responsibility for such errors as may
appear.

Although it should go without saying, this si&th edition will obviously beneBt from the
thoughts and suggestions of our readers, for which we will be e&tremely grateful, on how
we might be able to improve the ne&t edition.

$ jilliam Rowley S0
Uay 6-6x
(ondon

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The Breadth and

Complexity of the
International Energy
Industry
Doaé Bishop, Eldy Quintanilla RochH and Sara YcBrearty
King & Spalding LLP

Summary

OIL AND GAS: OVERVIEK OF TZE TRADITIONAL ENERGk SECTOR

ORGANIXATION OF TZE PETROLEUY E[PORTING COUNTRIES

NATIONAL OIL COYPANIES

OVERVIEK OF ENERGk-RELATED INVESTYENT DISPUTES

ICSID CONVENTION

NEK kORM CONVENTION

BILATERAL INVESTYENT TREATIES

TZE ENERGk CZARTER TREATk

CONCLUSION

ENDNOTES

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This chapter introduces the general nature and organisation of the international energy
industry, speciBcally as it relates to international arbitration practitioners. The international
]23
energy industry is the single largest user of international arbitration, and thus it is of
particular interest to arbitral practitioners. Uany arbitral advocates and arbitrators will be
involved at some point in their careers with the industry. ;or its part, given its breadth and
comple&ity and the si7e of many controversies, the industry has need of a truly international,
neutral and tailored mechanism for resolving disputes, and that need is addressed by
international arbitration.

The breadth and comple&ity of the energy industry stems from its truly international scope,
the nature and availability of energy sources, the multitude of transactions, actors and
stakeholders, as well as from its evolving nature. Traditional energy sources – oil, gas, coal
and nuclear power – have been complemented with the e&panding Beld of alternative and
renewable energy Ce.g., solar, wind, geothermal, biomass, hydrogen and hydropower2. The
transactions involved in the industry range from bidding arrangements to e&ploration, drilling,
e&ploitation, transportation, marketing and many more.

qespite various mergers of private oil companies, the participants in the industry are Fuite
]53
robust and diverse. The industry is no longer dominated by the 3seven sisters’ – the
original 3ma'or’ oil companies – but instead, independent and national oil companies are
strong players in the Beld. Wn fact, state oil companies today dominate the industry in terms
of reserves. :arious oilEservice companies are also important participants. Additionally,
the economic viability of certain pro'ects has changed dramatically, given the in5uence of
geopolitics, the level and volatility of oil prices, and environmental considerations. Wn turn,
]43
this has led in great part to the increased need to carry out decommissioning activities.
The availability of new technologies for e&ploration, e&ploitation and transportation have also
altered the global oil and gas market. All these developments have spurred new laws and
environmental policies regulating the industry.

1otably, there has been considerable focus on reducing carbon emissions as re5ected in
]63
the Haris Agreement, with many stakeholders acknowledging the need to transition to low
emission energy. )ut low emissions are only one factor that political leaders have to take
into account. Knergy security for all situations and energy that is affordable for all citi7ens
are other necessary factors to consider in a complicated geopolitical landscape.
]73
jhile investment in clean energy has risen by x- per cent since 6-6-, more is needed. ;or
e&ample, according to the Wnternational Uonetary ;und, reaching the net 7ero by 6-z- goals
set in the Haris Agreement, will reFuire lowEcarbon investments to rise from éD8J-- billion
]83
in 6-6- to éD8z trillion annually by 6-9-. The Wnternational Knergy Agency estimates that
global energy investment will rise to éD89.6 trillion in 6-9-, nearly /z per cent higher than
estimated levels for 6-69, with investment in clean energy accounting for the difference.E
]93
Additionally, demand for energy services is set to rise fastest in emerging markets and
]13
developing economies. And while most of the energy resources are stateEowned, private
]j03
sector investment is essential to meeting energy needs. This in turn reFuires foreign direct
investment and the participation of international energy companies.

Although deBning the breadth and comple&ity of the international energy industry is diLcult,
this chapter outlines some general background and areas of focus, although one should note
that the industry will inevitably change in the coming years.

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OIL AND GAS: OVERVIEK OF TZE TRADITIONAL ENERGk SECTOR

The energy sector began to develop in the Brst half of the twentieth century and grew rapidly.
Wn the early years, many governments, in need of foreign investment and technology, granted
generous concessions to international petroleum companies. )eginning in the /Jz-s
and accelerating in the /Jó-s, numerous concessions were e&propriated or renegotiated,
providing governments with a higher percentage of the revenues and greater control over
]jj3
production. Dome commentators have suggested that modiBcations and renegotiations
are inevitable given the lengthy lifespan of energy investments, emerging laws and changing
]j23
political climates. 1evertheless, the sanctity of contractual commitments and legal
security remain critical to energy investments.

Uost countries follow the regalian or domanial systems regarding ownership of subsurface
minerals. énder these systems, subsurface minerals belong to, or are controlled by, the
]j53
sovereign. Thus, international petroleum companies need permission from the state to
]j43
operate in these countries. Dtates deBne the conditions for investors to carry out their
activities, and these are ultimately re5ected in a granting agreement Ci.e., a legal instrument
by which the government directly, or through a stateEowned company, grants the private
oil company the right to certain interests in the hydrocarbons within the country, either in
]j63
place or after production2. The types of granting agreements vary depending on the host
country’s laws, economy, and social and political policies.

Generally, but certainly not invariably, one could categorise the granting instruments
geographically by saying that international petroleum companies enter into production
sharing agreements CHDAs2 with governments in Asia and Africa, licences with governments
in Kurope and service agreements Cor risk service agreements2 with governments in Douth
]j73
America. Iowever, these geographical categorisations are not invariable, and these
different types of agreements are adopted by some countries in the other geographical areas
as well. Uoreover, various elements of each of these types of agreements may be combined
in a hybrid contract.

A HDA often reFuires the participation in drilling and production activities of a local,
governmentEowned company, often including a carried interest for any e&ploratory wells.
Through the governmentEowned company’s participation in the pro'ect, as well as royalties,
bonuses and ta&es paid to the government, the government’s percentage 3take’ of the total
]j83
revenues of a pro'ect is often substantial. The percentage of government take will vary
from country to country, depending on many factors, such as historical agreements, costs,
and geological and Bnancial risks. The government take is an important consideration for
international oil companies in deciding whether to invest in a given country, and at times it
can be a matter of competition between governments for hydrocarbon investments.

An international petroleum company entering into an agreement with a government may act
on behalf of a consortium of companies that enter into a 'oint operating agreement to deBne,
among themselves, their rights and obligations in the venture. The 'oint operating agreement
will typically attach an accounting procedure to determine the method of calculating the
]j93
costs to be shared. The consortium usually acts through one of its members, which serves
as the operator, although the consortium’s decisions are usually made by a committee, with
the operator carrying out the decisions. To fund operations, the operator issues cash calls
to the members, the prompt payment of which is necessary to ongoing operations.

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The evaluation, bidding, negotiation and acFuisition phases of a pro'ect may be governed
among the consortium members by a participation agreement, a study and bidding
]j13
agreement, or a conBdentiality agreement. 0ompanies may agree to areas of mutual
interest in which they bind themselves to participate only with one another in acFuiring future
interests within a deBned area. qrilling agreements must be negotiated among oil companies
and drilling companies. Uany of these agreements now involve e&pensive offshore drilling
platforms or ships, and may involve e&tensive coordination with other oil service companies.
Wf the drilling is successful and production is economic Ccommercial2, offtake agreements
will be entered into by the members of the consortium to set out the method and procedure
]203
by which they will nominate and lift their share of the production for shipping and e&port. Wf
one consortium member takes more than its share in a given period, balancing agreements
may be necessary. Transportation agreements of various types will also be necessary for
shipment, generally by sea or by pipeline. ;inally, crude oil sales or e&change agreements
will be negotiated by the companies to dispose of their product. Kach of these agreements,
and each step of this chain, involves numerous issues that may create a dispute and a need
]2j3
for international arbitration.

Wnternational contracts not only deal with oil, but also with natural gas. 1atural gas is found
in oil reservoirs Cassociated gas2 or by itself CnonEassociated gas2. The traditional methods
]223
for natural gas e&ploration are the same as for oil. Wn the past, wells drilled for oil that
discovered only natural gas were often plugged because of the e&pense of transporting
]253
the gas and the lack of a natural gas infrastructure in most countries. This has changed
because of innovations in e&traction and transportation technologies, and the development
of gas infrastructures in many nations. These innovations have changed the landscape of
the oil and gas industry and created new international issues.

The increase in natural gas production has facilitated advancements in transportation

technology. Wn the past two decades, companies have become more willing to bear the
e&pense of facilities to transport natural gas by pipeline, to construct liFueBed natural gas
C(1G2 facilities, or to consume gas locally through power plants. Iistorically, many contracts
with host governments for oil e&ploration and production included only a short provision
stating that if nonEassociated natural gas was discovered in commercial Fuantities, then the
parties would negotiate a new agreement for the e&ploitation of the gas. This agreement to
]243
negotiate has raised challenges for the international petroleum industry.

Iori7ontal drilling and hydraulic fracturing, or 3fracking’, is yet another signiBcant

]263
technological advancement. ;racking allows access to oil and gas trapped in
]273
impermeable rock. Wt was pioneered in the énited Dtates and has returned the éD to 3the
]283
role of energyEproducing superEpower’. ‘ther countries are considering implementing this
]293
technology, including 0hina, Argentina, Australia, 0anada, Ue&ico and Douth Africa. This
is likely to reFuire foreign investment and international partnerships between investors and
countries. Although fracking has proven successful for production, there are environmental
concerns that may slow down or prevent its implementation in several 'urisdictions. ‘nly
time will tell the scope and range of foreign investment that will take place in this area, but a
need for international arbitration is probable.

‘ther interests often intersect with the energy sector, such as environmental issues.
They have risen to prominence through efforts involving corporate responsibility,
]213
brand management, environmental activism and changing regulations. Uoreover,
]503
environmental legal norms have become increasingly internationalised. There are now

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more than 6- multilateral environmental treaties relating to the environment and at least
the beginnings of the emergence of a customary international law on the sub'ect.E
]5j3
Knvironmental Cand social and governance2 CKDG2 issues are increasingly involved in
]523
international arbitration, and are often raised as counterclaims, 'urisdiction or admissibility
]553
ob'ections, or defences by respondent states in investment arbitrations. There are model
arbitration rules speciBcally tailored to KDG issues, for e&ample, the Iague Rules on )usiness
and Iuman Rights Arbitration published in 6-/J under the auspices of the 0enter for
]543
Wnternational (egal 0ooperation, and model clauses published by the American )ar
]563
Association.

UPSTREAY, DOKNSTREAY AND YIDSTREAY

The energy industry is essentially divided into three segmentsY upstream, downstream
and midstream. These segments basically represent four main activities necessary to
]573
the energy industryY producing, transporting, reBning and selling at retail. 3épstream’
refers to e&ploring for oil and gas reservoirs, drilling wells and producing hydrocarbons,
]583
also known as e&ploration and production. The downstream segment entails reBning,
]593
processing, distributing and marketing the oil and gas products. Uidstream refers to
the transportation of oil and gas inEbetween the initial production and the end user of
the hydrocarbons. 1ote that these three segments are governed by different laws and are
]513
sub'ect to different administrative and environmental regulations.

Hrivate energy companies are often classiBed as a 3ma'or’ or as an 3independent’ company.

To be classiBed as a ma'or, a company must be an 3integrated’ oil company, taking part in
]403
producing, transporting, reBning, and selling oil and gas products at retail. Wndependent
]4j3
companies are those that engage in fewer of these four main activities. Wnitially, the
industry was controlled by private international oil companies. Iowever, in recent decades
they have taken a backseat to national or stateEowned oil companies.

TZE CZANGING ROLE OF ZOST STATES IN TZE INTERNATIONAL ENERGk INDUSTRk

‘il and gas producing states are, of course, essential participants in the energy industry. The
energy sector has long been considered essential to security, geopolitical and vital national
]423
economic interests. This makes investments in the energy sector especially vulnerable to
]453
regulatory change and political risk.

As the international energy industry developed, host states evolved from being a 3passive’
business partner Ce.g., old concession contracts2 to being active and controlling forces Ce.g.,
]443
nationalisation, HDAs, stateEowned oil companies and regulation2. Dtates may participate
in the energy industry through a national oil company or through an energy ministry or
other government agencies. This will vary depending on the country’s national and legal
culture. Uany countries have hydrocarbon laws deBning government policies, organising the
industry, and creating incentives and disincentives for oil companies.

The position of a host state on various issues may shift over time, from imposing in5e&ible
]463
contractual terms to promoting investmentEfriendly conditions, to changing their laws and
regulations, often depending on popular sentiment or the need for investments depending
on oil prices and whether reserves or production are declining.

Take the case of Ue&ico, for e&ample. Wn /J9°, the Ue&ican government conBscated all
]473
foreign oil companies’ concession rights within the country. This was seen as a patriotic
]483
achievement and is still commemorated today. Dince then, Ue&ico’s energy sector has

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been monopolised by its national energy company, Hetr•leos Ue&icanos CHeme&2. )ut
in 6-/9, declining production and the need for new technology pushed Ue&ico towards
]493
instituting energy reforms allowing private investors to enter its market. Qet, again, starting
in 6-6/, Ue&ico has enacted a series of administrative measures shaping those very reforms
]413
that had opened up the country’s oil and gas sector to foreign investment.

Additionally, host states not only play the role of 3business partner’, they also fulBl a regulatory
role because they decide the energy and environmental policies that an international
petroleum company must follow, and they interpret and apply those regulations.

ORGANIXATION OF TZE PETROLEUY E[PORTING COUNTRIES

The creation of the ‘rgani7ation of the Hetroleum K&porting 0ountries C‘HK02 in /J4-
was a pivotal development in the energy industry. ‘HK0 is a permanent, interEgovernment
entity currently consisting of its Bve founding states – Wran, WraF, Suwait, Daudi Arabia and
:ene7uela – and later 'oining members Cto date, (ibya, the énited Arab Kmirates, Algeria,
]603
1igeria, Gabon, Angola, KFuatorial Guinea and 0ongo2. Wt is based in :ienna, Austria.

‘HK0 was created to prevent a precipitous drop in crude oil prices then affected by the
]6j3
discovery of huge new reserves. ‘ver time, ‘HK0’s role became more prominent, and it
became a vehicle for states to challenge the stance of international oil companies regarding
ownership rights, to encourage the renegotiation of international oil agreements and to
]623
engage in cartel pricing of oil.

NATIONAL OIL COYPANIES

Today, national oil companies have a fundamental role in the industry. 1ot only do they
]653
own appro&imately °z per cent of oil reserves, they also represent the ma'ority of volume
]643
growth in the industry. Reportedly, they control at least éD89 trillion in assets and are
]663
responsible for producing most of the world’s oil and gas. They were initially created in
response to security and nationalistic concerns and as vehicles for state participation in the
]673
energy industry. )ut they are now deemed by some to be the 3true giants’ of the energy
]683
sector.

‘f the 6- companies ranked as the biggest in the industry in terms of ownership of reserves
]693
of oil and gas, /4 are national oil companies. 1ational oil companies are usually created
by statute or decree. Generally, all their ownership interest is held by the state and they can
]613
vary in corporate form.

1ational oil companies sometimes face issues that private companies do not necessarily
face. ;or e&ample, national oil companies may be sub'ect to heightened political and social
pressure, or they may be reFuired to pay higher wages or adopt ineLcient production
]703
methods to favour employment. 1otwithstanding the above, the role of national oil
companies has grown from local participants to ma'or international players, often investing
in oil reserves located in other countries.

NATURAL GAS
1atural gas has received separate treatment in the energy industry owing to the diLculty and
e&pense associated with its transportation. ;or this reason, it has traditionally been produced
]7j3
and marketed for domestic consumption, at least in those countries with a developed
infrastructure for using natural gas. Thus, crossEborder transportation of natural gas was
once minimal in comparison with oil. )ut during the past few decades, the landscape has

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changed in response to energy demand, changes in oil prices, technological advances and
environmental considerations Csince it is a cleaner form of energy2.
]723
1atural gas is abundant in comparison with other fossil fuels. Iowever, it is diLcult to
]753
transport given its physical nature and volatility. These challenges led to the traditional
]743
wasteful use of natural gas by 5aring it Cburning it2 onEsite. Uany countries have now
constructed a domestic infrastructure for using natural gas, often by building gasEBred power
plants. Thus, they make use of the natural gas locally without having to transport it vast
distances.
]763
The most costEeffective way to transport natural gas is through highEpressure pipelines,
but natural gas can also be transported in specialised ships once it has been liFueBed C(1G2.
This process reFuires the cooling of the gas to E/4-á 0elsius, storing it in insulated tanks,
]773
transporting it in specialised ships and regasifying it at destination plants. This reFuires
the construction of multibillionEdollar (1G facilities. )ut the need for energy sources and the
desire to make use of natural gas discoveries have spawned a global market for (1G.

TZE OIL AND GAS CONTRACT

]783
A granting contract typically forms the foundation of an international oil and gas pro'ect.
These evolved from concession contracts to productionEsharing agreements, risk service
]793
contracts and licences.
]713
The oldest is the concession contract, which derived from the contracts used in the
]803
énited Dtates’ mining industry. A concession may refer to various types of contracts,
]8j3
permits, licences or instruments, depending on the applicable legal system. énder the
early concession agreements, a host country would essentially concede control over its
]823
energy resources to an international petroleum company. These early agreements had
certain common featuresY

X they granted title of the oil in place to the companiesM

X the concession areas covered vast tracts of landM
X the term of the concession was often 4- years or moreM
X the international oil company had control over the schedule and scale of operations
Ce&ploration and production2M and
]853
X the government received a oneEeighth royalty.

]843
Wnitially, concession agreements were negotiated on a caseEbyEcase basis, as international
petroleum companies attempted to discover reserves and operate in new host states.

The industry has generally shifted away from concession contracts in favour of HDAs. To a
signiBcant e&tent, HDAs are representative of the changes that the petroleum industry has
]863
e&perienced since the /Jó-s. They were Brst popularised in Wndonesia, but were Fuickly
]873
adopted by other countries. énder a HDA, the host country retains ownership and the right
to e&ploit resources while the international petroleum company is more akin to a 3contractor
]883
hired to perform the operations’, although this is not an entirely accurate analogy since
under many HDAs, oil companies can report in their public Blings Ce.g., Decurities and
K&change 0ommission Blings in the énited Dtates2 a percentage of the hydrocarbon reserves
]893
as their own. This is particularly important to companies because their stock price may
be driven, in part, by their reserve proBle. The contractor’s payment under a HDA involves an

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entitlement to recover costs once operations are successful Ccommercial2 and to a share of
]813
the production as proBt during a determined amount of time. Wf the area under contract is
]903
unproductive, the contractor receives no proBt. Thus, the Bnancial and geological risk of
Bnding oil in commercial Fuantities falls on the private oil companies. Typically, the company
has a certain number of years to e&plore for oil in a deBned geographical area and drill a
minimum number of wells, after which it must relinFuish back to the state any area from
which no production is likely to occur e&pediently.

Dome countries use risk service contracts, which are similar to HDAs. énder this type of
agreement, the contractor usually provides the funds reFuired for e&ploring and developing
petroleum resources. The host state will allow the contractor to recover its costs through the
sale of a certain percentage of the oil or gas once the pro'ect is successful. The host state
will also pay the contractor a fee based on a percentage of the revenues. The state retains
]9j3
ownership of the resources and production.

‘ther host countries – the énited Singdom, for e&ample – use a licensing system. The
licences vary depending on the location Conshore, offshore2 and the stage of the operation
]923
Ce&ploration or production2. (icences essentially entitle a petroleum company to operate
]953
in a speciBc geographical area in e&change for a royalty or fee. Wn general, the government
has ample policing powers over the licensee, and the licence can be revoked for a number
]943
of reasons.

The Association of Wnternational Hetroleum 1egotiators is a wellEknown, independent,

]963
notEforEproBt association for professionals involved in the energy industry. Wt has
developed a robust collection of model contracts, including virtually all the categories
mentioned above, as well as certain commentaries. These can be found on its website and
provide a more detailed understanding of the various contracts’ clauses and differences.

OVERVIEK OF ENERGk-RELATED INVESTYENT DISPUTES

A foreign investment dispute is a controversy between an investor from one state and
]973
a foreign government concerning an investment in the host state. ;oreign investment
has been given protection through international treaties, conventions and by customary
international law, and over time a subset of international law regulating investment disputes
has emerged. Today, there is a si7eable number of international arbitral awards relating to
the petroleum industry.

DIPLOYATIC PROTECTION
énder traditional international law, corporations and individuals did not have standing to
bring claims directly against governments. qiplomatic protection was the only remedy
available to a citi7en of a state with a claim against a foreign government. énder this regime,
the foreign investor would bring grievances to the domestic courts of the host state or
to the oLcials of his or her own country. The investor’s government would then have the
discretion to espouse the claim against the foreign government and protect the investor’s
rights through an e&change of diplomatic notes or, more recently, by bringing a claim before
]983
the Wnternational 0ourt of $ustice.

jhen the national governments of host states began to e&propriate foreignEowned pro'ects
in the /Jth century, they purported to rely on the international law principle of territorial
sovereignty. (ocal courts were often viewed as unsympathetic to foreign investors or were
reFuired to give effect to the local e&propriating decree, leading the investors to turn to

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their own governments for assistance. The investors’ governments, if they were inclined to
help their nationals, responded based on the international law principle of nationality Cin this
]993
conte&t, the state’s interest in representing its nationals2.

qiplomatic protection proved inadeFuate for many reasons. ;or the investor, the availability
of the remedy was unpredictable and sub'ect to a government’s many other interests.
;or the government, it was an unwieldy instrument for dealing with foreign investment
issues. The intervention of the investor’s government inevitably created con5icts with
the host state. Wt also had the potential to affect relationships with other states. As the
problems that governments faced became more comple& and governments developed
larger organisations to handle them, it became clear that more economical alternatives
to diplomatic protection and intervention were necessary. )ut an analogue to national
ad'udication was not feasible, for international law at that time did not recognise natural
or 'uridical persons as proper sub'ects. Thus, the international community looked for
]913
instruments that could provide an adeFuate forum and remedy.

ICSID CONVENTION
Wn /J4z, under the sponsorship of the Wnternational )ank on Reconstruction and
qevelopment, the 0onvention on the Dettlement of Wnvestment qisputes between Dtates
and 1ationals of ‘ther Dtates was e&ecuted and came into effect in /J44 Cthe W0DWq
0onvention2. The 0onvention created W0DWq to administer arbitrations between contracting
governments and nationals of other contracting governments for disputes relating directly
to an investment. W0DWq, in turn, promulgated sets of arbitral and conciliation rules. W0DWq
]103
was designed speciBcally to administer arbitrations of foreign investment disputes. énlike
]1j3
other ma'or arbitral institutions, W0DWq has 'urisdictional reFuirements. At the time of
writing, /zó countries have ratiBed the W0DWq 0onvention and seven countries have signed
]123
it.

Reports show that almost x- per cent of all cases registered with W0DWq Cand its Additional
;acility2 between /Jó6 and 6-/6 involved the energy sector, with oil, gas and mining disputes
]153
representing 6J per cent of all W0DWq claims in 6-6/.

NEK kORM CONVENTION

The énited 1ations 0onvention on the Recognition and Knforcement of ;oreign Arbitral
Awards Cthe 1ew Qork 0onvention2 was adopted on /- $une /Jz° and entered into force on
ó $une /JzJ. This treaty is the most signiBcant contemporary legislative instrument relating
]143
to international commercial arbitration. Wt provides a universal constitutional charter for
the international arbitral process and has proven to be an effective framework for enforcing
]163
international arbitration agreements and arbitral awards. Wt is of relevance in enforcing all
nonEW0DWq investment arbitral awardsM W0DWq cases e&clusively involve the W0DWq 0onvention.

BILATERAL INVESTYENT TREATIES

Uodern bilateral investment treaties C)WTs2 were Brst adopted in the /J4-s by Kuropean
]173
countries seeking to protect their nationals’ investments abroad. The énited Dtates then
followed suit in the /Jó-s. The proliferation of )WTs signalled an important landmark in
international relations and arbitration. To date, about 9,--- )WTs have been signed. They
contain similar provisions, leading some scholars to conclude that they may now e&press
]183
the customary international law standards for foreign investment. These treaties create
actionable standards of conduct for governments in their treatment of foreign investment,

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and typically provide for international arbitration to resolve disputes arising from allegations
of a violation of the treaty. Although )WTs have evolved in terms of structure and available
protections, they continue to be effective mechanisms to resolve investment disputes with
host states in a neutral forum.

TZE ENERGk CZARTER TREATk

The Knergy 0harter Treaty CK0T2 came into effect in /JJJ. 0urrently there are z- contracting
parties CxJ member states, mostly from central and eastern Kurope, and the Kuropean
]193
énion2. Wt is the only multinational treaty speciBcally dealing with investment issues in the
]113
energy industry. The Wnternational Knergy 0harter e&plains that 3the fundamental aim of
the Knergy 0harter Treaty is to strengthen the rule of law on energy issues, by creating a level
playing Beld of rules to be observed by all participating governments, thus minimising the
]j003
risks associated with energyErelated investments and trade’. Wt 3ensures the protection of
]j0j3
foreign energy investments based on the principle of nonEdiscrimination’. The K0T also
provides government consent to ad hoc international arbitration to resolve disputes with
foreign investors arising from their substantive obligations. Uore than z- arbitrations have
been brought under the K0T.

The K0T, however, is at an in5ection point and its longEterm viability is uncertain. ;irst,
the Kuropean 0ommission has proposed a coordinated withdrawal by both the Kuropean
]j023
énion and individual Uember Dtates. Decond, individual members, namely Wtaly, ;rance,
]j053
Germany, Holand, (u&embourg, Dlovenia and Hortugal, have all formally withdrawn. Third,
Wreland, the énited Singdom, Dpain, qenmark and the 1etherlands have announced plans to
]j043
withdraw. 1otably, the K0T has a sunset clause providing that the investments it covers
]j063
at the time withdrawal takes effect will continue en'oying protection for 6- years. Uember
parties have discussed the possibility of reducing or terminating the K0T’s sunset provision,
]j073
which would substantially reduce investment protection.

CONCLUSION
quring the past few decades, international tribunals have addressed many of the issues and
facets of the energy industry. These have included claims under bilateral and regional treaties
as well as customary international law dealing with e&propriations, unfair and uneFual
treatment, and denial of 'ustice. This guide addresses them by dividing them into sections,
each of which highlights a different facet of the international energy industry.

Wt is hoped the reader will Bnd in these pages a useful introduction and worthwhile
information concerning the arbitration of international energy disputes.

ENDNOTES
]j3
qoak )ishop is a partner, and Kldy “uintanilla RochN and Dara Uc)rearty are senior
associates, at Sing P Dpalding.
]23
Dee, e.g., W0DWq Annual Report, p. 6J C6-692 Cnoting that 6ó per cent of cases registered
in 6-69 involve the oil, gas and mining industry and /z per cent the electric power and
other energy industry2M W0DWq Annual Report, p. 6ó C6-6/2 Cnoting that 6J per cent of cases
registered in 6-6/ involve the oil, gas and mining industry and /x per cent the electric power
and other energy industry2M W0DWq Annual Report, p. 6z C6-6-2 Cnoting that 9- per cent of
cases registered in 6-6- involve the oil, gas and mining industry and 6- per cent the electric
power and other energy industry2.

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]53
AngloEHersian ‘il 0ompany, Gulf ‘il, Dtandard ‘il of 0alifornia, Te&aco, Royal qutch Dhell,
Dtandard ‘il of 1ew $ersey and Dtandard ‘il 0ompany of 1ew Qork.
]43
qecommissioning is the industryEpreferred term for the work necessary to manage and
dispose of oil and gas infrastructure and to minimise their environmental footprint once
they have reached the end of their economic life. The term 3abandonment’ is also used
to describe decommissioning activities. Dee ;l”via Sac7elnik Altit and Uark ‘sa Wgiehon,
3qecommissioning of épstream ‘il and Gas ;acilities’, in Oil And Gas, A Practical Handbook-
, Global )usiness Hublishing C6--J2 at 6zóM Heter 0ameron, 3qecommissioning of ‘il P
Gas WnstallationsY The (egal P 0ontractual Wssues’, Association of Wnternational Hetroleum
1egotiators C/JJ°2, p. x.
]63
The Haris Agreement is an international treaty adopted by /J4 parties on /6 qecember
6-/z. Wt entered into force on x 1ovember 6-/4. The overarching goal of the Haris
Agreement is to ensure the global average increase in temperature does not e&ceed
6á0 above preEindustrial levels and pursue efforts to limit the temperature increase
to /.zá0. Dee description of the Haris Agreement by the énited 1ations, available at
httpsYVVunfccc.intVprocessEandEmeetingsVtheEparisEagreement.
]73
Wnternational Knergy Agency, 3jorld Knergy ‘utlook’, /ó C6-692.
]83
Dee 3jorld 1eeds Uore Holicy Ambition, Hrivate ;unds, and Wnnovation to Ueet 0limate
Goals’, WU; Hublication, 6ó 1ovember 6-69.
]93
According to its DTKHD model, which provides 3an outlook based on the
latest policy settings, including energy, climate and related industrial policies’.
Wnternational Knergy Agency, 3jorld Knergy ‘utlook’, /ó, /Jó C6-692, available at
httpsYVViea.blob.core.windows.netVassetsV°4ede9JeExx94Ex6dóEba6aEedf4/x4óe-
ó-VjorldKnergy‘utlook6-69.pdf. The Wnternational Knergy Agency also provides an
announced pledges scenario CAHD2 model, which assumes 3all national energy and climate
targets made by governments are met in full and on time’. énder the AHD model, the total
increase in investment represents a x- per cent increase from 6-66 levels by 6-9-. Wd.
]13
id., at x4.
]j03
Dee, e.g., id., at // to /6.
]jj3
R qoak )ishop, 3Wnternational Arbitration of Hetroleum qisputesY the qevelopment of a (e&
Hetrolea’, __WWW YB Com. Arb. //9/, //z/ C/JJ°2.
]j23
Dee, e.g., 0rina )altag, 3The Knergy 0harter TreatyY The 1otion of Wnvestor’, 6z Int’l
Arbitration Law Library, 6 C6-/62 Cstating that 3the life span of energy investments often forces
the modiBcation of the terms of the agreements between investors and governments’2
Cinternal citations omitted2M qavid j Rivkin, Dophie $ (amb, 1icola S (eslie, 3The ;uture of
WnvestorEDtate qispute Dettlement Wn The Knergy DectorY Kngaging jith 0limate 0hange,
Iuman Rights and The Rule ‘f (aw’, Journal of World Energy Law and Business, 6 C6-/z2
Cstating that investments in the energy industry are especially vulnerable to regulatory
change and political interest2.
]j53
Hatrick jieland, 3Going )eyond HanaceasY Kscaping Uining 0on5icts in ResourceERich
0ountries Through UiddleEGround Holicies’, 6- NYU Envtl LJ /JJ, 6-° C6-/6–6-/x2M Thomas
j Uerrill, 3;our “uestions about ;racking’, 49 Case W Res L Rev Jó/, Jóó C6-/6–6-/92.

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]j43
Thomas j Uerrill Cfootnote /9, above2, Jó/, Jóó.
]j63
0laude quval, et al, 3Wnternational Hetroleum K&ploration and K&ploitation AgreementsY
(egal, Kconomic P Holicy Aspects’, 69 C6--J2.
]j73
R qoak )ishop Cfootnote //, above2, //9/, //z6.
]j83
id.
]j93
id.
]j13
id.
]203
id.
]2j3
R qoak )ishop Cfootnote //, above2, //9/, //z6.
]223
0laude quval, et al Cfootnote /z, above2, /°6.
]253
R qoak )ishop Cfootnote //, above2, //9/, //z6.
]243
id.
]263
Thomas j Uerrill Cfootnote /9, above2, Jó/, Jó6M $ohn U Golden, Iannah $ jiseman,
3The ;racking RevolutionY Dhale Gas a 0ase Dtudy in Wnnovation Holicy’, 4x Emory LJ Jzz, Jzó
C6-/x–6-/z2.
]273
Thomas j Uerrill Cfootnote /9, above2, Jó/, Jó6.
]283
$ohn U Golden, Iannah $ jiseman Cfootnote 6z, above2, Jzz, Jzó. Dee also Ale&andra )
Slass, qanielle Ueinhardl, 3Transporting ‘il and GasY éD Wnfrastructure 0hallenges’, /-- Iowa
L Rev Jxó, J4z C6-/x–6-/z2.
]293
Dee, e.g., $ohn U Golden, Iannah $ jiseman Cfootnote 6z, above2, Jzz, /-6°M Uichael
Slare, 3;rom Dcarcity to AbundanceY The 0hanging qynamics of Knergy 0on5ict’, 9 Penn St
JL & Int’l Aff /-, 66 C6-/x–6-/z2.
]213
Dee, e.g., qavid j Rivkin, Dophie $ (amb, 1icola S (eslie Cfootnote /6, above2, 9 to x
C6-/z2.
]503
Tseming Qang, Robert : Hercival, 3The Kmergence of Global Knvironmental (aw’, 94
Ecology Law Quarterly 4/z C6--J2.
]5j3
qavid j Rivkin, Dophie $ (amb, 1icola S (eslie Cfootnote /6, above2, 9.
]523
Dee e.g., 3Resolving climate change related disputes through
arbitration and AqR’, W00 publication JJJ K1G, available at
httpsYVViccwbo.orgVwpEcontentVuploadsVsitesV9V6-/JV//ViccEarbitrationEadrEc
ommissionEreportEonEresolvingEclimateEchangeErelatedEdisputesEenglishEversi
on.pdfM Uatteo ;ermeglia, 0atherine Iigham, Sorey DilvermanERoati and $oana Det7er
3?WnvestorEDtate qispute Dettlement% as a new avenue for climate change litigation’, (ondon
Dchool of Kconomics and Grantham Research Wnstitute, commentary, 6 $une, 6-6/, available
at httpsYVVwww.lse.ac.ukVgranthaminstituteVnewsVinvestorEstateEdisputeEsettlem
entEasEaEnewEavenueEforEclimateEchangeElitigationV.
]553
Dee e.g., Perenco Ecuador Limited v. Republic of Ecuador, W0DWq 0ase 1o. AR)V-°V4M
Burlington Resources Inc. v. Republic of Ecuador, W0DWq 0ase 1o. AR)V-°VzM David Aven et
al. v. Republic of Costa Rica, é10WTRA( 0ase 1o. é10TV/zV9, Worley Parsons v. Ecuador,

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H0A 0ase 1o. 6-/JE/zM Eco Oro Minerals Corp. v. Republic of Colombia, W0DWq 0ase 1o.
AR)V/4Vx/.
]543
Available at
httpsYVVwww.cilc.nlVcmsVwpEcontentVuploadsV6-/JV/6VTheEIagueERulesEonE)usin
essEandEIumanERightsEArbitration=0W(0EdigitalEversion.pdf. The Hermanent 0ourt of
Arbitration CH0A2 serves as the secretariat for proceedings under the Iague Rules
on )usiness and Iuman Rights Arbitration. Dee “uestions and Answers related
to the Iague Rules on )usiness and Iuman Rights Arbitration, available at
httpsYVVwww.cilc.nlVcmsVwpEcontentVuploadsV6-6/V-zV“AETheEIagueERules.pdf.
]563
The American )ar Association model clauses related to KDG issues are available at
httpsYVVwww.americanbar.orgVgroupsVhuman=rightsVbusinessEhumanErightsEiniti
ativeVcontractualEclausesEpro'ectV.
]573
Krnest K Dmith, et al, International Petroleum Transactions, zx C6nd edition2.
]583
‘il and Gas WndustryY A Research Guide, (ibrary of 0ongress available at
httpsYVVguides.loc.govVoilEandEgasEindustryVupstream Cstating 3The upstream segment of the
oil and gas industry contains e&ploration activities, which include creating geological surveys
and obtaining land rights, and production activities, which include onshore and offshore
drilling’2M $ohn Dchumacher, 3A Hrimer on the ‘il and Gas Wndustry’, Facts & Findings, The
Magazine for Paralegals C/ $uly 6-/x2.
]593
$ohn Dchumacher Cfootnote 9ó, above2.
]513
0laude quval, et al. Cfootnote /z, above2, /ó4.
]403
Krnest K. Dmith, et al. Cfootnote 94, above2, zx C6nd edition2.
]4j3
id.
]423
Uichael Slare Cfootnote 6°, above2, /-, //.
]453
Dee e.g., qavid j Rivkin, Dophie $ (amb, 1icola S (eslie Cfootnote /6, above2, 6.
]443
0laude quval, et al Cfootnote /z, above2, Dections W: to :.
]463
id., at page ó.
]473
R qoak )ishop Cfootnote //, above2, //9/, //z/.
]483
Wt is commemorated on /° Uarch, the anniversary of the issuance of the Brst order that
e&propriated the assets of almost all the foreign companies operating in Ue&ico. The order
was issued by Ue&ican Hresident (a7aro 0ardenas.
]493
Dee, e.g., Gaurav Dharma, 3Ue&ico’s Knergy Dector
Reform jorth the ó4EQear jait’, Forbes C/z August 6-/x2,
www.forbes.comVsitesVgauravsharmaV6-/xV-°V/zVme&icosEenergyEsectorEreformEw
orthEtheEó4EyearEwaitM Gaurav Dharma, 3Knergy Uarket Reforms Seep Ue&ico’s
‘ptimism Iigh qespite ‘il Hrice Dlump’, Forbes C// Uarch 6-/z2,
www.forbes.comVsitesVgauravsharmaV6-/zV-9V//VenergyEmarketEreformsEkeepEme&
icosEoptimismEhighEdespiteEoilEpriceEslump.
]413
Dee, e.g., Andrew Dchneider, 3Ue&ico’s Hresident is Reversing Knergy Reforms, Iurting
his 0ountry’s ‘il Hroduction – and the éD,’ Iouston Hublic Uedia C66 April 6-662,

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www.houstonpublicmedia.orgVarticlesVnewsVinEdepthV6-66V-xV/6Vx66JJ-Vme&icos
EpresidentEisEreversingEhisEcountrysEenergyEreformsEhurtingEhisEcountrysEoi
lEproductionEandEtheEuEsV.
]603
(ist of ‘HK0 member countries available at
www.opec.orgVopec=webVenVabout=usV6z.htm.
]6j3
0laude quval, et al Cfootnote /z, above2, x°, /-/.
]623
id.
]653
Dee 0hristopher Ielman, 3The jorld’s )iggest ‘il
and Gas 0ompanies – 6-/z’, Forbes C/J Uarch 6-/z2,
www.forbes.comVsitesVchristopherhelmanV6-/zV-9V/JVtheEworldsEbiggestEoilEan
dEgasEcompanies.
]643
id.
]663
Dee, qavid Uanley et al., 3Iidden Giants,’ Wnternational Uonetary ;und Cqecember 6-/J2,
www.imf.orgVHublicationsVfanddVissuesV6-/JV/6VnationalEoilEcompaniesEneedEm
oreEtransparencyEmanley.
]673
Krnest K Dmith, et al Cfootnote 94, above2, z° to zJ.
]683
31ational ‘il 0ompaniesY Really )ig ‘il’, The Economist C/- August 6--42,
www.economist.comVnodeVó6ó4J°4.
]693
id.M 0hristopher Ielman, 3The jorld’s )iggest ‘il
and Gas 0ompanies – 6-/z’, Forbes C/J Uarch 6-/z2,
www.forbes.comVsitesVchristopherhelmanV6-/zV-9V/JVtheEworldsEbiggestEoilEan
dEgasEcompanies.
]613
Krnest K Dmith, et al Cfootnote 94, above2, z° to zJ. ;ootnote z6 at 46.
]703
id., at 46.
]7j3
Thomas j Uerrill Cfootnote /9, above2, Jó/, Jó9.
]723
Krnest K Dmith, et al., International Petroleum Transactions, /-6z C9rd edition2.
]753
id., at /-96.
]743
id., at /-6ó.
]763
Wt is calculated that transporting natural gas is four to Bve times more e&pensive than
transporting oil. Dee Krnest K Dmith, et al Cfootnote 94, above2, /-6°.
]773
0laude quval, et al Cfootnote /z, above2, /°6.
]783
Haul Uichael )lyschak, 3Arbitrating ‘verseas ‘il and Gas qisputesY )reaches of 0ontract
:ersus )reaches of Treaty’, 6ó Journal of Int’l Arbitration 4, zóJ C6-/-2.
]793
0laude quval, et al Cfootnote /z, above2, Dections W: to : C6--J2. These are the main Cbut
not all2 types of agreements in the energy industry.
]713
id., at x/.
]803
id.

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]8j3
id., at z°.
]823
Haul Uichael )lyschak Cfootnote 4ó, above2, zóJ, z°/.
]853
R qoak )ishop Cfootnote //, above2, //9/, //z/.
]843
Haul Uichael )lyschak Cfootnote 4ó, above2, zóJ, z°/.
]863
R qoak )ishop, $ames 0rawford, j Uichael Reisman, Foreign Investment Disputes,
Cases Materials and Commentary, 6/J CSluwer (aw2 Cinternal citations omitted2.
]873
0laude quval, et al Cfootnote /z, above2, 4J.
]883
id. at ó/.
]893
0laude quval, et al Cfootnote /z, above2, ó/.
]813
id.
]903
R qoak )ishop, $ames 0rawford, j Uichael Reisman Cfootnote óz, above2, 6/4 Cinternal
citations omitted2.
]9j3
id. at 666.
]923
id. at 66-.
]953
Haul Uichael )lyschak Cfootnote 4ó, above2, zóJ, z°9.
]943
R qoak )ishop, $ames 0rawford, j Uichael Reisman Cfootnote óz, above2, 66- to 66/
Cinternal citations omitted2.
]963
;or more about the Association of Wnternational Hetroleum 1egotiators, see
httpsYVVwww.aipn.orgVaboutEaipnV.
]973
R qoak )ishop, $ames 0rawford, j Uichael Reisman Cfootnote óz, above2, J.
]983
id., at / to 9.
]993
id., at / to x.
]913
R qoak )ishop, $ames 0rawford, j Uichael Reisman Cfootnote óz, above2, / to x.
]103
id. at page z.
]1j3
id. at page /6.
]123
Dee httpsYVVicsid.worldbank.orgVaboutVmemberEstatesVdatabaseEofEmemberEstates.
]153
qavid j Rivkin, Dophie $ (amb, 1icola S (eslie Cfootnote /6, above2, / C6-/z2M W0DWq
Annual Report, p. 6ó C6-6/2 Cnoting that 6J per cent of cases registered in 6-6/ involve the
oil, gas and mining industry2.
]143
Gary ) )orn, International Arbitration: Cases and Materials, 96 C6nd edition, Sluwer, 6-/z2.
]163
id., at 6ó to 9z.
]173
This occurred with the signing of the Germany–Hakistan bilateral investment treaty in
/JzJ, which entered into force in /J46. Rudolf qol7er, 0hristopher, Dchreuer,Principles of
International Investment Law, 4 to ó C‘&ford éniversity Hress, 6-/62.
]183
R qoak )ishop, $ames 0rawford, j Uichael Reisman Cfootnote óz, above2, /.

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]193
id.M The Knergy 0harter Treaty, available at
httpsYVVwww.energycharter.orgVprocessVenergyEcharterEtreatyE/JJxVenergyEcha
rterEtreatyV.
]113
0rina )altag, 3The Knergy 0harter TreatyY The 1otion of Wnvestor’, 6z Int’l Arbitration Law
Library, ° C6-/62.
]j003
‘verview of the Knergy 0harter Hrocess available at
httpsYVVwww.energycharter.orgVprocessVoverviewV.
]j0j3
id.
]j023
3Kuropean 0ommission proposes a coordinated Ké withdrawal
from the Knergy 0harter Treaty’, ó $uly 6-69, available
httpsYVVenergy.ec.europa.euVnewsVeuropeanEcommissionEproposesEcoordinatedEe
uEwithdrawalEenergyEcharterEtreatyE6-69E-óE-ó=en2.
]j053
The individual member states’ withdrawal took effect as followsY Wtaly – $anuary
6-/4M ;rance, Germany and Holand – qecember 6-69. Additionally, the following
members’ withdrawal will take effect as followsY (u&emburg – $une 6-6xM Dlovenia
–‘ctober 6-6xM Hortugal – ;ebruary 6-6z. Dee the K0T’s press release, 3jritten
notiBcation of withdrawal from the Knergy 0harter Treaty’, ó Uarch 6-6x, available at
httpsYVVwww.energycharter.orgVmediaVnewsVarticleVwrittenEnotiBcationE ofEw
ithdrawalEfromEtheEenergyEcharterEtreatyE6V#t&=news=pi/~z)controller~zq[1ew
sPt&=news=pi/~z)action~zq[detailPcIash[Jd9cJó°d4-ód499axbe z66-66ób
d4bcz]YZYte&t[The ~6-qepositary~6-of~6-the~6-Knergy,effect~6-on~6-6~6-;ebru
ary~6-6-6z.
]j043
Kuropean Harliament )rieBng, 3Ké withdrawal from the
Knergy 0harter Treaty, qecember 6-69’, p. /, available at
httpsYVVwww.europarl.europa.euVRegqataVetudesV)RWKV6-69Vózx496VKHRD=)RWC6-6
92ózx496=K1.pdfM Hress Release, 3éS departs Knergy 0harter Treaty’, available at
httpsYVVwww.gov.ukVgovernmentVnewsVukEdepartsEenergyEcharterEtreaty.
]j063
K0T Article xóC92 C3The provisions of this Treaty shall continue to apply to Wnvestments
made in the Area of a 0ontracting Harty by Wnvestors of other 0ontracting Harties or in the
Area of other 0ontracting Harties by Wnvestors of that 0ontracting Harty as of the date when
that 0ontracting Harty’s withdrawal from the Treaty takes effect for a period of 6- years from
such date.’2.
]j073
K0T Hress Release, 3Dunset 0lause CArticle xó of the K0T2 in relation to Article 46 of the
:ienna 0onvention on the (aw of Treaties C:0(T2’, updated 9 1ovember 6-66, available at
httpsYVVwww.energycharter.orgVmediaVnewsVarticleVsunsetEclauseEarticleExóEo
fEtheEectEinErelationEtoEarticleE46EofEtheEviennaEconventionEonEtheElawV.

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Eldy Quintanilla RochH [email protected]

Sara YcBrearty [email protected]

1100 Louisiana, Suite 4100, Houston, TX 77002, United States

Tel: +1 713 751 3200

https://www.kslaw.com/

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Taxation-Related ISDS
Anna Crevon-Tarassova, Asha Ra?an and [hilda Voca?
Dentons

Summary

KZEN CAN A TA[-RELATED DISPUTE BE BROUGZT TO ISDS’

STATE ACTIONS UNDER TZE GUISE OF TA[ATION AND STANDARDS OF TREATk

PROTECTION

ENDNOTES

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1o government can e&ist without ta&ation. This money must necessarily be

levied on the peopleM and the grand art consists of levying so as not to oppress.
Frederick the Great

This chapter focuses on investment disputes in the energy sector and the state’s e&ercise of
its sovereign right regarding its ta& regime. je Brst look at when a dispute relating to ta&ation
measures can be brought under international investment agreements CWWAs2. Then we delve
into when a ta&ation measure is seen to breach a standard of protection under an WWA.

KZEN CAN A TA[-RELATED DISPUTE BE BROUGZT TO ISDS’

]23
;ew international investment treaties deBne a 3ta&’ or 3ta& measure’. Arbitral tribunals have
relied on an autonomous understanding according to which a measure is considered a
ta& under international law if four reFuirements are met. These areY C/2 there is a lawM C62
that imposes a liability on classes of personsM C92 to pay money to the stateM Cx2 for public
]53
purposes. This determination is made on a caseEbyEcase basis. Wn the words of a tribunal
]43
in one recent decision, ’¶tähe necessary analysis is one of substance.’ As a result, faced with
]63
the same measure, investment tribunals may come to opposite conclusions.

Ta& measures challenged in investorEstate dispute settlement CWDqD2 cases have involved,
among others, reforms in the feedEin tariffs and incentives to solar energy, withdrawal of :AT
subsidies, :AT e&ceptions or nonEpayment of :AT refunds, increase in windfall proBt ta&es
]73
and royalties, imposition of capital gain ta&es and initiation of ta& investigations or audits.

TA[-RELATED INVESTYENT DISPUTES ARE COVERED Bk INTERNATIONAL

INVESTYENT TREATIES
As a preliminary matter, not every ta&Erelated dispute can be submitted to WDqD. A distinction
is drawn between ta& disputes and ta&Erelated investment disputes.

Ta& disputes concern the Fuantum of a foreign investor’s ta& liability or, more generally, the
determination of whether and how a particular transaction is ta&able under municipal law of
one state Cor several if the transaction is international2. 0onversely, ta&Erelated investment
disputes concern allegations of breach of an investment treaty resulting from speciBc
]83
sovereign measures taken by a state in the Beld of ta&ation. Wn a ta&Erelated investment
]93
dispute, the very legitimacy of the ta& measure is put into Fuestion. ‘nly ta&Erelated
investment disputes can be submitted to WDqD.

Uost older investment treaties do not e&clude ta&Erelated measures from their coverage.
Wf not e&plicitly e&cluded from treaty coverage, ta&Erelated disputes are generally within the
]13
scope of investment treaties. Wn this regard, the tribunal in Cairn v. India noted that despite
a 3widespread and longstanding consensus among Dtates that customary international
law imposes few, if any, restrictions on the right of a Dtate to set and enforce ta& law’,
this consensus has no impact on the arbitrability of ta&Erelated disputes arising from an
]j03
investment treaty. Wn such cases, the arbitrability of ta&Erelated claims is determined by
the treaty, which cannot be eFuated to customary international law.

INTERNATIONAL INVESTYENT TREATIES CAN E[CLUDE TA[-RELATED CLAIYS

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The term 3carveEout’ denotes a clause that limits the ability of investors to bring ta&Erelated
]jj3
claims under an investment treaty. 0arveEouts are more freFuent in recent treaties.
Iowever, no uniform approach e&ists among states as to how to structure these provisions.

Treaties with carveEout clauses fall broadly within the following three categoriesY

X treaties with a general and comprehensive carveEout that e&cludes the application of
the treaty to all matters of ta&ationM
X treaties with targeted carveEouts that e&clude ta&ation measures from the application
of speciBc rights or standards under the treaty, such as U;1 or national treatmentM
and
X treaties with multiElayered carveEouts that e&clude the application of the treaty to ta&
measures but provide for e&ceptions that e&plicitly cover ta&ation measures.

A ta&ation carveEout Ceither general, targeted or multiElayered2 does not lead to an automatic
dismissal of a claim involving ta&Erelated measures. qepending on the wording of the treaty
and the parties’ positions, it is upon the tribunal to determine 'urisdiction over such claims
]j23
or their admissibility.

The wording of the treaty combined with factual considerations may also lead tribunals
to defer the Fuestion of whether a measure constitutes a ta&ation measure to the merits
]j53
phase.

)y way of e&ample, in Yukos v. Russian Federation, this issue was raised as a 'urisdictional
ob'ection. Iowever, the Yukos tribunal held that 3the background to, and motivation behind’
the measures in Fuestion 3go to the heart of the present dispute’ and that it would 3not rule
on this crucial issue in a vacuum’. The tribunal therefore deferred the issue to the merits
]j43
phase.

jhen the award was challenged before the Iague 0ourt of Appeal, the court went further. Wt
ruled that the 'urisdiction of the tribunal 3is Conly2 determined’ by the provisions of the treaty
]j63
dealing with 'urisdiction in the dispute settlement provision. The court observed that the
ta&Erelated carveEout provision is contained in a part of the treaty which does not deal with
the settlement of disputes, but in a part which 3contains several more general provisions.’E
]j73
Therefore, according to the Iague 0ourt of Appeal, the decision on the K0T ta&ation
measures carveEout does not go the tribunal’s 'urisdiction, but is an issue for the merits.

TREATIES TZAT CONTAIN A GENERAL AND COYPREZENSIVE CARVE-OUT

Treaties in this category generally contain a standEalone provision that indicates that the
investment treaty shall not apply to matters of ta&ation. The carveEout is typically found
in treaty provisions dealing with the scope of application of the treaty or with e&clusions
therefrom.

)y way of e&ample, the Wndia–éAK )WT states that 3the provisions of this Agreement shall not
]j83
apply to any matters of ta&ation.’ Dimilarly, the qenmark–Russian ;ederation )WT indicates
]j93
that 3the provisions of this Agreement shall not apply to ta&ation.’ Dome )WTs entered by
1ew <ealand also contain a general carveEout, for instance the 0hina–1ew <ealand )WT
provides as followsY

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the provisions of this Agreement shall not apply to matters of ta&ation in the
territory of either 0ontracting Harty. Duch matters shall be governed by the
domestic laws of each 0ontracting Harty and the terms of any agreement
]j13
relating to ta&ation concluded between the 0ontracting Harties.

As a result, the treaty does not cover ta&ation matters.

Wn addition, while some treaties do not contain a carveEout for ta&ation measures, they may
contain general provisions on the state’s regulatory powers that ultimately set limitations on
the nature of the measures covered by treaty protection.

;or instance, Wtaly has recently updated its model )WT, which includes speciBc provisions
e&plicitly reaLrming the state’s 3right to regulate within ¶itsä territor¶yä to achieve legitimate
policy ob'ectives’ and conBrming that the standards of protection under the )WT 3shall not be
interpreted as a commitment from ¶the stateä that it will not change the legal and regulatory
framework.’ The Wtaly Uodel )WT also addresses the speciBc case of ta& incentives and
provides that the state’s decision 3not to issue, renew or maintain a subsidy’ in the absence
]203
of any speciBc commitment 3shall not constitute a breach’ of the treaty.

TREATIES TZAT CONTAIN TARGETED CARVE-OUTS

Wn this category, the investment treaty is broadly applicable to ta&ation matters but e&clusions
may apply to speciBc standards of protection. Targeted carveEouts often e&clude ta&ation
measures from U;1 and national treatment standards of protection. Dtates structure
targeted carveEouts in different ways. ;or e&ample, the ;rench Uodel )WT, in its national
treatment and U;1 provisions, contains a subEclause indicating that 3the provisions of this
]2j3
article do not apply to ta& matters.’ The Ue&ico–éS )WT includes a standEalone provision
]223
on ta& e&ceptions to the application of national treatment and U;1. ‘ther treaties only
]253
carve out the U;1 standard in relation to double ta&ation avoidance treaties.

TREATIES TZAT CONTAIN YULTI-LAkERED CARVE-OUTS

This category includes more sophisticated and comple& treaties. These contain general
carveEout clauses that e&clude ta&Erelated measures from the scope of the treaty. At the
same time, by means of clawback clauses, they specify that certain standards of protection
would apply to ta&ation measures. The result is that the treaty applies to certain ta&Erelated
claims, as e&plained below. The éD Uodel )WT and certain multilateral investment treaties
like the Knergy 0harter Treaty CK0T2 and the 1orth American ;ree Trade Agreement C1A;TA2
]243
fall within this category. )elow, we use the K0T to illustrate the multiElayered carveEout
mechanism.

The K0T carveEout clause in Article 6/C/2 provides as followsY

e&cept as otherwise provided in this Article, nothing in this Treaty shall

create rights or impose obligations with respect to Ta&ation Ueasures of the
0ontracting Harties.

The Brst part of Article 6/C/2 indicates that the clawbacks in subEclauses 6/C62–Cz2 render
the treaty applicable to speciBc ta&ation claims. Arbitral tribunals have outlined the twoEstep
test to apply Article 6/C/2Y a characterisation of ta& measure under domestic law followed
]263
by a bona Bde consideration under international law. énder international law, only actions

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motivated by the purpose of raising general revenue for the state can fall within the scope of
Article 6/C/2. Actions taken under the guise of ta&ation, but that aim to achieve an unrelated
]273
purpose, such as destruction of an investment, do not fall within the scope of Article 6/C/2.
The investor seeking to e&clude the application of the carveEout in Article 6/C/2 bears the
burden of proof that the alleged ta&Erelated measure aims to achieve an unrelated purpose.E
]283

‘n the other hand, the clawback clauses in subEclauses 6/C62ECz2 of the K0T e&clude certain
standards of protection from the general carveEout. Wn simple terms, the clawback clauses
bring certain ta&Erelated matters back within the scope of protection of the treaty. As a result
of the clawbacks, protection under the U;1 standard in Article 6/C92 and protection from
e&propriation in Article 6/Cz2 apply to ta&Erelated investment disputes – thus, e&cluding these
standards from the general ta&ation carveEout.

The clawbacks are sub'ect to FualiBcations. ;or instance, Article 6/C92 allows for protection
under the U;1 standard only to matters relating to indirect ta&es, and e&cludes from its
scope of protection those relating to ta&ation on income or on capital or substantially similar
]293
ta&es. The e&propriation clawback in Article 6/Cz2 is more comple& and contains a Bltering
mechanism that reFuires prior referral of the e&propriation claim to ta&ation authorities of
the host and home states. Hrior arbitral tribunals have dealt with the binding nature of this
precondition with different results. jhereas some tribunals acknowledge that the obligation
]213
of prior referral e&ists, others have noted that prior referral reFuirement under certain
]503
circumstances would be futile and thus, a failure to do so would not be fatal to the claim.

The 1A;TA multiElayered carveEout mechanism is similar to the K0T mechanism in some
respects. Article 6/-9C/2 contains a general carveEout that e&cludes ta&Erelated measures
from its ambit. Iowever, the e&clusion is not absolute. The clawback clause in Article
6/-9Cx2Cb2 makes national treatment and U;1 standards applicable to ta&Erelated measures
under speciBc conditions. Article 6/-9C42 provides for protection from e&propriation on the
condition that the matter is Brst submitted to the appropriate ta& authorities, as deBned in
the treaty, for a determination of whether the measure constitutes an e&propriation.

Dome recent investment treaties have also included multiElayered ta&Erelated carveEouts as
part of their provisions. ;or e&ample, the Dwit7erlandEWndonesia )WT C6-662 provides for an
e&press carveEout e&cluding ta&ation measures from the protections afforded by the treaty.
]5j3
Iowever, this provision is followed by a clawback for e&propriation and transfer of funds.

KZEN DOES A TA[ YEASURE BREACZ TZE STANDARDS OF PROTECTION OF AN IIA’

The answer to this Fuestion involves the same inFuiry as for other regulatory measures
adopted by a host state that affect an investor’s rights under an WWA. The standards most
freFuently invoked by investors as being violated by the host state’s ta& measures are
e&propriation and fair and eFuitable treatment C;KT2. )elow, we discuss some prominent
arbitral decisions in ta&Erelated WDqD and the principles that we can draw therefrom.

STATE ACTIONS UNDER TZE GUISE OF TA[ATION AND STANDARDS OF TREATk

PROTECTION
Arbitral tribunals have drawn a distinction between bona Bde ta&ation measures that affect
an investment, and actions taken by a state under the guise of ta&ation through 3improper
]523
or abusive use of the power to ta&.’ Wn the latter case, a state’s actions are not considered
to relate to actual ta&ation measures and, therefore, will not be e&cluded from the scope of
application of an WWA regardless of the presence of a ta&ation carveEout clause.

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The claimants in the Yukos arbitrations successfully argued that the ta& reassessments, :AT
charges, Bnes and asset free7es, threats to revoke licences and duress to sell Qukos’ main
production facility were not bona Bde ta&ation measures. According to the tribunalY

after having now traversed, at some length, the treatment of Qukos by Russian
ta& authorities, the bailiffs and the courts, and having considered the totality of
the evidence, especially the :AT evidence, the Tribunal has concluded that the
primary ob'ective of the Russian ;ederation was not to collect ta&es but rather
]553
to bankrupt Qukos and appropriate its valuable assets.

Wn some K0T cases against Dpain, claimants have similarly tried to argue that the state’s
]543
ta&ation measures on renewable energy installations were not bona Bde, or were part of
]563
a scheme 3intended to deprive the 0laimants of their rights under the K0T’ and a mere
]573 ]583
sham. Iowever, these arguments have so far been consistently re'ected. Wn Eiser v.
Spain, the tribunal held that 3the present case does not on the facts reach a situation where
the ta& enforcement measures are found to have been used as part of a pattern of behavior
aimed at destroying 0laimants.’ As a result, the tribunal ruled that the measures would not
]593
fall within the scope of the clawback clause, 3were such a case to be made out’.

(ikewise, in Sevilla Beheer v. Spain, the tribunal held that the ta&ation measure satisBed 3the
largely accepted criteria of a ta&Y it was established by (aw C(aw /zV6-/62, in respect of a
class of persons Cconventional and RK electricity producers2 and imposed an obligation to
]513
pay money to the Dtate for public purposes.’

Dimilar disputes have arisen in the conte&t of measures taken by )ulgaria in the renewable
energy sector. Wn ACF v. Bulgaria, )ulgaria argued that the impugned measures constituted
ta&es within the meaning of Article 6/ of the K0T and, therefore, the claims relating to these
measures fell outside the tribunal’s 'urisdiction. The tribunal analysed in considerable detail
the attributes of the measures in Fuestion, found them to be bona Bde ta&es that were
nonEdiscriminatory in their application and held that claims in relation to such measures fell
]403
outside its 'urisdiction.

TA[ATION YEASURES AND STANDARDS OF TREATk PROTECTION

Wn cases dealing with actual ta&ationErelated investment disputes – as opposed to cases
arising from a state’s actions under the guise of ta&ation – the standards most freFuently
invoked by investors are protection from e&propriation and ;KT, addressed in turn below.

E[PROPRIATION
jhen faced with claims of e&propriation, tribunals have focused on the effect of the
host state’s ta&ation measure. The investigation involved is thus similar to cases in which
claimants argue e&propriation due to a host state’s regulatory measures. Dubstantial
deprivation of property as a result of the host state’s ta&ation measures must be shown.

Wn EnCana v. Ecuador, the claimant argued that denial of :AT credits and refunds amounting
to /- per cent of the value of transactions associated with the company’s oil production and
]4j3
e&port activities amounted to e&propriation under the 0anada–Kcuador )WT. The tribunal
found that the state’s conduct did not affect the claimant’s ability to perform a normal range
of commercial activities or render the value derived from its investment 3so marginal or
]423
unproBtable as to effectively deprive them of their character as investments.’ Wt noted that

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3only if a ta& law is e&traordinary, punitive in amount or arbitrary in its incidence would issues
]453
of indirect e&propriation be raised.’ The claimant also argued that by not disbursing the ta&
refunds, the state directly e&propriated its investment. The tribunal clariBed that sums owed
to an investor by way of :AT refunds could, in principle, Fualify as an 3investment’ under the
]443
)WT. The tribunal also acknowledged that retrospective changes in domestic law entailed
]463
a loss of the investor’s right. Iowever, according to the tribunal, the ta& authorities’ policy
on oil refunds did not rise to the level of repudiation of a legal right so as to amount to a
]473
direct e&propriation.

Wn Occidental v. Ecuador, the claimant similarly argued indirect e&propriation due to Kcuador’s
]483
3refusal to refund the :AT’. According to the tribunal, 3there has been no deprivation of
the use or reasonably e&pected economic beneBt of the investment, let alone measures
]493
affecting a signiBcant part of the investment’ and the claimant failed to prove that it had
]413
been substantially deprived of the value of its investment.

K&propriation arguments in disputes arising from Kcuador’s (aw x6 also failed. That (aw
granted Kcuador a participation of z- per cent in the 3e&traordinary revenues’ from the sale of
crude oil when the sale price e&ceeded a reference price set by the Kcuador Uinistry of Knergy
and Uines. Wn 6--ó, Kcuador increased its participation in these e&traordinary revenues from
]603
z- per cent to JJ per cent.

Wn Perenco, the claimant argued that this measure amounted to an e&propriation of its
investment under the Kcuador–;rance )WT. The tribunal ruled that the ta& 3came close
]6j3
to, but did not cross the line’ of indirect e&propriation. According to the tribunal, 3the
Bnancial burden of paying JJ per cent of the revenues above the reference price, while
disadvantageous to Herenco, did not bring its operation to a halt or, to revert to the tests
previously cited, effectively neutralise the investment or render it as if it had ceased to e&ist.’E
]623

Wn Burlington, the claimant argued that this constituted an e&propriation of its investment
under the éD–Kcuador )WT. The tribunal re'ected the claim. The measure resulted in a z° per
cent reduction in the claimant’s 3total oil revenues’ from one block of the oil Beld and a ó-.6
per cent reduction in respect of another block. According to the tribunal, this did not indicate
a substantial deprivation, as the ta& did not render the claimant’s investment 3unproBtable or
]653
worthless.’

Arguments of e&propriation in a case arising from Uongolia’s decision to adopt a windfall

proBt ta& on some commodities also failed. Wn Paushok v. Mongolia, claimants argued
that a windfall proBt ta& of 4° per cent on sales of gold at prices higher than éD8z-- per
]643
ounce constituted an e&propriation under the Russia–Uongolia )WT. The tribunal was
unpersuaded. An accounting loss of éD8/ million for one year could not be seen as indicating
the destruction of an ongoing enterprise with a history of strong annual proBts, especially
]663
in the conte&t of favourable market conditions and subseFuent favourable legislation. Wn
]673
the tribunal’s view, the measures had not led to 3destruction’ of the enterprise that would
]683
Fualify as 3tantamount’ to e&propriation.

A Bnding of e&propriation is, thus, a factEbased inFuiry. Wn cases where investors have
succeeded in showing substantial deprivation, tribunals have found e&propriation.

Wn Goetz v. Burundi, a dispute under the )elgiumV(u&embourg–)urundi )WT arose from

)urundi’s withdrawal of ta& and customs e&emptions relating to the production of precious
metals. The tribunal found that the )WT obligated the host state to refrain from taking

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any measure that would deprive or restrict the investor’s right to ownership, including any
]693
measure that would have a similar effect. The state’s withdrawal of the ta& e&emption
forced the investors to stop all activity and stripped them of any beneBt they could have
e&pected from their investment. The tribunal, as a result, found the measure to have a similar
]613
effect to one depriving or restricting ownership under the )WT.

Wn Ampal-American v. Egypt, a dispute under both the Kgypt–éD )WT and the Kgypt–Germany
)WT arose from the revocation of ta& e&emptions. Her the claimants, the licence to operate
under a ta&Efree 7one system for a period of 6z years constituted an investment directly
]703
protected under the )WT. The tribunal found that the claimants’ inclusion in the ta&Efree
7one system was a fundamental part of their investment structure and that Kgypt’s decision
to remove the consortium’s ta&Efree status 3took away a deBned and valuable interest that
had been validly conferred according to Kgyptian law at the time that the investment was
]7j3
made and that had been guaranteed by the Dtate for a deBned period’. Wt was, therefore,
]723
tantamount to e&propriation.

FET
Wn most cases, investors have also brought ta&ationEbased claims in relation to the breach
of ;KT. Among these, investors’ claims succeeded even though, by and large, tribunals
have recognised that an investor is not immune to regulatory changes. The principle is that
ta&ation measures must be proportional to the standard of protection granted to an investor.

;or instance, in Cairn v. India, the dispute arose from retroactive ta&es levied by the state
by way of a legislative amendment in 6-/6. The tribunal recognised that the principle of
legal certainty is not absolute, and some retroactive regulations could be 'ustiBed by a public
purpose. Iowever, in this instance, the tribunal found that there was no 3speciBc public
]753
purpose that would 'ustify applying the 6-/6 amendment to past transactions’. According
to the tribunal, the state failed to adeFuately balance the claimants’ interest in legal certainty
]743
with its own regulatory interests. Wndia’s retroactive ta&ation was thus 3grossly unfair’ and
violated the ;KT standard.

Wn Perenco, in view of (aw x6 e&plained above, the tribunal ruled that Kcuador’s decision to
increase the state’s participation in the 3e&traordinary revenues’ to JJ per cent resulted in
3effectively removing virtually all of the upside potential above the reference ¶saleä price’ for
crude oil set by the Kcuadorian authorities. Through this measure, the state was effectively
forcing the investors to surrender their rights under the participation contracts and migrate
]763
to service contracts. This constituted a breach of the ;KT undertaking.

(ikewise, and in relation to the same (aw x6, the Murphy v. Ecuador tribunal found that
Kcuador’s measure not only 3fundamentally, and pre'udicially’ changed the business and legal
framework, but did so 3within the conte&t of an increasingly hostile and coercive investment
]773 ]783
environment’. Kcuador’s behaviour breached ;KT standard.

At times, a claimant has succeeded in establishing a violation of ;KT although the tribunal
did not make a Bnding of e&propriation in relation to the same measure. ;or instance, in
Occidental v. Ecuador, the tribunal upheld ‘ccidental’s claims under the )WT’s ;KT standard
on the basis that Kcuador’s denial of ‘ccidental KPH’s :AT reimbursement applications
]793
signiBcantly changed the framework under which its investment had been made. ‘ther
tribunals have similarly found a violation of ;KT despite Bnding that no e&propriation
]713
occurred.

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Argentina’s measures between 6--x and 6--ó, raising e&port ta&es on crude oil and fuel,
also gave rise to a series of cases. Wn Total v. Argentina, the claimant argued that Argentina’s
imposition of e&port ta&es on crude oil, natural gas and (HG breached the ;KT standard in
the ;rance–Argentina )WT. The investor argued that the e&port ta&es violated the guarantees
contained in a series of decrees adopted by Argentina, which provided that producers would
have the right to receive compensation if the government restricted the e&port of crude oil
]803
and its derivatives. The tribunal re'ected the claim. Wn the tribunal’s view, the e&port ta&es
constituted 3Bscal measures Cto which oil producing and e&porting countries normally have
recourse2 that are generally applicable to crude oil e&porters Cand not addressed speciBcally
]8j3
to Total2’. These e&port ta&es, the tribunal added, are part of the general Bscal legislation to
]823
which the investors were sub'ect, unless their application was shown to be discriminatory.
Uoreover, the concession did not promise 3Bscal stability’ or an e&emption from potential
]853
government intervention.

Arbitral tribunals thus strive to balance states’ right to make regulatory changes and
investors’ right to operate within a stable regulatory framework.

To conclude, states maintain considerable discretion on how they wish to structure their ta&
regimes. Iowever, this discretion is not unfettered. Wf a state has entered into WWAs that do not
e&clude ta&ation measures, in certain cases the manner in which speciBc ta& measures are
applied to investments protected under those WWAs could lead to a breach of a state’s treaty
undertakings.

ENDNOTES
]j3
Anna 0revonETarassova is a partner, Asha Ra'an is a senior associate and _hilda :oca' is
an associate at qentons.
]23
1oting that Article 6/Có2 K0T, Article 6/-ó 1A;TA and Article /J of the 6-/J
Argentina–0hile ;TA provide guidance on the deBnition of 3ta&’ and 3ta&ation measure’.
]53
EnCana v. Ecuador, (0WA 0ase 1o. é19x°/, Award and Hartial qissent, 9 ;ebruary 6--4,
para. /x6M Duke Energy v. Peru, W0DWq 0ase 1o. AR)V-9V6°, Award, /° August 6--°, para.
/óxM Burlington v. Ecuador, W0DWq 0ase 1o. AR)V-°Vz, qecision on $urisdiction, 6 $une 6-/-
para. /4zM Murphy v. Ecuador, (II), H0A 0ase 1o. 6-/6E/4, Hartial ;inal Award, 4 Uay 6-/4,
para. /zJM Sun Reserve v. Italy, D00 0ase 1o. : C6-/4V962, Award, 6z Uarch 6-6-, para. z6/M
Yukos v. Russian Federation, H0A 0ase 1o. AA 66ó, Award, /° $uly 6-/x, para. /x-ó CdeBning
ta&ation measures under Article 6/ K0T as 3actions that are motivated by the purpose of
raising general revenue for the Dtate.’2.
]43
ACF v. Bulgaria, W0DWq 0ase 1o. AR)V/°V/, Award, z $anuary 6-6x, para. 4J°.
]63
;or e&ample, Kcuador’s (aw x6 amended the Iydrocarbon (aw and granted Kcuador a
participation of initially z- per cent and then JJ per cent in the 3e&traordinary revenues’ from
the sale of crude oil when the sale price of the oil e&ceeded a reference price. This was
considered as a ta& measure by the Burlington and Perenco tribunals while the Occidental
and the Murphy tribunals considered that (aw x6 was not a ta& measure Csee Burlington v.
Ecuador, above note 9, para. /4óM Perenco v. Ecuador, W0DWq 0ase 1o. AR)V-°V4, qecision on
$urisdiction and (iability, /6 Deptember 6-/x, para. 9ózM Occidental v. Ecuador, W0DWq 0ase
1o. AR)V-4V//, Award, z ‘ctober 6-/6, para. z-JM Murphy v. Ecuador (II), above note 9, para.
/J-2.

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]73
é10TAq, 3Wnternational investment agreements and their implications for ta& measuresY
what ta& policymakers need to know’, é.1. qoc. é10TAqVqWAKVH0)VW1;V6-6/V9, 6-6/, p. ó.
]83
Cairn v. India, H0A 0ase 1o. 6-/4E-ó, ;inal Award, 6/ qecember 6-6-, para. °9xM jilliam
j. Hark, 3Ta& and Arbitration’, in j. j. Hark Ced.2, Arbitration International, :olume 94, Wssue
6 C6-6-2, p. /44.
]93
Hark, above note ó, p. /4ó.
]13
é10TAq, above note 4, p. /4.
]j03
Cairn v. India, above note ó, para. °9x.
]jj3
Uatthew qavie, 3Ta&ationE)ased Wnvestment Treaty 0laims’, in Thomas Dchult7 Ced.2,
Journal of International Dispute Settlement, ‘&ford éniversity Hress 6-/z, :olume 4 Wssue /
pp. 6-6–66ó.
]j23
;or e&ample, in Occidental I, Kcuador pleaded that the ob'ection based on the ta&ation
carveEout in the treaty should be addressed as an issue of 'urisdiction, whereas the ob'ection
based on the speciBc measures covered by ta&ation Cclawback for e&propriation2 should be
addressed as an issue of admissibility Csee Occidental v. Ecuador I, (0WA 0ase 1o. é19x4ó,
Award, / $uly 6--x, para. 9ó2M also in Qukos, the Russian ;ederation argued that the carveEout
in Article 6/ K0T was a matter of 'urisdiction, and claimants pleaded that the carveEout
went to admissibilityVmerits because it related to the e&istence of rights and obligations with
respect to the alleged ta&ation measures CYukos v. Russian Federation, H0A 0ase 1o. AA
66ó, Wnterim Award on $urisdiction and Admissibility, 9- 1ovember 6--J, para. z4°2.
]j53
Hark, above note ó, p. /°zM Audley jilliam Dheppard, 3Ta& and arbitration Can WDqD update2’,
in j. j. Hark Ced.2, Arbitration International, :olume 9J, Wssue 6 C6-692, pp. 9/xE994.
]j43
Yukos v. Russian Federation, above note /6, paras. z°xEz°z. Another e&ample of a tribunal
deciding to defer this issue to the merits phase is EnCana v. Ecuador, above note 9, Hartial
Award on $urisdiction, 6ó ;ebruary 6--x, paras. 9xEx-.
]j63
Russian Federation v. Hulley Enterprises Limited, Yukos Universal Limited, Veteran
Petroleum Limited, The Iague 0ourt of Appeal, /° ;ebruary 6-6-, para. z.6.z.
]j73
id., para. z.6.4.
]j83
Wndia–énited Arab Kmirates )WT, 6-/9, Article 6C92.
]j93
qenmark–Russian ;ederation )WT, /JJ9, Article //C92.
]j13
0hina–1ew <ealand )WT, /JJ°, Article zC62M also see Argentina–1ew <ealand )WT, /JJJ,
Article zC62M 0hile–1ew <ealand )WT, /JJJ, Article °M Iong Song, 0hina DAR–1ew <ealand
)WT, /JJz, Article °C62.
]203
Wtaly Uodel )WT, 6-66, Article 4.
]2j3
;rance Uodel )WT, 6--4, Article z.
]223
Ue&ico–énited Singdom )WT, 6--4, Article zCb2 Ce&cluding the application of the national
treatment and U;1 standard in relation to 3any international agreement or arrangement
relating wholly or mainly to ta&ation or any domestic legislation relating wholly or mainly to
ta&ation.’2

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]253
Dee (ao Heople’s qemocratic Republic–:iet 1am )WT, /JJ4, Article xCc2M also
0ambodia–Ualaysia )WT, /JJx, Article 9C92Cb2.
]243
1A;TA, Article 6/-9M éD Uodel )WT, 6-/6, Article 6/M énited Dtates of America–éruguay
)WT, 6--z, Article 6/.
]263
Antaris v. Czech Republic, H0A 0ase 1o. 6-/xE-/, Award, 6 Uay 6-/°, para. 66xM Voltaic v.
Czech Republic, Award, H0A 0ase 1o. 6-/xE6-, /J Uay 6-/J, para. 64-M Photovoltaik v. Czech
Republic, H0A 0ase 1o. 6-/xE6/, Award, /J Uay 6-/J, para. 6xJM WA v. Czech Republic, H0A
0ase 1o. 6-/xE/J, Award, /J Uay 6-/J, para. 96óM I.C.W. v. Czech Republic, H0A 0ase 1o.
6-/xE66, Award, /J Uay 6-/J, para. 9-°.
]273
Yukos v. Russian Federation, above note 9, para. /x-óM Voltaic v. Czech Republic, above
note 6z, para. 64zM I.C.W. v. Czech Republic, above note 6z, para. 9/9M Photovoltaik v. Czech
Republic, above note /J, para. 6zxM and WA v. Czech Republic, above note 6z, para. 996.
]283
Novenergia II v. Spain, D00 Arbitration 6-/zV-49, ;inal Arbitral Award, /z ;ebruary 6-/°,
para. z6/.
]293
Infra Red v. Spain, W0DWq 0ase 1o. AR)V/xV/6, Award, 6 August 6-/J, para. 9/°M NextEra v.
Spain, W0DWq 0ase 1o. AR)V/xV//, qecision on $urisdiction, (iability and “uantum Hrinciples,
9/ Uay 6-/J, para. 9°9.
]213
Plama v. Bulgaria, W0DWq 0ase 1o. AR)V-9V6x, Award, 6ó August 6--°, para. 644.
]503
Yukos v. Russian Federation, above note 9, para. /x6°M Isolux v. Spain, D00 Arbitration
:6-/9V/z9, /6 $uly 6-/4, para. óz°.
]5j3
Wndonesia–Dwit7erland )WT, 6-66, Article 9. Another e&ample of a recent treaty providing
for a multiElayered ta&Erelated carveEout is the SoreaE0ambodia )WT, 6-6/, Article J.9.
]523
Eiser and Energia Solar v. Spain, W0DWq 0ase 1o. AR)V/9V94, ;inal Award, x Uay 6-/ó,
para. 6ó/.
]553
Yukos v. Russian Federation, above note 9, para. óz4.
]543
Eiser and Energia Solar v. Spain, above note 96, para. 6zJM FREIF v. Spain, D00 0ase
: 6-/óV-4-, ;inal Award, ° Uarch 6-6/, paras. 9zJE944M Eurus v. Spain, W0DWq 0ase 1o.
AR)V/4Vx, qecision on $urisdiction and (iability, /ó Uarch 6-6/, paras. /4/E/4°M Infracapital
v. Spain, W0DWq 0ase 1o. AR)V/4V/°, qecision on $urisdiction, (iability and qirections on
“uantum, /9 Deptember 6-6/, paras. 9xzE9z6M Sevilla Beheer v. Spain, W0DWq 0ase 1o.
AR)V/4V6ó, qecision on $urisdiction, (iability and the Hrinciples of “uantum, // ;ebruary
6-66, paras. 4°óE4Jx.
]563
RREEF v. Spain, W0DWq 0ase 1o. AR)V/9V9-, qecision on $urisdiction, 4 $une 6-/4, para.
/J-.
]573
id., para. /J/. Dee also, Eurus v. Spain, above note 9x, para. /46.
]583
Eiser and Energia Solar v. Spain, above note 96, para. 6ó-M RREEF v. Spain, W0DWq 0ase
1o. AR)V/9V9-, qecision on Responsibility and on the Hrinciples of “uantum, 9- 1ovember
6-/°, para. /°°.
]593
Eiser and Energia Solar v. Spain, above note 96, para. 6ó-.

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]513
Sevilla Beheer v. Spain, above note 9x, para. 4JJ. Dee also, Eurus v. Spain, above note 9x,
paras. /4JE/°-M FREIF v. Spain, above note 9x, paras. 94óE9óJM Infracapital v. Spain, above
note 9x, paras. 9z9E9ó°.
]403
ACF v. Bulgaria, above note x, paras. ó6-Eó6J.
]4j3
EnCana v. Ecuador, above note 9, para. /óó.
]423
id., para. /óx.
]453
id., para. /óó.
]443
id.,para. /°9.
]463
id., para. /°ó.
]473
id., para. /Jó.
]483
Occidental v. Ecuador I, above note /6, para. óJ.
]493
id., para. °J.
]413
ibid.
]603
id., para. 6-.
]6j3
Perenco v. Ecuador,above note z, para. 4°x.
]623
id., para. 4°z.
]653
Burlington v. Ecuador, W0DWq 0ase 1o. AR)V-4V-°Vz, qecision on (iability, /x qecember
6-/6, para. xz-.
]643
Paushok and others v. Mongolia, é10WTRA(, Award on $urisdiction and (iability, 6° April
6-//, para. 99x.
]663
ibid.
]673
ibid.
]683
id., para. 994.
]693
Goetz v. Burundi [I], W0DWq 0ase 1o. AR)VJzV9, qecision on (iability, 6 Deptember /JJ°,
para. /6x Ctranslation from ;rench by authorsY 3il ressort des termes mêmes de l’article 4 que
cette disposition ne vise pas seulement les mesures privatives et restrictives de propriété
stricto sensu, mais régit plus largement toutes mesures “ayant un effet similaire%’2.
]613
ibid.
]703
Ampal-American and others v. Egypt, W0DWq 0ase 1o. AR)V/6V//, qecision on (iability and
Ieads of (oss, 6/ ;ebruary 6-/ó, para. /z° citing claimant’s position.
]7j3
id., para. /°9.
]723
ibid.
]753
Cairn v. India, above note ó,para. /°/4.
]743
ibid.
]763
Perenco v. Ecuador, abovenote z, paras. 4-9–4-4.

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]773
Murphy v. Ecuador CWW2, above note 9, para. 6°/.
]783
id., para. 6°6.
]793
Occidental v. Ecuador I, above note /6, para. /J-. 0onversely, in EnCana, a case based
on the same measure, in the absence of any wording in the 0anadaEKcuador )WT reFuiring
the Dtate to accord fairness, the tribunal recognised that a foreign investor 3has neither
the right nor any legitimate e&pectation that the ta& regime will not change, perhaps to its
disadvantage, during the period of the investment’, EnCana v. Ecuador, above note 9, para.
/ó9.
]713
CMS Gas v. Argentina, W0DWq 1o. AR)V-/V°, Award, /6 Uay 6--z, para. 6°/M Sempra
v. Argentina, W0DWq 0ase 1o. AR)V-6V/4, Award, 6z Deptember 6--ó, paras. 9-9–9-xM
Occidental II, above note x, para. xzzM Novenergia v. Spain, above note 6ó, paras. ó4-–ó49.
]803
Total S.A. v. Argentine Republic, W0DWq 0ase 1o. AR)V-xV/, qecision on (iability, 6ó
qecember 6-/-, paras. 9z6–9zx.
]8j3
id., para. x9x.
]823
ibid.
]853
id., para. x9z.

Anna Crevon-Tarassova [email protected]

Asha Ra?an [email protected]
[hilda Voca? [email protected]

Thurn-und-Taxis-Platz 6, 60313 Frankfurt, Germany

Tel: +49 69 4500 12 290

http://www.dentons.com

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Construction
Arbitrations Involving
Energy Facilities
Doug Wones AO

Summary

TIYE

COST

QUALITk

SCOPE

POLITICAL, ECONOYIC AND SOCIAL

CONCLUSION

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)etween /Jó/ and 6-6/, total energy consumption across the globe has more than
]23
doubled, bringing with it a host of challenges for the construction of energy infrastructure
that is capable of e&tracting secure fuel sources, converting them into energy and distributing
them to the end user. Among these challenges are economic and supply disruptions brought
about by the covidE/J pandemic and sanctions against Russia Cthe world’s largest e&porter
]53
of fossil fuels2 for its invasion of ékraine, the need to combat the rising price of energy for
]43 ]63
consumers, and growing commitments towards the energy transition.

Asia is one area that has seen signiBcant growth in both the supply of, and demand for,
energy. )etween /JJ- and 6-6/, the share of total energy supply from nonE‘K0q Asia
]73
Ce&cluding 0hina2 increased from /z to x- per cent, while energy production from ‘K0q
]83
Asia and ‘ceania increased from /x to /ó per cent of total global energy supply. Wn
terms of renewable energy developments, Asia contributed to almost half of the global
growth in renewable energy generation capacity in 6-66 Cwith 0hina driving the e&pansion
]93
in hydropower, solar energy and wind energy2.

There is no Fuestion that commercial arbitration has emerged as the primary forum for
]13
the resolution of disputes arising from pro'ects for the construction of energy facilities. Wn
recent years, construction and energy cases have accounted for the ma'ority of arbitrations
]j03
administered by the Wnternational 0ommercial 0ourt CW002. Wnternational enforceability
provides a key advantage in an industry that freFuently brings together for each pro'ect a
vendor and a range of specialist contractors from different parts of the world. Hrocuring the
e&pertise of an e&perienced energy industry practitioner to preside over a dispute neutralises
the risks associated with resolving highly technical disputes in fora that are unsophisticated
in international commercial matters. Wts increased prevalence is also due to the inclusion of
arbitration clauses in leading standard form contracts, including the Wnternational ;ederation
of 0onsulting Kngineers C;WqW02 0onditions of 0ontract for 0onstruction CRed )ook2, 0ontract
for KH0VTurnkey Hro'ects CDilver )ook2 and 0ontract for Hlant and qesignE)uild CQellow )ook2
]jj3
Cparts of the 6-/ó ;WqW0 Duite2, and the 1ew Kngineering 0ontract, of which the fourth
]j23
edition C1K0x2 was published in 6-/ó.

There are uniFue commercial considerations that apply to energy pro'ects. These include
preEconstruction considerations and postEconstruction uses and demands that are speciBc
to energy facilities. These considerations also encompass political factors that can in5uence
legal and economic policy, such as terms of trade, subsidies and ta&es. jhat these pro'ects
all have in common, however, is the core need for the mobilisation of resources and e&pertise
for the design and construction of facilities, with riskEallocation provisions that account for
these additional risks.

Accordingly, when disputes arise, they are concerned with the usual array of contractual
clauses and legal principles that are common to construction disputes. The purpose of this
chapter is to provide a broad overview of these issues of risk, and the laws and issues of
contract that underline disputes between energy pro'ect participants when they do arise. Wt
is hoped that this will serve as a guide that familiarises readers with the landscape in this
area.

The issues that arise in construction arbitrations involving energy pro'ects are e&plored
across Bve key themesY time, cost, Fuality, scope, and political, economic and social risk. ;or
each theme, this chapter Brst e&plores issues of risk and the manner in which they can be

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addressed through contract drafting, and then considers the issues of legal and contractual
principles that freFuently arise in contentious arbitration disputes.

This chapter is concerned with commercial arbitrations between participants in construction

pro'ects for energy facilities, as opposed to investorEstate claims arising from such pro'ects,
which are covered comprehensively in other chapters in this book.

TIYE

TIYE-RELATED RISM
Wt is often said that time is everything in construction. The adverse effects and losses
that 5ow from delay in a pro'ect’s completion are often wideEranging and severe. They
can include an increase in costs for the contractorM lost production and revenue for the
ownerM adverse effects on the payback of loans to BnanciersM cash 5ow and subseFuent
solvency issuesM knockEon delays in multiEphase pro'ectsM negative publicity, particularly in
governmentEfunded public pro'ectsM and breaches of ancillary arrangements to the original
contract upon which the pro'ect’s viability depends Ce.g., offtake agreements, contracts for
inputs2. This Bnal category is highly signiBcant in construction pro'ects for energy facilities.
;acility owners will more often than not have entered into a binding offtake agreement to
supply energy at a speciBed level to an offtake partner from the date of pro'ect completion,
and will become liable for liFuidated damages and other claims in the event that they are
unable to meet this commitment in a timely manner. The resulting liability is often si7eable.

TimeErelated risks are generally allocated to the contractor. A detailed pro'ect schedule will
establish the milestones that a contractor must meet Cin addition to a more general pro'ect
]j53
schedule that is developed at an earlier stage of the pro'ect2. The detailed pro'ect schedule
will encompass key milestones, including targets and dates for a notice to proceed, phase
milestones, practical completion, commissioning activities and Bnal completion. The critical
path of activities will be evident from this schedule, as will be the level of 5oat available to
absorb some delay in the pro'ect’s performance. jhen critical delay to a pro'ect occurs, the
contractor will Bnd itself sub'ect to an owner’s claim for general and liFuidated damages.

qespite this default position, delay to a pro'ect can eFually be a result of events that are the
responsibility of the owner. A contractor may Bnd itself aggrieved, and the pro'ect hindered,
as a result of an owner’s acts of prevention, which may include active obstruction of the
siteM failure to provide designs, materials or other obligations that a contractor needs to
perform its scope of worksM or imposing contractually valid variations or change orders on
the contractor. The contractor may seek a range of remedies against the owner, including
e&tensions of time and damages.

;inally, neutral delays in the form of force majeure fall to the contract in accordance with
the default position under the common law. )y contrast, the 6-/ó ;WqW0 Duite confers
upon the contractor a right to seek an e&tension of time in respect of neutral delay events
C0lause /J2. The characterisation of an event as force majeure can form the sub'ect of
heated contention. Iowever, it must be noted that since the emergence of the covidE/J
pandemic, new contracting parties are more cognisant of the reality of force majeure events
and may therefore seek to carefully address the risk allocation of this type of event within
their contracts.

TIYE-RELATED DISPUTES

OKNER CLAIY FOR LIQUIDATED DELAk DAYAGES

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0onstruction contracts often include a liFuidated damages clause as the principal Cor
e&clusive2 remedy available to compensate an owner for a contractor’s failure to achieve
timely completion. This remedy levies from the contractor an agreed monetary sum that
scales per day or per week, sub'ect to an agreed cap B&ed at a percentage of the contract
price Coften /- to 6- per cent2. This sum represents a genuine preEestimate of the losses
that an owner will suffer as a result of delayed completion, and is compensatory rather than
punitive in nature. The main rationale behind liFuidated damages clauses is to avoid the
comple& and costly task of proving losses resulting from delay individually in accordance
with general principles of contract recovery.

The categories of loss that may be compensable through a liFuidated damages clause
include those listed in the immediately preceding section of this chapter. Wn a number of
recent landmark decisions, there has been 'udicial recognition of a broad range of losses,
both monetary and nonEmonetary in nature, that may be taken into account when calculating
the rate of liFuidated damages payable for delay. The concept of protectable legitimate
]j43
interests was introduced by the éS Dupreme 0ourt in Cavendish. The approaches of the
]j63
Australian Iigh 0ourt in Paciocco and the 1ew <ealand Dupreme 0ourt in 127 Hobson
]j73
Street Limited v. Honey Bees Preschool Ltd were broadly consistent with this test of
]j83
legitimate commercial interest.

Iowever, claims for liFuidated delay damages are sub'ect to two key limitationsM the doctrine
of penalties and the prevention principle.

TZE PENALTIES DOCTRINE

énder the common law, the doctrine of penalties dictates that where a liFuidated damages
clause stipulates an amount wholly disproportionate to the value of the construction
contract, such that it takes the form of a payment in terrorem, courts will not enforce
]j93
the clause. The test for what constitutes an in terrorem clause differs substantially in
]j13
each common law 'urisdiction. The fundamental proposition of law is that a liFuidated
damages clause must be compensatory and not punitive. )y contrast, in civil law
'urisdictions, a liFuidated damages clause that is disproportionate to actual losses suffered
is not struck out as void, but rather civil courts will ad'ust the sum stipulated in the clause
to accord with the actual losses suffered. This position is perhaps less arbitrary, though it
circumvents to some degree the ob'ective of liFuidated damages clauses, being to avoid
having to calculate actual losses.

TZE PREVENTION PRINCIPLE

The prevention principle states that an owner will not be entitled to claim liFuidated damages
against a contractor for a period of delay infected with delays that are the responsibility of the
owner. ;or instance, if a pro'ect falls /- days behind schedule, seven of which fall to causes
that are the responsibility of the contractor and three to causes that are the responsibility of
the owner, the owner will lose altogether the right to claim liFuidated damages in respect of
the full /- days. The rationale behind this is that the owner can no longer rely on the original
date of completion and so there can be 3no B&ed date from which the liFuidated damages
]203
could run’. Any apportionment of this delay is inimical to the common law prevention
principle. The results of this principle may at times seem arbitrary and contrast with the
approach taken by civil courts that apportion delay losses. The severe conseFuences for an
owner are further magniBed if the parties’ agreement speciBes that liFuidated damages are

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an e&clusive remedy for delay, which may preclude a party from claiming general damages
]2j3
in the alternative.

This situation is freFuently overcome by an owner by granting an e&tension of time to the

contractor in respect of periods of ownerEcaused delay. This e&tension must be sourced
within the contract documentation and will often involve a regime that reFuires a contractor
to give notice of ownerEcaused delays, often within speciBed time limits, which are then
assessed and granted or declined by the relevant umpire Ceither the pro'ect owner or a site
engineer2. Iowever, these e&tension of time provisions can create further issues that may
interfere with an owner’s right to claim liFuidated damages. This particularly arises when
a contractor fails to comply with notice provisions that are a condition precedent to the
contractor’s e&tension of time claim. Wn situations of concurrent delay, authority has been
divided on whether the prevention principle will apply to prevent the owner from claiming
]223
liFuidated damages if the contractor has not complied with these notice reFuirements.
Wn Australia, this has resulted in many contracts including provisions that allow owners to
unilaterally provide e&tensions of time, regardless of any compliance with notice provisions
by the contractor. Wn these circumstances, courts in Australia have held that when such
a unilateral e&tension of time clause e&ists, 3there is an implied duty of good faith in
]253
e&ercising the discretion’ on the part of the owner. Wt therefore seems that in common law
'urisdictions where unilateral e&tension of time clauses are agreed, owners may be unable
to withhold e&tensions of time merely to invoke the operation of the prevention principle.

Wn civil law 'urisdictions, there is no e&plicit eFuivalent of the prevention principle. Wnstead
civil courts rely on the principles of good faith and fair dealing to give effect to the universal
]243
principle that one shall not beneBt from one’s own wrongdoing. Dome countries, such
as 0hina and Douth Sorea, provide codiBed authority for courts to better apportion any
liFuidated damages amounts between the loss caused by the owner’s preventing conduct
]263
and the contractor’s delay. ‘thers, such as Germany and ;rance, provide authority that
a party will not be liable for nonEperformance or delay that has resulted from an e&ternal
]273
cause not attributable to that party. Any failure to do so may disentitle the contractor to
an e&tension entirely or permit the contract administrator to reduce the period of e&tension
]283
accordingly.

CONTRACTOR(S CLAIYS FOR DISRUPTION

qisruption disputes are concerned with a contractor’s loss of productivity as a result of
some form of disturbance by the employer. These disputes will commonly centre around
]293
the 3uneconomic working’ of the contractor as a result of the employer’s conduct.

A contractor will be entitled to claim damages only in respect of disruption caused by the
pro'ect owner. The right of claim may be deBned by contract or, absent e&press contractual
provisions, as a breach of an implied term of contract that the owner will not prevent or hinder
]213
the contractor in the e&ecution of its work. The Dociety of 0onstruction (aw’s qelay and
qisruption Hrotocol Cthe D0( Hrotocol2 comments that 3most standard forms of contract do
]503
not e&pressly address recovery for disruption’M however, while limited in number, there do
e&ist standard form contracts setting out terms that oblige compensation 3for speciBc events
]5j3
that could lead to disruption’.

0ontractors making disruption claims are reFuired to demonstrate a connection between the
alleged disruptive event and the increased costs associated with their loss of productivity or
uneconomic working. This will generally reFuire a comparison between the tender schedule

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and delivery mechanisms, and the adapted schedule and mechanisms as a result of the
disruption. There are a variety of methods by which disruption and productivity costs can be
]523
calculated and the law is not prescriptive of any one method over another.

A common approach taken by contractors is the 3measured mile’ approach, in which the
contractor will compare its rate of productivity in a part of the pro'ect that has not been
disrupted with the rate of productivity in the disrupted part of the pro'ect. Hroductivity in this
approach is measured by the number of hours taken to produce a unit of work. This approach
may be impracticable if a pro'ect has been disrupted from its inception, meaning that there is
no baseline productivity from which to measure the disruption. As an alternative, the tender
will usually specify an e&pected level of productivity, and a loss of productivity is realised
when the actual productivity rate is less than the planned productivity rate.

0laimants should also be wary that when selecting a baseline period of work that is
not disrupted to compare with disrupted work, there must be a reasonable degree of
comparability between the speciBc work and surrounding circumstances at both ends of the
]553
pro'ect. The value of any comparison is otherwise substantially diminished. ;or e&ample,
the laying of foundations that is free of disruption cannot be used a measurement for the
disrupted piping fabrication of a pro'ect.

CONTRACTOR(S CLAIYS FOR PROLONGATION

Hrolongation disputes involve contractor claims for costs associated with delay as a result of
ownerEbased action. They can comprise a broad range of overhead costs, opportunity costs
and additional direct costs incurred as a result of the delay. These are often determined by
reference to the tender schedule and, importantly, any e&press provisions contained in the
construction contract setting out terms of recovery of prolongation costs.

A contractor asserting a claim for prolongation costs will need to Brst prove the causation of
delay and form of the prolongation. Wn arbitrations involving energy facilities, this freFuently
reFuires the engagement of programming e&perts to analyse and identify the delay Coften
through a schedules analysis approach2, and then a Fuantum e&pert to particularise the
various cost items to substantiate the prolongation claim.

0ost items that are often claimed as prolongation costs include direct costs associated with
additional performance days, such as labour costs, utility e&penses and security e&pensesM
indirect home oLce overheads incurred by the contractor’s corporate management, 'ob site
]543
and engineering support personnel costsM idle eFuipment costsM and mitigation costs.

SUSPENSION OF KORM Bk A CONTRACTOR

Hrimacy is given to the contract for matters concerning the suspension of work by a
contractor. The contractor’s right to suspend is generally tied to Bnancial concerns, namely
]563
nonEpayment or a failure by the owner to show evidence of its Bnancial arrangements.
]573
A contractor has no common law right to suspend work. An e&ception occurs where the
nonEpayment may be characterised as repudiatory conduct or in breach of an essential term
of the contract, in which case the contractor may accept the repudiation of the contract and
]583
terminate.

Wn the event of a dispute, there will often be allegations of wrongful suspension and claims
for damages to compensate losses 5owing therefrom. The liability that may follow can

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be substantial and can include costs to complete Cconsidered later in this chapter2. A
contractual right to suspend work must therefore be e&ercised with caution.

TERYINATION OF CONTRACT AND CONSEQUENCES

]593
The right to terminate arises both contractually and at common law. Wn general, a party
may not unilaterally terminate without lawful reason. The main causes for termination
include repudiation, anticipated repudiation, serious breach, frustration, illegality, statutory
conferral of the right, or where contractually allowed. The burden of proving lawful
]513
termination lies on the party purporting to terminate the contract.

The conseFuences of termination may be deBned by the parties’ contract, but will otherwise
be sub'ect to the common law principles described below.

jhen a contractor accepts termination at common law for the owner’s conduct, for e&ample
by repudiation, nonEpayment or serious breach, there are three avenues of recovery availableY
damages, quantum meruit and a debt action for amounts payable at the time of termination.
A contractor is entitled to recover losses 5owing from termination of the contract to put
the contractor in the position it would be in had the contract been performed, including
reliance and e&pectation losses in accordance with general principles of the recoverability of
damages for breach of contract.

Alternatively, a contractor may seek to recover in quantum meruit, that is, on restitutionary
principles that a contractor is entitled to reasonable payment for work completed to the point
]403
of termination. A quantum meruit claim, however, is sub'ect to limitations prescribed in
]4j3
the contractual agreement, relinFuishes a contractor’s ability to claim loss of proBts on
]423
the remainder of work and reFuires the contractor to choose between making a claim for
]453
damages or quantum meruit.

jhen an owner accepts termination at common law for conduct of the contractor, it is
usually entitled to recover damages 5owing from the termination. ;or e&ample, if the owner
engages a new contractor to complete some work, the owner is generally able to claim
any increase in pro'ect costs associated with the new contractor against the defaulting
contractor by way of contractual rights, or BrstElimb damages under Hadley v. Baxendale
]443
for direct losses that naturally arise out of the breach. The owner is still under a duty
to mitigate its losses. A contractual power to terminate will usually dictate the rights of
owners and contractors, or if a clause does not prescribe the conseFuences of termination,
]463
claims for direct losses are usually implied into the contract. Wnsofar as liFuidated
damages, or secondElimb Hadley v. Baxendale damages for indirect losses that are within
the contemplation of both parties, are concerned, an owner’s right to liFuidated damages in
]473
general is valid until the point of termination. The parties may alter this right by agreement
in the terms of the contract. ‘n restitution grounds, and therefore separate to damages, an
owner may be entitled to recover overpayment to the contractor, provided the contractor has
]483
totally failed to deliver any consideration for the overpayment. Wn Australia, however, the
position is that the contract price will generally operate as a 3cap’ on the value, which can be
]493
recovered by a quantum meruit claim.

A contract may also be terminated on mutual terms, either by agreement or abandonment.

Wf a contract is terminated by mutual agreement, the procedure for doing so is dictated
by the contractual termsM however, parties may need to evidence some form of deed
]413
or consideration. Wf a contract is terminated by mutual abandonment, however, it is
necessary to show that one party has indicated it will not proceed with the contract Cin some

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cases, nonEperformance by both parties over a period is suLcient2 with the consent of the
]603
other.

As the right to termination appears both in contract and in common law, it is critical that the
parties make clear which route of termination is being pursued. Although the broad effect
of termination under both routes will align, the legal conseFuences and procedures that
accompany the termination will invariably differ.

RELIEF FOR FORCE YAWEURE

A contractor may seek an e&tension of time on the grounds of force majeure under most
]6j3
standard form contracts for ma'or construction work. The term force majeure is a
label that is used by contracting parties to refer to a supervening act or event beyond
the control of the parties. Iowever, this concept originates from ;rench civil law and is
not a recognised doctrine in Australian or Knglish law. Wn common law, it is a creature
of contract and will be interpreted by the ordinary rules of contractual interpretation. The
elements for a successful claim for relief will typically include that an event occurred that
was unforeseeable and beyond the reasonable control of either party. The threshold for a
force majeure claim, however, will usually be lower than that reFuired to invoke the doctrine
of frustration in common law. The party seeking relief will often be reFuired to comply with
notice reFuirements and mitigate the effects of the neutral delay events on the pro'ect.

DpeciBc e&amples of force majeure events that may affect energy pro'ects include sudden
shortages in the supply of labour or materials, labour strikes, weather conditions, economic
events and government actions. As mentioned earlier, a contractor’s entitlement to relief for
force majeure is founded solely in contract. The default allocation of neutral risks at common
]623
law falls against the contractor. As previously mentioned, however, in light of disputes
arising from delays associated with the covidE/J pandemic, later contracting parties are likely
to be more wary of the risks of force majeure events and should be careful to allocate risk
e&pressly in the contract.

COST

COST-RELATED RISM
The need to complete work within budget is known as the cost risk. Hro'ects for the
construction of energy facilities generally adopt a lumpEsum B&ed price contract structure,
which naturally places cost risk on the shoulders of the contractor. This fee will be based on
careful negotiation and cost assessment. 1onetheless, cost overruns will eat directly into
the contractor’s proBt margin.

There are two categories of e&ceptions to this default position. The Brst comprises cost
overruns that the law mandates will not be borne by the contractor. These may include
costs overruns 5owing from an owner’s acts of prevention or breach of contract. The second
category comprises cost overruns arising from neutral events for which the contractor is not
responsible according to the terms of the relevant contract. The parties are free during the
negotiation of the terms of the contract to allocate risk for neutral delays in whatever manner
they see Bt.

Additional costs incurred as a result of increases in the scope of work are dealt with
separately further below. (eaving scope changes aside, there are a multitude of issues that
can arise during the course of a pro'ect that result in in5ated costs, some of which arise

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from intentional conduct, others from factors that were completely unforeseeable. K&plored
immediately below are some of the common claims and issues that arise in this conte&t.

COST-RELATED DISPUTES

GENERAL DAYAGES
General damages seek to restore an aggrieved contractual party to the position he or she
]653
would have been in had the contract been properly performed. They are compensatory in
nature.

The seminal case of the modern understanding of general damages is the Knglish Iigh
]643
0ourt case of Hadley v. Baxendale. Do far as calculating damages is concerned, the 0ourt
established what is today referred to as the 3two limbs’ of damagesM direct losses Cthose that
arise naturally out of the breach2 and indirect losses Cthose that arise as a result of breach
and are said to be within the contemplation of both parties at the time of the contract’s
inception2.

These foundational principles provide the basis for a range of claim types, including for costs
of disruption, acceleration or prolongation as well as costs to correct or complete the work,
or both. Iowever, they are sub'ect to the aggrieved party’s obligation to take reasonable
]663
measures to mitigate its losses.

CONTRACTOR(S GLOBAL AND TOTAL COST CLAIYS

A contractor who suffers cost overruns as a result of events that are the responsibility
]673
of the owner may seek to recover these costs using the total cost method. This
allows causation of the various heads of loss to be proved collectively, when it would
]683
otherwise be impracticable to disentangle them. The principles of law governing total cost
]693
claims as espoused by the courts are many. ;our elements have emerged in 0anadian
'urisprudenceY

X that the contractor’s tender was reasonableM

X that the actual cost is fair and reasonableM
X that the overruns resulted from changes or overrunsM and
]613
X the lack of another practical method available to Fuantify the damages.

]703 ]7j3
;ormulations of the reFuirements in Australia, the énited Dtates and the énited
]723
Singdom are broadly consistent with this position. Wn all these 'urisdictions there is also
]753
an e&tremely high threshold to be met before a total cost claim will succeed. Accordingly,
it will be preferable in the ma'ority of cases for a contractor to particularise and separately
prove its heads of loss.

ACCELERATION DAYAGES
Acceleration claims arise when a contractor has incurred additional costs for e&pediting
construction. A decision to accelerate may be made pursuant to the owner’s instruction or
as a commercial decision when the contractor has not been given an e&tension of time and
believes that the costs of acceleration will be less than the liFuidated damages it must pay
for delayed completion. The Fuestion of whether the contractor is entitled to acceleration
costs is ultimately one of contractual interpretation, and depends on whether the contractor
or the owner is responsible for the need to accelerate.

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Wn general, acceleration costs are the total cost of performing the work in the accelerated
manner, less the costs of performing the work at the rate speciBed in the contract. Wt has
been recognised that the speciBc costs that may be incurred by a contractor accelerating
construction may include premium pay, costs of additional tools, eFuipment, labour and
]743
overtime. Therefore, it is critical that the contractor record all relevant costs incurred
during the accelerated period, such as the cost of additional resources and the amount of
overtime worked.

There is currently no consensus among relevant consultants, contractors and employers

concerning how acceleration claims should be calculated. Hossible methods include a global
cost or total cost approach, a time impact methodology, and formulaic approaches Cas
]763
speciBed in the contract2.

CONTRACTOR(S CLAIYS FOR LATENT CONDITIONS

A range of neutral issues lead to cost overruns Cand delay2. A few include unforeseen physical
ground conditions that are common given the often remote locations where energy facilities
are often built. These are known as latent conditions.

The meaning of latent condition and the availability of relief for the contractor will differ
between contracts. The time risk and cost risk associated with hidden ground conditions
will fall by default to the contractor, in the absence of contractual provisions stipulating
]773
otherwise. This is due to the assumption that a principal will select a contractor on
the basis of their e&pertise and, therefore, the contractor is better placed to assess the
ground conditions likely to be encountered. Iowever, the allocation of risk for latent defects
under several standard forms, including the ;WqW0 Duite, is sub'ect to an ob'ective test of
]783
whether the condition was reasonably foreseeable by an e&perienced contractor. This is
a comple& Fuestion for which a resolution may reFuire the e&pertise of an arbiter with an
]793
astute technical understanding.

LIYITATION, E[CLUSION AND INDEYNITk CLAUSES

(imitation and e&clusion of liability clauses are often featured in construction contracts to
protect a party from incurring e&cessive liability for delayed or defective performance.

A popular limitation or e&clusion clause is one that limits or e&cludes the recoverability
]713
of indirect or conseFuential losses. An aggrieved contractor may thereby be limited to
]803
claiming direct losses. The characterisation of losses as direct or indirect will often be a
point of contention between disputing parties, and so astute contract drafters will often be
e&plicit in what type of loss is not recoverable, for e&ample, by listing loss of earnings as an
e&cluded or limited loss.

Wn a similar vein, construction contracts may also feature indemnity clauses that oblige
one party to reimburse another in circumstances in which the latter suffers losses arising
from a speciBc event, usually thirdEparty actions. These indemnity clauses will often be
present in contracts between owner and contractor or in between a head contractor and
subcontractors and, like limitation or e&clusion clauses, assist with risk allocation in the
contract. ;or e&ample, indemnity clauses may be used to indemnify the owner for claims
by third parties against the owner arising out of the contractor’s construction of the asset. Wt
follows that when designing indemnity clauses, it is crucial that the parties clearly stipulate
the scope and the e&tent of the indemnity that is intended.

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K&clusion of liability and indemnity clauses will be given the ordinary meaning, but in the
]8j3
event of ambiguity, will be interpreted contra proferentem.

QUALITk

QUALITk RISM
A further fundamental risk in construction relates to defects in a contractor’s performance
or in the ultimate facility under construction. The risks associated with Fuality fall broadly
into two categoriesY C/2 the risk that performance does not comply with e&press contractual
stipulations for materials and workmanship Ccommonly by reference to accepted industry
standards, for e&ample the internationally recognised standards set by the Wnternational
‘rgani7ation for Dtandardi7ation2M and C62 the risk that the ultimate facility is not Bt for
purpose Ci.e., suitable to meet targets and earn revenue upon completion2. “uality risks are
particularly pertinent given the rapid development of new technologies involved in renewable
energy pro'ects. These risks involve technical inFuiries that are often within the purview of
an independent pro'ect engineer.

énderlying these risks most commonly are issues in design, materials and workmanship.
Uore subtle factors that are also relevant to consider include the risk that a poorly conceived
delivery structure will cause challenges in delivering a compliant facility, as well as cultural
differences between the parties that can have an impact from the time of parties meeting
at the negotiating table through to activities at the site and thereafter Csuch as language
barriers, business culture clashes, legal customs and heritage2.

The adverse conseFuences of poorEFuality construction of energy facilities are wideEranging.

Wf defects lead to output falling short of production targets, this can result in thirdEparty
liability on the part of the pro'ect owner to an offtake partner or Bnancier. jhen ma'or pro'ects
for national infrastructure are involved, the risks can be magniBed and shortfalls in power or
water supply may have repercussions for local industry and communities. The owner may
seek indemnities from the contractor, or otherwise pursue a claim for damages against him
or her in respect of thirdEparty liabilities.

QUALITk-RELATED DISPUTES

BREACZ OF CONTRACTUAL STANDARDS OR FITNESS FOR PURPOSE

Wf a contract includes a Btness for purpose obligation, the contractor must ensure that
the completed works will be Bt for their intended purpose. Wn construction pro'ects where
the contractor was also procured to undertake the design phase, this Fuality standard is
]823
usually implied into the contract. To avoid ambiguity, best practice dictates that the owner
should specify e&pressly in clear terms the essential reFuirements for the ultimate pro'ect
facility. Dome desired purposes are capable of deBnite assessment, e&amples being having
]853
a design life of a certain number of years or particular outputs from the construction
of a power plant. Wn other cases, however, the contract may reFuire the pro'ect to have the
capacity to achieve certain results in a range of conditions. qeterminations that materials or
workmanship breach speciBed contractual standards, on the other hand, entail a comparison
against a B&ed baseline. This is a technical inFuiry of fact in the Brst instance, but the issue
of remedies for breaches of building and design standards involves additional Fuestions of
contract and law that are addressed below.

A particular source of tension that may arise in this area is in the con5ict between
design life and design standards where these two reFuirements are not strictly aligned

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Cfor e&ample, if the design life reFuirement obliges the contractor to go beyond the design
standards speciBcations2. This is of pertinence in energy construction pro'ects where design
reFuirements and speciBc purposes will often be stipulated. Wndeed, a con5ict between such
design speciBcations and design life provisions seemed to arise in MT Højgaard A/S v. E.ON
]843
Climate & Renewables, wherein a speciBed design for the foundation of a wind turbine
was unable to fulBl Cunbeknown to the contractor2 a stipulated design life of 6- years. Wn that
case, it was held these reFuirements were not incompatible but additional. 1evertheless,
the interplay of design reFuirements and purpose obligations must be considered by parties
when allocating risk within the contract, bearing in mind that performance obligations will
often be prioritised in con5icts with design speciBcation obligations.

PROWECT ENGINEER OR CONTRACT ADYINISTRATOR

The pro'ect engineer is freFuently the neutral arbiter called upon to resolve disputes about
Fuality at the pro'ect site, armed with the power to issue certiBcates as to time, cost and
Fuality. The status of that certiBcate will be determined in the Brst instance by contract, but
also in accordance with applicable rules of law.

Wmportant aspects of the pro'ect engineer’s role include the followingY

X The duty of independence and impartiality. This manifests both in various standard
form contracts and at common law. Wt is a Fuintessential duty of a decision maker
to avoid con5icts of interest and associations that might give rise to bias or the
appearance of bias. A breach of these reFuirements can have the effect of invalidating
certiBcates for payments, certiBcates as to the achievement of milestones or
certiBcates as to the Fuality of work.
X Acting in accordance with procedural fairness, by affording due process and a right
to be heard to each party interested in the outcome of a decision. Iowever, this right
may be curtailed or eliminated when the contract so provides.
X The potentially Bnal and binding nature of certiBcates. The character of engineers’
certiBcates is a Fuestion of interpretation of the contract terms and, speciBcally,
whether the parties intended an engineer’s or administrator’s certiBcation to be a
Bnal and binding determination of Fuality of work Cor other contractual milestone2.
Wf indeed this is found to be the case, grounds for challenging the Fuality of work will
depend on a party’s ability to overturn the certiBcate on one of several narrow grounds
of appeal, which may include a manifest error, fraud, bad faith or gross negligence.
Harties may wish to specify in their contracts the grounds on which the certiBcate may
be revoked. jhen a Bnal and binding certiBcate protects an engineer from challenge
by a contractor, the owner may still be entitled to claim damages against the engineer
for breach of contract or negligence for careless errors in the certiBcation process.

The above three points provide fertile grounds for challenges to certiBcates as to the Fuality
of work.

DEFECTS LIABILITk PERIOD

]863
A common feature in construction contracts is a 3defects liabilityVnotiBcation period’,
within which an owner can direct a contractor to remedy any defects in the work brought to
the contractor’s attention. The contractor will need to comply with a properly made reFuest
to avoid breaching the contract.

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The right of an owner to have a contractor cure defects within this period is sub'ect to such
notice reFuirements as may be speciBed in the contract, and to principles of waiver and
estoppel that may preclude an owner from directing the contractor to correct defects to
which the owner has previously, by words or conduct, acFuiesced.

LATENT DEFECTS
A latent defect, as the name suggests, is a hidden defect that could not have been discovered
at the time of the pro'ect’s handover with reasonable inspection. Duch a defect may manifest
itself many years later and thus demonstrate an earlier breach of contract by the contractor.
A prominent e&ample is combustible cladding, which caused the Bre at Grenfell Tower in
]873
(ondon in 6-/ó and the Uelbourne (acrosse )uilding ;ire in 6-/x. The key issue with
latent defects is that the defects liability period will most likely have concluded, so the
owner does not have a right to reFuire the contractor to remedy the work under the relevant
contractual clause. The owner may pursue a claim for damages in tort or contract, sub'ect
to potential time bars under statutes of limitations. Iowever, some 'urisdictions, including
Australia and the énited Singdom, do not recognise a common law duty of care owed by
builders to subseFuent purchasers in pure economic loss cases, such as a claim for the cost
]883
of rectifying the defect or for diminution in building value. Wn those circumstances, there
]893
may be statutory regulations that allocate liability.

OVERVIEK OF REYEDIES FOR DEFECTIVE KORM

Dub'ect to applicable terms of contract, the following remedies are available to an owner in
respect of defective construction servicesY

X qamages amounting to the cost of rectifying the defective work are the primary
remedy available to an owner. An important FualiBcation of this remedy is that
awarding damages in the sum of rectiBcation costs must not be unreasonable
having regard to the cost and beneBt of undertaking the work. This inFuiry
into reasonableness involves a broad discretion to take into account all relevant
circumstances, but will reFuire consideration of whether the aggrieved party suffers
real loss, and whether the cost of remedial work is disproportionately large
]813
compared to the cost of the original work. Wmportantly, it reFuires an inFuiry into
]903
3reasonableness in relation to the particular contract and not at large’.
X DpeciBc performance, as a remedy reserved for the e&ceptional circumstances where
an award of damages would be inadeFuate Cfor e&ample, when urgent repair work is
needed and the contractor is the only party capable of performing the work within the
]9j3
reFuired time2.
X ‘ther categories of damages may be sought for losses and liabilities incurred as
a result of the contractor’s defective performance grounded in ordinary principles
of recovery for breach of contract. This may include delay claims and claims for
additional costs, as covered earlier in this chapter.

Also relevant are the laws of waiver and estoppel as they apply to potential acFuiescence by
the owner to defects in the contractor’s work, by words or conduct.

SCOPE

SCOPE RISM

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The scope of work that the contractor is reFuired to complete is generally conceived
prior to the bid phase of a pro'ect. At this stage, the task entails the selection of a
procurement methodology and the speciBcation of core functions and performance criteria
for the endEuse facility. Wn pro'ects for the construction of energy facilities, this will generally
reFuire designation of a design and construct or turnkey methodology, identiBcation of the
key features and layout, and speciBcation of reFuired output capacity Ce.g., megawattage
generated by a power plant, or barrels produced by oil platforms and pipelines2. These
criteria will then be formalised, in as much detail as the owner desires, in the Bnal contract
documentation. Wn the ;WqW0 and W00 standard forms, these are known as the employer’s
]923
reFuirements.

A risk tradeEoff occurs at this pointY more detail in the employer’s reFuirements results in less
5e&ibility for the contractor in performance and therefore a greater risk of change orders.
The less detail in the employer’s reFuirements, the less likelihood of change orders but the
greater risk that the contractor in performing will produce an ultimate work that does not
]953
Fuite Bt the owner’s desired facility.

To whom does the risk of changes in scope fall# A perfunctory response might be that the
risk in a B&edEfee turnkey pro'ect lies entirely with the contractor to take such steps as are
necessary to complete the facility in a timely manner for the agreed sum. That might be
true in the hypothetical situation in which an employer perfectly deBnes the scope of work in
the technical documents. The position is complicated, however, if there are inconsistencies,
shortcomings or deBciencies in the designs or other speciBcations provided by the owner,
as is often the case.

These issues are addressed through riskEallocation provisions and contractual clauses that
facilitate variations and change orders where necessary. The risk of scope changes arising
from shortcomings in the technical information provided by the owner can be allocated in
one of three waysY

X strictly against the contractor, as occurs under the 6-/ó ;WqW0 Dilver )ook, which
reFuires the contractor to warrant that it has scrutinised the employer’s reFuirements
and is responsible for the accuracy of information in them Ce&cept for such
information as it is not possible for the contractor to verify2 C0lause z./2M
X strictly against the owner, who is held responsible for errors in design and data,
therefore granting the contractor a right to added time and payment for the scope
change Cas is the case under the $0T qesign and )uilding 0ontract, 0lause 6./2M or
X balanced, so that a contractor may point out errors in the employer’s design and
data and will have a contractual mechanism to seek additional time and payment for
]943
additional work Cas is the case under the ;WqW0 Qellow )ook, 0lauses z./ and /92.

SCOPE-RELATED DISPUTES
Wf an owner denies a proper claim by a contractor for additional time and payment for
outEofEscope work, an arbitrator may grant the following remedies in the conte&t of a later
disputeY

X the contractor may claim sums for the cost of the work and an allowance for proBt in
]963
quantum meruitM and
X

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where the contract has an e&tension of time clause, the contractor will be granted
an e&tension in respect of the delay resulting from the outEofEscope work Cthereby
reducing the contractor’s liability for delayErelated damages2M or
X where the contract does not have an e&tension of time clause, the variation may be
construed as an act of prevention by the owner that will disentitle it altogether from
claiming liFuidated damages for delay Csee earlier discussion regarding the operation
of the prevention principle2.

The Fuantum of outEofEscope work and the amount of time reFuired to complete such work
can be a source of contention in construction disputes. They often need to be resolved with
the assistance of evidence from e&perts in matters of Fuantum and construction scheduling.
The pricing of additional outEofEscope work is generally done by reference to either the agreed
rates for work used for tender pricing, or another schedule of rates agreed between the
parties for the work. Alternatively, the contractor may be entitled to a fair valuation of its
]973
costs if reasonably and properly incurred.

POLITICAL, ECONOYIC AND SOCIAL

Holitical, economic and social factors can have a Bnancial impact on parties to energy
pro'ects, owner and contractor alike. These factors are closely intertwined. Holitical decisions
are made based on economic and social considerations leading to legal changes. Three
manifestations of these risks that arise from time to time in energy pro'ects, and are
accordingly considered, areY

X Risk / – changes in applicable lawsY including changes in subsidies or ta&

arrangements, local content reFuirements, local labour laws, tariffs and other terms
of trade.
X Risk 6 – contractor price risk arising from changes in the market for supplies needed
for construction.
X Risk 9 – owner price risk arising from changes in the market price of the energy
commodity to be produced.

Recovery for losses 5owing from these risks will only be possible if a contractual right of
recovery or contract price ad'ustment has been negotiated and agreed between the parties.
This reFuires a commercial decision by the partiesY whether risk from political, economic
]983
and social factors should be left to lie where it falls or be allocated between them.

Turning to Risk /, the parties’ interests are best served when the performance of the pro'ect
remains a viable and proBtable endeavour for both. This ensures timely completion to the
reFuisite standard. quring the multiple years that a ma'or energy construction pro'ect can
run, there is a substantial risk of adverse changes to local laws and regulatory frameworks
]993
that may create an imbalance in a contract. ‘ften it will be the wish of the parties that
such a risk not be left to chance. The risk will be allocated so that a contractor will beneBt
from an increase in the contract price to account for additional costs resulting from changes
in applicable laws. Wn return, the contractor will account for part of any windfall resulting from
a beneBcial change in the law. Thus, both parties’ interests are protected and the uncertainty
associated with a change of law is hedged. This same approach applies to risks of adverse
changes in ta& rates, tariffs and subsidies.

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This allocation can be achieved in two waysY through a general provision of risk transfer, or
a riskEspeciBc clause.

The Brst type is a general provision protecting against an adverse change in applicable laws.E
]913
This leaves open to potential dispute whether the change is a change of applicable law,
which will depend on the deBnition of applicable law. This often raises Fuestions of whether
a change is a change of mere policy, a change in a private agreement between a pro'ect party
and a government agency, or a genuine change in the law. Another element that can arise
is whether the change in law was foreseeable and therefore e&pected by the parties at the
time the contract was negotiated and agreed.

The second type consists of speciBc provisions that protect against these risks. ‘ne e&ample
]103
is a change in local content reFuirements, which reFuire international companies to use
a minimum level of local labour Cor otherwise no more than a ma&imum percentage of
foreign labour2. This seeks to preserve local social standards and economies, and achieve
sustainability. (ocal content may be cheaper or more e&pensive than imported labour. There
are a multitude of other risks of legislative change that the parties may speciBcally wish to
include in their allocation of risk. This avoids surprises at a later stage that may 'eopardise
the Bnancial viability of the pro'ect for one of the parties.

As to Risks 6 and 9, price risk will lie where it falls by default. Again, however, if the parties wish
to eliminate this element of uncertainty, they can hedge the risk through contract drafting.
Hart of any windfall or loss to a party can be shifted to the other to maintain a balanced
Bnal outcome in a multiEyear pro'ect. The need for the parties to manage this risk becomes
more clearly pronounced in pro'ects whose performance spans many years. The volatility of
market prices for materials, eFuipment and commodities, if left unchecked, has the potential
to throw the commercial terms of the negotiated contract out of balance. There are a number
of ways this can be addressed. A schedule of prices may be set out in a contract with
provision made for ad'ustments in the contract price for movements in e&cess of a certain
limit. Alternatively, a contract may make more general provision for economic rebalancing
of a contract at a later date.

CONCLUSION
As is clear, the issues that arise in construction arbitrations concerning energy facilities
consist of the same fundamental claims, contractual issues and legal principles as the
broader world of construction disputes. The energy industry brings with it additional
comple&ity in the form of international players and risks, economic and political forces at
an international level, and strict productionEdriven scheduling and performance. The risks
associated with energy construction have also rapidly evolved in recent years in light of the
covidE/J pandemic and the need to address the changing climate in the development of the
modern energy economy. This chapter has sought to provide a brief introduction to many of
these issues and the associated commercial risks.

ENDNOTES
]j3
qoug $ones A‘ is an independent international arbitrator. The author gratefully
acknowledges the assistance provided in the preparation of this chapter by his legal
assistants, Rebecca <hong and )rendan ‘fner.

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]23
Wnternational Knergy Agency, 3Sey jorld Knergy Dtatistics’ C6-6/2, at 9xM énited 1ations
qepartment of Kconomic and Docial Affairs, 3Knergy Dtatistics Hocketbook’ C6-662, at /.
]53
Wnternational Knergy Agency, 3jorld Knergy ‘utlook’ C6-692, at °/M Wnternational Knergy
Agency, 3jorld Knergy ‘utlook’ C6-662, at °° to J6.
]43
Wnternational Knergy Agency, 3jorld Knergy ‘utlook’ C6-692, at z9 to z4.
]63
Dee, e.g., 0‘H64 Glasgow 0limate HactM Wn5ation Reduction Act C6-662 in the énited Dtates
of AmericaM RKHowerKé C6-662 in the Kuropean énionM /xth ;iveEQear Hlan C6-662 in 0hinaM
The )asic Holicy for the Reali7ation of G_ C6-662 in $apan.
]73
Wnternational Knergy Agency, 3Knergy Dtatistics qata )rowser’ C6-692.
]83
id.
]93
Wnternational Renewable Knergy Agency, 3Renewable 0apacity Iighlights’ C6-692, at 6.
]13
Dchool of Wnternational Arbitration, “ueen Uary éniversity of (ondon, 36-/° Wnternational
Arbitration DurveyY The Kvolution of Wnternational Arbitration’ C6-/°, Durvey2, at 9-.
]j03
W00 0ommission, 3Resolving 0limate 0hange Related qisputes through Arbitration and
AqR’ C6-/J2, at /9.
]jj3
Dee 0lause 6/.4 of these contract forms.
]j23
Dee, e.g., ‘ption j9 of the 1ew Kngineering 0ontract, xth edition ¶1K0xä contract forms.
]j53
The Wnternational ;ederation of 0onsulting Kngineers ¶;WqW0ä 6-/ó Duite, 0lauses °.6 and
°.9M 1K0x, 0lauses 9- and 9/.
]j43
Cavendish Square Holding BV v. Talal El Makdessi M ParkingEye Limited v. Beavis ¶6-/zä
éSD0 4ó.
]j63
Paciocco & Anor v. Australia and New Zealand Banking Group Limited ¶6-/4ä I0A 6°
¶Pacioccoä.
]j73
127 Hobson Street Limited v. Honey Bees Preschool Ltd ¶6-6-ä 1<D0 z9.
]j83
Although, critically, Paciocco differed on the application of the penalties doctrine in eFuity
to nonEbreaches of contract. Paciocco followed the approach in Andrews v. Australia and
New Zealand Banking Group Ltd ¶6-/6ä I0A 9-, in which it was held that a breach of contract
was not necessary to enliven the penalties doctrine, diverging here from the Knglish approach
in Cavendish.
]j93
Clydebank Engineering and Shipbuilding Co v. Don Jose Ramos Yzquirdo y Castaneda
¶/J-zä A0 4M Dunlop Pneumatic Tyre Co Ltd v. New Garage Motor Co Ltd ¶/J/zä A0 óJ.
]j13
;or an inEdepth consideration of the penalties doctrine across 'urisdictions, see qoug
$ones, 31avigating Henalties and (iFuidated qamages across 0ommon (aw and 0ivil (aw
$urisdictions’ C6-/J2, at 94Cx2, in The International Construction Law Review, z64.
]203
McAlpine Humberoak v. McDermott International C/JJ62 z° )(R /, 6/ C(loyd ($2.
]2j3
Baese Pty Ltd v. RA Bracken Building Pty Ltd C/J°J2 z6 )(R /9-, /9J CGiles $2.
]223
North Midland Building Ltd v. Cyden Homes Ltd ¶6-/°ä Kj0A 0iv /óxxM Multiplex
Constructions (UK) Ltd v. Honeywell Control Systems Ltd (No. 2) ¶6--óä )(R /JzM Gaymark

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 RETURN TO CONTENTS RETURN TO SUYYARk

Investments Pty Ltd v. Walter Construction Group Ltd ¶/JJJä 1TD0 /x9. ;or an inEdepth
consideration of these issues, see my article, qoug $ones, 30an Hrevention )e 0ured by
Timebars’ C6--J2, International Construction Law Review, zó.
]253
Probuild Constructions (Aust) Pty Ltd v. DDI Group Pty Ltd ¶6-/óä 1Dj0A /z/.
]243
Dee Interfoto Library Ltd v. Stiletto Visual Programmes Ltd ¶/J°°ä / All KR 9x°, 9z6 to 9z9
C)ingham ($2.
]263
0ontract (aw of the Heople’s Republic of 0hina CAdopted at the Decond Dession of the
1inth 1ational Heople’s 0ongress on /z Uarch /JJJ and promulgated by ‘rder 1o. /z of the
Hresident of the Heople’s Republic of 0hina on /z Uarch /JJJ2 Art. //xM Sorean 0ivil 0ode
Art. 9J°E6.
]273
German 0ivil 0ode C)G)2 D. 6°-C/2M ;rench 0ivil 0ode Art. //xó.
]283
Buildability Ltd v. O’Donnell Developments Ltd ¶6-/-ä )(R /66M Ho Pak Kim realty Co Pte
Ltd v. Revitech Pte Ltd ¶6-/-ä DGI0 /-4.
]293
Baulderstone Hornibrook Pty Ltd v. Qantas Airways Ltd ¶6--9ä ;0A /óx, ¶/--äM Kay Lim
Construction & Trading Pte Ltd v. Soon Douglas (Pte) Ltd ¶6-/6ä DGI0 /°4, ¶ó6ä.
]213
Dee Dociety of 0onstruction (aw, 3qelay and qisruption Hrotocol’ C6nd ed, ;ebruary 6-/ó2,
at ¶/°.9ä to ¶/°.xä.
]503
id., at ¶/°.xä.
]5j3
id. Dee, e.g., 1K0x, 0lause 6z.9.
]523
Dee The Dociety of 0onstruction (aw, 3qelay and qisruption Hrotocol’ C6nd ed, ;ebruary
6-/ó2, at ¶/°./6ä.
]553
Dee Clark Concrete Contractors, Inc v. General Services Administration, GD)0A /x9x-,
JJ–/, ).0.A. 9-, 6°-, /JJJ j( /x9Jóó C/JJJ2, cited in $eff ;uchs and Tong <hao, 3qisruptionY
Technical CKvaluation of 0ausation and “uantiBcation Uethods’ in Sim Rosenberg, Krin Uiller
Rankin and )ryan qayton Ceds2, Dealing with Delay and Disruption Cforthcoming, Dweet P
Ua&well2 6ó9, 6°ó.
]543
jiley R jright WWW and Uark )aker, 3qamages in 0onstruction Arbitrations’ in $ohn A Trenor
Ced2, The Guide to Damages in International Arbitration C(aw )usiness Research, (ondon,
6-/42.
]563
;WqW0 Duite 6-/ó, 0lause /4./.
]573
Carillion Construction Ltd v. Felix (UK) Ltd ¶6--/ä )(R /, ¶9xäM Longyuan-Arrk (Macao) Pte
Ltd v. Show and Tell Productions Pte Ltd ¶6-/9ä DGI0 /4-, ¶ózä.
]583
Wui Fu Development Co Ltd v. Tak Yuen Construction Co Ltd ¶/JJJä IS0;W J9.
]593
Dee ;WqW0 Duite 6-/ó, 0lause /z CTermination by Kmployer2 and 0lause /4.6 CTermination
by 0ontractor2.
]513
Urban I (Blonk Street) Ltd v. Ayres ¶6-/9ä Kj0A 0iv °/4, ¶zzä.
]403
Heyman v. Darwins Ltd ¶/Jx6ä A0 9z4M Len Lichtnauer Developments Pty Ltd v. James
Trowse Constructions Pty Ltd ¶6--zä “0A 6/xM Sopo v. Kane Constructions Pty Ltd (No. 2)
¶6--Jä :D0A /x/, ¶zäM Mann v. Paterson ¶6-/Jä I0A 96.

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]4j3
Mann v. Paterson ¶6-/Jä I0A 96, ¶/xäM Heyman v. Darwins Ltd ¶/Jx6ä A0 9z4.
]423
As a quantum meruit claim acts as an alternative to a damages claim.
]453
United Australia Ltd v. Barclays Bank Ltd ¶/Jx/ä A0 /, 6J to 9-.
]443
¶/°zxä KjI0 $ó-.
]463
McNab NQ Pty Ltd v. Walkrete Pte Ltd ¶6-/9ä “D0 /6°, ¶6Jä.
]473
Bluewater Energy services BV v. Mercon Steel Structures BV ¶6-/xä KjI0 6/96 CT002,
¶z64ä.
]483
DO Ferguson & Associates v. Sohl C/JJ62 46 )(R Jz.
]493
Mann v. Paterson ¶6-/Jä I0A 96, ¶/-/ä, ¶6-zä. 1ettle, Gordon and Kdelman $$ refer to
e&ceptional circumstances in which it may be necessary or appropriate that the value of the
work be determined without reference to contract price, including when there is no e&pressly
stipulated contract priceY at ¶6-9ä.
]413
Commodore Homes WA Pty Ltd v. Goldenland Australia Property Pty Ltd ¶6--óä jAD0
/x4 ¶96ä.
]603
Eastgate Properties Pty Ltd v. J Hutchinson Pty Ltd ¶6--zä “D0 /J4, ¶z6äM Letizia Building
Co Pty Ltd v. Redglow Asset Pty Ltd ¶6-/9ä jAD0 /ó/, ¶//4ä.
]6j3
Dee, e.g., $0T qesign and )uild 0ontract 6-/4, 0lause 6.6z./xM 1K0x, 0lauses /J, 4-./C/J2M
;WqW0 Red )ook 6-/ó, 0lauses /°./ to /°.4.
]623
Dee foundational case of Company of Proprietors of the Brecknock and Abergavenny
Canal Navigation Co v. Pritchard C/óJ42 4 TR óz-.
]653
Robinson v. Harman C/°x°2 /zx KR 949, 94zM Clark v. Macourt ¶6-/9ä I0A z4, ¶óäM Bunge
SA v. Nidera BV ¶6-/zä éSD0 x9, ¶/xäM MFM Restaurants Pte Ltd v. Fish & Co Restaurants Pte
Ltd ¶6-/-ä DG0A 94, ¶zxä to ¶z4ä.
]643
¶/°zxä KjI0 $ó-.
]663
Lagden v. O’Connor ¶6--xä / A0 /-4ó, /-óó to /-°°.
]673
;or a detailed analysis of total cost claims, see Dteven Dtein and Qelena Archyan, 3The
Total 0ost UethodY Ws it qead Qet# A 0rossE$urisdictional 0omparative Analysis’ ¶6-/4ä, The
International Construction Law Review, x9-.
]683
Golden Hill Ventures Ltd v. Kemess Mines Inc ¶6--6ä )0D0 /x4-.
]693
Walter Lilly and Company Ltd v. Giles Patrick Cyril Mackay ¶6-/6ä KjI0 /óó9 CT002.
]613
Eco-Zone Engineering Ltd v. Grand Falls-Windsor (Town) ¶6--zä 1(Tq /Jó, ¶69°ä.
]703
DM Drainage & Constructions Pty Ltd v. Karara Mining Ltd ¶6-/xä jAD0 /ó-, ¶JJä.
]7j3
Baldi Bros Constructors v. United States, z- ;ed 0(, óx C6--/2.
]723
Walter Lilly and Company Ltd v. Giles Patrick Cyril Mackay ¶6-/6ä KjI0 /óó9 CT002M
William Clark Partnership Ltd v. Dock St PCT Ltd ¶6-/zä KjI0 6J69 CT002.
]753
Dee Mainteck Services Pty Ltd v. Stein Heurtey SA ¶6-/xä 1Dj0A /°x, ¶/J/ä to ¶/J6äM Neal
& Co v. US, 94 ;ed. 0l. 4-- C/JJ42, cited in $ohn ) Tieder $r, 3Total 0ost and UodiBed Total

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0ost 0laims in the énited Dtates’ CDpeech, qR); /9th Annual Wnternational 0onference P
Training jorkshop, 6 to x Uay 6-/92.
]743
‘verton 0urrie, 3Avoiding, Uanaging and jinning 0onstruction qisputes’ ¶/JJ/ä, The
International Construction Law Review, 9xx, 94J.
]763
H R qavison, 3Kvaluating 0ontract 0laims’, ‘&ford C)lackwell, 6--°2.
]773
Thorn v. London Corporation C/°ó42 / App 0as /6-M Worksop Tarmacadam Co Ltd v.
Hannaby (CA) C/JJz2 44 0on (R /-zM Thiess Services Pty Ltd v. Mirvac Queensland Pty Ltd
C6--42 66 )0( x9ó.
]783
;or a detailed discussion of latent conditions, see Gordon Dmith, 3(atent 0onditions and
the K&perienced 0ontractor Test’ ¶6-/4ä, International Construction Law Review, 9J-.
]793
éS cases on latent conditions include Obrascon Huate Lain SA v. Her Majesty’s Attorney
General for Gibraltar ¶6-/xä KjI0 /-6° CT002, and Van Oord UK Ltd and SICIM Roadbridge
Ltd v. Allseas UK Ltd ¶6-/zä KjI0 9-óx.
]713
;WqW0 Duite 6-/ó, 0lause /ó.4.
]803
Aquatec-Maxcon Pty Ltd v. Barwon Region Water Authority ¶6--4ä :D0 //ó ¶/-9ä.
]8j3
Elvanite Full Circle Ltd v. AMEC Earth & Environmental (UK) Ltd ¶6-/9ä KjI0 //J/ CT002,
¶6JóäM Erect Scaffolding (Australia) Pty Ltd v. Sutton ¶6--°ä 1Dj0A //x, ¶°óä.
]823
McKone v. Johnson ¶/J44ä 6 1DjR xó/, xó6 to xó9M Jurong Towen Corp v. Sembcorp
Engineers & Constructors Pte Ltd ¶6--Jä DGI0 J9, ¶óä. Dee ;WqW0 Duite 6-/ó, 0lause x./.
]853
Although this has been interpreted as an appro&imate lifetime following MT Højgaard A/S
v. E. On Climate & Renewables UK Robin Rigg East Ltd ¶6-/zä Kj0A 0iv x-ó.
]843
MT Højgaard A/S v. E.ON Climate & Renewables ¶6-/óä éSD0 zJ. Dee also SSE Generation
Ltd v. Hochtief Solutions AG and Another (CSOH) ¶6-/4ä 0D‘I /óó C0DWI2M 125 OBS
(Nominees 1) and Another v. Lend Lease Construction (Europe) Ltd and Another (QBD (TCC))
¶6-/óä KjI0 6z CT002.
]863
Dee, e.g., ;WqW0 Duite 6-/ó, 0lause //.
]873
Uatthew )ell, 3?Iow is that Kven Hossible#% Raising 0onstruction Regulation from the
Ashes of Grenfell Tower’ C6-/°2, 9zC92, The International Construction Law Review, 99x.
]883
Brook6eld Multiplex Ltd v. Owners Corporation Strata Plan 812 C6-/x2 6zx 0(R /°zM
Woolcock Street Investments Pty Ltd v. CDG Pty Ltd C6--x2 6/4 0(R z/zM Thomas & Anor
v. Taylor Wimpey Developments Ltd & Ors ¶6-/Jä KjI0 //9x CTechnology P 0onstruction
0ourt2.
]893
Dee, e.g., )uilding and ‘ther (egislation C0ladding2 Amendment Regulation 6-/° C“ld2.
]813
Scott Carver Pty Ltd v. SAS Trustee Corporations ¶6--zä 1Dj0A x46, ¶x4ä.
]903
Ruxley Electronics Ltd v. Forsyth ¶/JJ4ä A0 9xx, per (ord $auncey.
]9j3
Taylor Woodrow Construction (Midlands) Ltd v. Charcon Structures Ltd C/J°62 ó 0on (R
/ C0A2.
]923
;WqW0 Duites 6-/ó, 0lause /./.9/.

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]953
;or a discussion of the risk tradeEoff in deBning the employer’s reFuirements, see Kric
Kggink, 30orrect scoping of Kmployer’s ReFuirementsY The Hrevention of 0hange ‘rders#’
¶6-/óä, The International Construction Law Review, x.
]943
A comprehensive work on variations to the scope of work is Uichael Dergeant and Ua&
jielic7ko,Construction Contract Variations CWnforma (aw from Routledge, 6-/x2.
]963
Dee Miccon Hire Pty Ltd (in liquidation) v. Birla Mt Gordon Pty Ltd ¶6-/9ä “D0 /9J, ¶96ä.
]973
Weldon Plant Ltd v. Commission for the New Towns ¶6--/ä / All KR C0omm2 64x, ¶/zä.
]983
The Brst and second of these risks arise from e&press policy decisions by the government
of the 'urisdiction where the pro'ect is located. Accordingly, changes in policy that adversely
affect pro'ect participants may be the sub'ect of an investorEstate claim under an applicable
investment treaty. As stated earlier, this chapter is not concerned with the potential
investorEstate implications, but rather the signiBcance of these issues between contracting
parties seeking to achieve an optimal allocation of risk between them.
]993
;or e&ample, the recent decision of the 0ourt of $ustice of the Kuropean énion inE
Slovak Republic v. Achmea BV, in which the 0ourt held that the arbitration clause under
a 1etherlands–Dlovakia bilateral investment treaty, and implying that arbitrations under
intraEKé bilateral investment treaties more generally, were incompatible with Ké law. This
has led to concerns as to whether arbitral awards rendered under the Knergy 0harter Treaty
are also unenforceableY see $ Robert )asedow, 3The Achmea $udgment and the Applicability
of the Knergy 0harter Treaty in WntraEKé Wnvestment Arbitration’ C6-6-2 69C/2, Journal of
International Economic Law, 6ó/.
]913
Dee, e.g., $0T qesign and )uild 0ontract 6-/4, 0lause 6.64./6M 1K0x ‘ption _6, 0lause
/ó.6M ;WqW0 Red )ook 6-/ó, 0lause /°.4.
]103
;or a discussion of local content laws in Africa, see e.g., Wbironke T. ‘dumosuEAyanu,
3;oreign qirect Wnvestment 0atalysts in jest AfricaY Wnteractions with (ocal 0ontent (aws
and WndustryE0ommunity Agreements’ C6-/62 9zC/2 1orth 0arolina 0entral (aw Review 4zM
)artrand Uontembault, 3Dtate Dovereignty in Wnternational Hro'ects Takes on a 1ew (uster’
C6-/92 International Business Journal 6°°, 6JJ to 9--.

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Offshore Vessel
Construction Disputes
Wames Brown, Killiam Cecil and Andreas Dracoulis
Haynes and Boone, LLP

Summary

KZk PARTIES CZOOSE TO ARBITRATE

ARBITRATING UNDER TZE LYAA TERYS

TkPES OF DISPUTES ARISING FROY TZESE PROWECTS

STRATEGIES FOR SUCCESS IN TZE ARBITRATION OF DISPUTES

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Wt was not until the late /Jó-s that deepEwater offshore oil and gas e&ploration became
signiBcantly viable. The driver was the everEincreasing demand for oil and gas products,
which provided the opportunity to raise the capital necessary to design and then build the
incredibly comple& 5oating assets needed to e&plore for, and then produce, oil and gas in
such hostile environments.

Today, it is not unusual for oil and gas drilling and production to be undertaken in water to
depths in e&cess of /-,--- feet. The units that undertake this work are incredibly comple&
feats of engineering and may take up to three years to construct. 0ertainly at the peak of the
market, the most comple& and technologically advanced new build units cost at least éD8/
billion to construct.

The offshore oil and gas industry today, however, reFuires more than merely the deployment
of drilling units for its operation. The industry now reFuires a full range of vessels to support
it, including 5oating production storage o"oading C;HD‘2, 5oating storage units C;Dés2,
accommodation vessels C5oatels2, heavyElift vessels, pipeElaying vessels and myriad support
vessels.

Herhaps unsurprisingly, it is the largest and most sophisticated commercial shipEbuilding

yards that moved into the construction of offshore oil and gas 5oating units. Wncentivised
by the potentially lucrative nature of building these types of assets, it has tended to be the
shipyards of Douth Sorea, 0hina and Dingapore that have been the preEeminent builders.

)eing a development from commercial shipbuilding, pro'ects tend to be undertaken on

similar contractual terms and to incorporate aspects of both construction and sale of goods
contracts.

Dince the last edition of this guide, the market for the construction of these units has
remained depressed, and particularly so when compared to the previous highs seen in the
Brst half of the previous decade, when skyEhigh charter rates for offshore units supported
massive demand for new build units. This is despite oil, at the time of writing, trading at
around éD8°-. jhile this is less than the éD8/-- per barrel at the time of the last edition,
due to increased demand following the lifting of worldwide lockdown restrictions, the release
of the pentEup demand that ensued and the war in ékraine, this is far from a depressed price.
Iowever, that this has not yet translated to increased demand for new build offshore units is
due, in part, to the glut of offshore units available to the market, and the considerable global
economic uncertainty that persists, as well as the uncertainty that relates to the place of
carbon fuels in the energy transition.

Time will tell whether there will be a considerable uplift in offshore oil and gas pro'ects.
The jest’s reappraisal of its willingness to rely on Russian oil and gas – despite trends
towards greener sources of energy – does appear to be driving signiBcantly more new
offshore pro'ects as jestern nations in particular seek to secure alternative supplies. Wf so,
then increased demand for the construction of the marine assets utilised in the offshore
e&ploration and production of oil and gas could again lead to the types of disputes that arise
in a 3hot’ market Cwhich we detail below2. ;or now, however, it remains the case that ongoing
proceedings Cusually arbitration2 tend to concern cancellation disputes Coften related to new
build contracts for deepwater units2.

This chapter provides an overview as to why arbitration is the typical method of dispute
resolution relating to new building pro'ects, and the types of disputes that commonly

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arise and how they are usually resolved, and considers some common strategies for their
successful resolution by arbitration.

KZk PARTIES CZOOSE TO ARBITRATE

EASE OF ENFORCEYENT
]23
That disputes should be resolved by way of arbitration is usually a simple choice for the
parties.

jith the builder and the buyer of the unit usually in separate countries, and agreeing for
their disputes to be resolved in the forum of a neutral third country, the ease of enforcing
a legal determination made in one country against the assets of the other party in another
will be at the forefront of the parties’ minds when negotiating their contract. Arbitration will
therefore usually be the preferred method of dispute resolution, given the relative simplicity
with which awards can be enforced between contracting states to the é1 0onvention on the
Recognition and Knforcement of ;oreign Arbitral Awards /Jz° C1ew Qork 0onvention2.

CONFIDENTIALITk
A belief that arbitration provides for a conBdential method of dispute resolution is usually a
further important factor in the parties’ decision to choose it. This is particularly relevant when
the matters in dispute are commercially sensitive, which is often the case in the conte&t of
offshore construction disputes.

As a matter of Knglish law, an Knglish court will uphold the implied duty on the parties to treat
the arbitration as conBdential, unless there are valid reasons not to, for e&ample, because
disclosure is in the interests of 'ustice. Iowever, parties will often wish to make e&press
provision for the e&tent to which the process is to be conBdential, and the circumstances in
which the outcome of an arbitral process may be disclosed to others Ce.g., providing for the
outcome of the proceedings to be disclosed to the parties’ bankers or auditors2.

Harties should recognise the limits on the conBdentiality of the arbitral process. ;ailure
to adhere to the terms of an award will usually permit the other party to have the award
recognised as a court 'udgment, which will be a public document.

ABILITk TO CZOOSE TZE YEYBERS OF TZE TRIBUNAL AND TZE PROCEDURE

Dpecifying arbitration will also usually allow the parties to provide for the FualiBcations and
characteristics of the person or persons who will determine their disputes, and the manner
in which they will do so. je consider these issues below as part of our discussion of the
terms promulgated by the (ondon Uaritime Arbitrators Association C(UAA2.

(ondon arbitration is the procedure of choice, and Knglish law is often the governing law of
choice for these types of disputes for a number of reasons, best summarised as follows.

;irst, (ondon is historically the preEeminent forum for international maritime Cincluding
shipbuilding2 disputes, and it has more recently developed a strong reputation in international
construction disputes. This is in no small part a result of the advent of the Arbitration Act
/JJ4, which provides an effective framework for the conduct of international arbitrations.

Decond, there is a substantial and very wellEadvanced body of Knglish contract law, much of
which has developed in the conte&t of maritime and construction disputes, so Knglish law is
wellEsuited to governing these types of pro'ects.

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Third, (ondon has a number of specialist legal practitioners in the Beld of shipbuilding.

;inally, and perhaps of most signiBcance to international parties with acute concerns about
the neutrality of the chosen 'urisdiction, (ondon arbitrators Cand the Knglish courts2 have a
reputation for impartiality and integrity.

ARBITRATING UNDER TZE LYAA TERYS

Although the (UAA is the most popular arbitration body for the determination of offshore
vessel construction disputes, it does not administer or supervise the conduct of its
arbitrations or provide institutional help in the traditional sense. Wnstead it provides a set of
rules, referred to as Terms, that the parties agree will govern any arbitration proceedings.
(UAA arbitrations are, therefore, not dissimilar to ad hoc arbitrations.

The current (UAA Terms, issued in 6-6/, are applicable to arbitrations commenced on or
]53
after / Uay 6-6/ and replace the (UAA Terms 6-/ó. The (UAA indicates that its TermsE
]43
provide for a light touch approach covering key aspects of the arbitration but leaving
considerable scope for the parties to adopt procedures to suit the case. To some e&tent, the
(UAA Terms do not add a great deal to the structure already in place under the Arbitration
Act /JJ4, but they do provide a tried and tested framework for the resolution of disputes
relating to shipbuilding Cincluding offshore vessel construction2.

Therefore, procedures that reFuire the input of the arbitration body Cfor e&ample, emergency
]63
arbitrator provisions as found in the rules of many of the ma'or arbitral institutions or the
procedure for the scrutiny of awards as found in the Wnternational 0hamber of 0ommerce’s
Arbitration Rules CW00 Rules22 are absent from the (UAA Terms precisely because they are
not appropriate for the ad hoc style of the (UAA environment.

ESTABLISZYENT OF TZE TRIBUNAL

The (UAA Terms provide for a simple mechanism for the establishment of the tribunal. The
default position is for a tribunal of three arbitrators, with each party choosing one arbitrator at
the outset of the arbitration and the two partyEappointed arbitrators choosing a chairperson.
Wn practice, it is very often the case in (UAA arbitration that the preliminary stages – up to,
and occasionally beyond, any procedural hearings following the e&change of initial written
submissions – are conducted by the partyEappointed arbitrators alone. Hrovided that the two
arbitrators can agree, the parties and their counsel are generally content with this approach,
and it re5ects the 5e&ibility inherent in (UAA arbitrations. This can be contrasted with the
rules of some of the institutional arbitral bodies whereby the parties, and their appointed
]73
arbitrators, have less autonomy.

Although (UAA members are capable of hearing a broad range of disputes, including
offshore shipbuilding disputes, unless the parties agree otherwise in the arbitration clause
Cwhich is rare in offshore construction pro'ects2, the (UAA Terms themselves place no
restrictions on the parties’ choices of arbitrator. Ience, the e&pertise of the (UAA members
is supplemented by a number of senior Knglish lawyers Cincluding retired 'udges2 with
signiBcant e&perience of, and e&pertise in, arbitrating disputes in the offshore construction
sector and who are available for appointment as arbitrator whether or not they are members
of the (UAA. Wt is common, therefore, to Bnd tribunals made up of at least two senior
Knglish lawyers, with the third member sometimes having a technical industry background
depending on the nature of the dispute.

PROCEDURE

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;ollowing the constitution of the tribunal, the procedure in (UAA arbitrations tends to follow
that adopted in the Knglish courts, with the e&change of written submissions followed by
disclosure and thereafter factual and e&pert evidence. Harties are not bound to a particular
approach, and the procedural steps Csuch as disclosure and the provision of e&pert evidence2
can be tailored to the particular characteristics of the dispute. ;urthermore, and particularly
in the conte&t of the construction of a comple& offshore vessel, which must adhere in
operation to stringent regulatory reFuirements, it is not unusual for parties to fall into dispute
Cduring the course of the pro'ect2 about how the vessel is being constructed in a speciBc
respect. Resolving these issues at the time could be critical, depending on the nature of the
dispute and the e&tent to which ad'ustments to the construction of the unit can be made at
a later time. Wn this event, the parties are often assisted by the use of an e&pedited procedure
that, although not formally provided for in the (UAA Terms, can be raised with the tribunal
at the outset of the arbitration as soon as the partyEappointed arbitrators are chosen and,
therefore, before any steps are taken.

Wn our e&perience, (UAA tribunals are always alive, and responsive, to the procedural needs
of the parties, a characteristic that was highlighted during the covidE/J pandemic. je were
involved in a number of (UAA arbitrations for which the hearings have had to proceed on
a remote or virtual basis, including one rig construction dispute that was ad'ourned part
heard at the outset of the pandemic but that was rescheduled on a remote basis within
weeks thereafter. The (UAA also published guidelines for remote and semiEremote hearings
Csee the Di&th Dchedule to the (UAA Terms 6-6/2, which it rightly anticipated woul be of
assistance even after the effects of the pandemic were behind us, given that parties and
tribunals alike are now very much alive to the potential beneBts.

RELATED PROCEEDINGS
Although the (UAA Terms set out no formal provisions for the consolidation of arbitrations,
this is rarely a consideration, in part because most offshore construction contracts
signiBcantly restrict the postEdelivery liability of the builder Cas discussed below2, and, with
the possible e&ception of guarantee agreements Csee below2, invariably the only relevant
protagonists are the builder and its buyer. The (UAA Terms, however, e&pressly permit
the tribunal to deal with two or more arbitrations raising common issues of fact or law
concurrently Ci.e., the proceedings are still separate2, which can be helpful in offshore vessel
construction disputes in which sister units are under construction at the same shipyard.

Guarantee agreements between the buyer and the builder’s bank, providing for preEpaid
delivery instalments to be refunded in the event of cancellation of the shipbuilding contract
by the buyer, are often made sub'ect to Knglish law and Knglish court 'urisdiction. Wn normal
circumstances, this is of no conseFuence because these guarantees will not respond until
the arbitration between the buyer and the builder is concluded. Wn the event of related
guarantee proceedings taking place in the Knglish courts at the same time as the underlying
arbitration, although this could lead to the risk of con5icting decisions, there may be scope
to stay the court proceedings pending the outcome of the arbitration.

TZE AKARD
The (UAA Terms provide that the award should normally be available within si& weeks
from the close of proceedings. Although this is rarely realistic in the case of a substantial
offshore vessel delivery dispute, in our e&perience (UAA arbitration tribunals are diligent in
the production of their awards, and in all but the most comple& cases the award can be

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e&pected within appro&imately three months following the conclusion of the hearing. The
pedigree of the tribunals appointed in these arbitrations also maintains a high standard of
awards, such that practitioners and parties involved in these disputes have not sought to
lobby for the introduction of a scrutiny process similar to that found in the W00 Rules.

TkPES OF DISPUTES ARISING FROY TZESE PROWECTS

qisputes relating to offshore vessel construction pro'ects can be divided broadly into two
groupsY those relating to events before the vessel is delivered, and those relating to events
after delivery.

qealing Brst with preEdelivery disputes, the type of dispute that is likely to arise is often
determined by the state of the market. The period between when the contract is signed and
the contractual date of delivery of the vessel is often in the region of twoEandEaEhalf to three
years. The state of the offshore market can change dramatically during this time. This will
affect the market value of the vessel at delivery and, therefore, whether the buyer is paying
more or less than the current market value. The state of the offshore market at delivery may
also affect whether the buyer has an operating contract for the vessel after delivery.

These two factors may signiBcantly affect how the buyer will view its contractual rights and,
in particular, its right to cancel the contract. Wn a falling market, a buyer is more likely to be
prepared to e&ercise any contractual cancellation right that accrues. Wn a rising market, a
buyer will seek to hold the builder to its contractual obligations, but will probably be reluctant
to cancel the construction contract and place a replacement construction contract with
another builder, which will almost certainly be for a higher price and with a signiBcantly later
delivery date.

LIMELk PRE-DELIVERk DISPUTES IN A FALLING OFFSZORE YARMET

Wn a poor offshore market, cancellation disputes are much more common.

1ormally, the construction contract will provide for a contractual delivery date. Wf the builder
does not deliver the vessel by that date, the builder will become liable, after a few days of
grace, for liFuidated damages for delay. Wf the delay in delivery continues for a speciBed period
through the fault of the builder, normally between /°- and 6/- days Cthe cancelling date for
builder delay2, the buyer may cancel the construction contract and obtain a refund of the
preEdelivery instalments of the contract price, plus interest.

The buyer may also be entitled to claim damages for its losses, although these are often
e&cluded under the terms of the contract.

Kven without a claim for damages, however, in circumstances where the market value of the
vessel is substantially less than the contract price, a full refund of the preEdelivery instalments
plus interest will normally adeFuately compensate the buyer.

Wn addition, if the total delay, including certain types of permissible delay such as force
majeure, e&ceeds a speciBed period Cthe dropEdead date2, the buyer will normally have an
additional contractual right to cancel the contract.

The buyer’s remedy for cancellation on the dropEdead date is normally the same as
cancellation on the cancelling date for builder delayM namely, the buyer obtains a refund of
the preEdelivery instalments of the contract price, although the buyer normally only receives
interest at a lower rate, or even no interest at all.

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The key issue in these cancellation disputes is generally whether the builder is entitled to an
e&tension of time, and therefore whether the relevant cancellation date had arisen when the
buyer purported to cancel.

Wf the cancelling date had not yet arisen, then the purported cancellation by the buyer is likely
to be a repudiatory breach of contract, entitling the builder to accept that cancellation as
bringing the contract to an end, and to claim damages.

The circumstances under which the builder is entitled to an e&tension of time will vary,
depending on the terms of the contract and which cancellation right has been e&ercised by
the buyer. Wt is likely, though, that variations ordered by the buyer, or other delays for which
the buyer is responsible, will entitle the builder, in theory, to an e&tension of time. )earing in
mind that these are highly comple& construction pro'ects spanning a number of years, these
disputes also can be comple& and timeEconsuming, particularly if the builder is adopting the
approach of claiming every conceivable potential e&tension of time and hoping that at least
some of these claims will be upheld.

These types of disputes are likely to involve a substantial amount of factual evidence as to
the causes of the potential delay. They are also likely to reFuire technical e&pert evidence
on, for e&ample, whether the claimed causes of delay were the responsibility of the buyer,
or simply part of the builder’s scope of work in developing the design to produce a vessel
that complies with the contract. There is also likely to be e&pert evidence from delay e&perts
on whether the alleged causes of delay were on the critical path and, therefore, did result in
overall delay to the delivery of the vessel.

The comple&ity of the arbitration will be increased substantially if the builder purported to
tender the vessel for delivery before the buyer served its cancellation notice.

Wn offshore construction contracts, one of the most diLcult issues is to determine precisely
when the vessel is in a deliverable condition and, therefore, can be tendered for delivery by
the builder. 1ormally, the contract does not reFuire every minor defect in the vessel to be
rectiBed before delivery. This is because a delay in delivery of the vessel can have signiBcant
Bnancial conseFuences for the builder, not only as a result of its liability to pay liFuidated
damages for delay under the contract, but also because of the delay to the payment of the
delivery instalment by the buyer. As such, the contract normally speciBes that the vessel can
be delivered with minor defects, provided they do not affect the safety or operability of the
vessel and are remedied by the builder as soon as possible after delivery.

Wf the builder has purported to tender the vessel for delivery before the buyer tries to cancel,
then in addition to arguments as to whether the builder was entitled to an e&tension of time,
and therefore the buyer cancelled too early, there will also be an argument whether the vessel
was in a deliverable condition when tendered for delivery.

The deliverability issue will involve factual evidence as to the e&istence of the defects, as
well as e&pert evidence on the conseFuences of any such defects. Again, if the buyer adopts
a scattergun approach as to which defect or defects prevented the vessel from being in a
deliverable condition, this can greatly increase the time and cost involved in the arbitration.

LIMELk PRE-DELIVERk DISPUTES IN A RISING OFFSZORE YARMET

Wn a rising market, it is very unlikely that a buyer will want to cancel a contract. Wn these
circumstances, it is often the case that the offshore construction market will also be
overEheating and the builder will have e&perienced signiBcant cost overruns and delays. The

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builder may therefore attempt to claim e&tensions of time to avoid liability for liFuidated
damages for delay, or to claim an entitlement to additional payment in respect of alleged
variations to the work or for implementing measures to accelerate the pro'ect. These
disputes are generally less substantial than cancellation disputes.

This assumes, however, that the construction contract has limited the buyer’s claims for
damages for delay in delivery to a B&ed amount of daily liFuidated damages. Wn a rising
market, these are unlikely to compensate the buyer fully for its real losses 5owing from the
delay in delivery, particularly if the buyer is not only losing out on revenue from the vessel, but
is also itself sub'ect to liFuidated damages for delay payable to its client under the operating
contract for the vessel. Wf the e&clusion provisions in the contract are not watertight, the buyer
may well seek to bring a very signiBcant claim for damages for delay.

POST-DELIVERk KARRANTk DISPUTES

Given the comple&ity of construction pro'ects for offshore vessels, it is inevitable that these
vessels will sometimes not be built to the contractually reFuired standards. Therefore,
irrespective of the oil price at any one time, disputes will arise after delivery in respect of
perceived construction defects.

Given the enormous revenueEearning capacity of these units, the Bnancial conseFuences for
a buyer of a postEdelivery defect may be severe. The buyer will wish to pass on to the builder
as much of its losses as possible. The builder, however, is invariably unwilling to assume the
full risk of the buyer’s losses.

The parties’ competing interests will typically be reconciled within the warranty of Fuality
provision that can be found in almost all such construction contracts, and which generally
adopt a standard approach.

TZE KARRANTk PERIOD

A warranty period will usually be provided Coften for /6 months2, typically running from the
date the unit is delivered to the buyer, during which, if a defect materialises, the builder’s
warranty obligations will be invoked.

The contract will specify what parts of the unit the builder warrants against defects during
the warranty period – typically the vessel and all parts, and the machinery and eFuipment
designed, manufactured or furnished by the builder.

The warranty will usually provide that these will be free of defects resulting from causes
such as defective materials, miscalculation, poor workmanship or failure to construct in
conformity with the contract, as well as specifying the types of defects that are not covered.
These may include defects arising from 3perils of the sea, rivers or navigation’, normal
wear and tear, improper operation, or any alteration or addition by the buyer not previously
approved by the builder.

A great many arbitrations involve determining whether a defect falls within the warranty
provisions.

NATURE OF TZE BUkER(S AND TZE BUILDER(S OBLIGATIONS

The warranty provision will usually reFuire the buyer to make prompt notiBcation when a
defect is discovered. qepending on the clarity of the drafting, failure to do so may give rise
to a dispute about whether this sounds only in a claim for damages by the builder Ci.e., in the

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event that it has increased the builder’s ultimate cost of repair2 or whether the buyer’s right
to a repair is lost.

There will usually be a longstop date Coften a speciBed number of days beyond the end of the
warranty period2 by which the occurrence of a defect must be notiBed. ;ailure to do so will
usually e&pressly absolve the builder of any responsibility. Given the contractual signiBcance
of serving a valid defect notice, there are freFuently disputes as to whether the buyer served
a valid notice in time and in compliance with all the reFuirements of the contract.

Assuming that proper notice has been given, the builder’s primary obligation will usually be
to remedy at its shipyard and at its e&pense, whether by repair or replacement, any defect
against which the vessel is under warranty.

As it is very likely to be impractical for the vessel to return to the builder’s shipyard, the
contract will almost always entitle the buyer to have repairs undertaken elsewhere, sub'ect to
the builder’s right to inspect the defect prior to repair. The builder will be obliged to reimburse
the buyer’s costs of carrying out the repair Cor to pay some other measure of reimbursement,
such as the costs that would have been incurred if the work had been undertaken at the
builder’s yard2.

E[TENT OF TZE BUILDER(S LIABILITk

The warranty provisions will typically seek to limit the entitlement of a buyer to recover
compensation in respect of losses suffered and costs incurred as a result of defects.

A critical issue is often whether the warranty provision should be construed as a 3complete
code’ of the parties’ obligations for postEdelivery defects Ci.e., setting out the entire e&tent
of the builder’s obligations Cand the buyer’s rights2 with all obligations otherwise arising
e&cluded2 or whether it is intended to provide additional rights to those arising under
common law for defects in the vessel.

As postEdelivery defects may often result in signiBcant Bnancial conseFuences for a buyer,
the builder will wish to provide for the warranty provisions in the construction contract to
stand as a complete code of the parties’ rights and obligations, and to curtail any entitlement
of the buyer to recover Bnancial losses resulting from postEdelivery defects. The builder will
want to conBne the buyer’s rights solely to rectiBcation of the defect Cwhether at the builder’s
shipyard or elsewhere2 but with no other compensation being payable.

Iaving positively deBned its obligations in respect of defects, a builder will normally seek
to provide that all the buyer’s other rights, whether under the contract or otherwise, will
be e&cluded, and that the buyer’s rights will be conBned to those set out in the warranty
provision. The builder will wish, in particular, to ensure that any liability arising by law as to the
Fuality of the unit, in particular under the éS’s Dale of Goods Act /JóJ, is e&cluded. ;urther,
the builder will typically then seek to ensure that all other Bnancial conseFuences resulting
from defects are accounted for by the buyer.

Wn light of the freFuent signiBcant disparity between the cost of repairing a defect and a
buyer’s overall losses resulting from a defect, disputes often arise as to whether the builder’s
liability for the buyer’s losses over and above the cost of repairing the defect have been
effectively e&cluded.

STRATEGIES FOR SUCCESS IN TZE ARBITRATION OF DISPUTES

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‘nly foolhardy practitioners would believe that they alone are able to determine the outcome
of an arbitral process. Rather, myriad decisions and factors will affect the outcome of
any arbitration. The e&perienced and pragmatic practitioner will recognise this and, while
ensuring that the client is always reminded of the risk inherent in the arbitral process, will seek
to minimise that risk as far as possible by the adoption of sensible strategies and practices
for the resolution by arbitration of the highly comple& disputes that commonly arise from
these types of pro'ects.

Wt is beyond the limits of this chapter to provide a full analysis of how best these disputes
may be resolved by way of arbitration. je, however, highlight below some of the key ways in
which a party may be able to ma&imise its prospects of success in a comple& offshore unit
constructionErelated arbitration.

Wn our e&perience, a primary strategic ob'ective, whether pursuing or defending a claim, is to

identify as early as possible what will be the narrative of the case to be advanced on behalf of
the party in Fuestion. qoing so allows for effort and resources to be focused on the pursuit
of the party’s case through to the conclusion of the proceedings.

A number of steps can be taken to achieve this ob'ective.

;or e&ample, a key early step in any arbitral process is to ensure that all potentially relevant
documents are gathered and collated as soon as possible. Any document destruction
policies should be promptly suspended and a full and considered analysis undertaken as to
the location and nature of documents that may be held by the party relating to the dispute.
Wn an age of electronic documents, which has hugely increased the burden of undertaking
disclosure, the key is to ensure that all relevant material is captured. ;ailing to do so will lead
to failures to disclose relevant documentation and perhaps, in the worst possible outcome,
to an inability to do so if the material is subseFuently lost or destroyed. The resulting effect
on a party’s credibility in the eyes of the tribunal may be suLcient to turn the outcome of the
arbitral process.

0are should be taken early to identify a party’s key factual witnesses, who should be briefed
on what is reFuired of them, with resources being committed early to working with the
witnesses to ascertain and record the relevant facts. A case will often be won or lost based
on the performance of a party’s factual witnesses in crossEe&amination. Wt is therefore always
a sound investment of time and money to ensure that witnesses are advised about the level
of detail that they will be reFuired to provide in their witness evidence and the e&tent to which,
ideally, they will need to substantiate their evidence with contemporaneous documentation.

Dimilarly, early identiBcation of the relevant e&pert issues that are at the core of the dispute,
and then the prompt and careful identiBcation and appointment of appropriate e&perts, can
signiBcantly enhance the prospects of success in arbitration. ;urther, the early involvement
of an e&pert allows for the prospect of it being determined earlier in the process that the
case is likely to turn on matters of e&pert evidence rather than the factual evidence. Wf
so, the e&perts may be able to provide guidance as to the nature of the factual evidence
that is reFuired, and so avoid a more e&tensive and costly process of gathering factual
evidence. The early appointment of e&perts may similarly allow for a 3sense check’ to be
performed in respect of the factual evidence provided by the witnesses and can be a check
against partisan factual witnesses, who would be susceptible to being discredited during
crossEe&amination at the Bnal hearing.

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Wn arbitrations as comple& as those that often arise in these substantial construction

pro'ects, organisation and the early determination of a party’s case will often be key. This
will also tend to be effective in giving rise to the possibility of e&ploring an early settlement
that would avoid the substantial costs involved in a full and Bnal arbitral hearing.

ENDNOTES
]j3
$ames )rown, jilliam 0ecil and Andreas qracoulis are partners at Iaynes and )oone 0qG
((H.
]23
The contract may sometimes specify, however, for preliminary steps of alternative dispute
resolutionY for e&ample, meetings of senior managers, or mediation before arbitration.
]53
;or present purposes, the focus is purely on the main body of the (UAA Terms.
Although the (ondon Uaritime Arbitrators Association also has intermediate and small
claims procedures, these are unlikely to apply in an offshore vessel construction dispute.
]43
Refer to the (UAA’s commentary on the (UAA Terms 6-6/.
]63
Dee, for e&ample, (0WA Rules, 6-6- edition Cat Article J)2 and W00 Rules, 6-6/ edition Cat
Article 6J2.
]73
Dee, for e&ample, the (0WA Rules pursuant to which all appointments are made by the
(ondon 0ourt of Wnternational Arbitration.

Wames Brown [email protected]

Killiam Cecil [email protected]
Andreas Dracoulis [email protected]

29 Ludgate Hill, London EC4M 7JR, United Kingdom

Tel: +44 20 8734 2800

http://www.haynesboone.com/

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LNG Arbitrations
Ben Zolland and Steven Sparling
K&L Gates LLP

Summary

DISPUTES RELATING TO FAILURES TO DELIVER LNG

YISSED CARGOES

COYYERCIAL OPERATIONS DATE )CODz

UPKARDS FLE[IBILITk

ZARDSZIP FOR SELLERS

OTZER FAILURES TO DELIVER

DISPUTES RELATING TO OVERSUPPLk OF LNG

TAME-OR-PAk AS AN UNENFORCEABLE PENALTk’

DOKNKARDS FLE[IBILITk

ZARDSZIP FOR BUkERS

OTZER FAILURES TO TAME DELIVERk

DISPUTES RELATING TO FORCE YAWEURE

FORCE YAWEURE FOR DELAkED DELIVERIES

FORCE YAWEURE FOR DELAkED FACILITIES

DISPUTES RELATING TO RESCZEDULING, DIVERSIONS AND DESTINATION

RESTRICTIONS

RESCZEDULING

DISPUTES RELATING TO TERYINAL CAPACITk AND USE

DISPUTES RELATING TO TZE PRICE OF LNG

ENDNOTES

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(iFueBed natural gas C(1G2 is one of the great connectors of world trade. Wt connects
territories over vast distances. Wt connects companies with different cultures and economic
interests. Wt has been commercialised for more than z- years, and will 5ourish in the coming
decades, with substantial growth in its use predicted. Wt is also the most realistic transition
source of energy between the circumstances today and a future where fossil fuels are
less readily utilised, due to environmental reasons. Wt is also the most immediate source
of relief from market disruptions brought about by con5ict and other CsanctionsErelated2
displacement. Wt is the best available means for overcoming turmoil in established pipeline
gas transportation routes, for e&ample, in the conte&t of global events arising from the
position taken with respect to ékraine by the Russian ;ederation, the world’s largest e&porter
of pipeline natural gas.

(iFuefying natural gas Cwhich involves cooling it to appro&imately E/4/á02 allows it to

be transported by ship, which has enabled countries with large gas reserves not linked
by pipelines to other markets to sell gas around the world. Terminals for receiving and
regasifying (1G have been built in many parts of the world, and the market for (1G has
grown. (1G plays different roles in different parts of the world. Wn some markets, it is the
primary source of gas supplyM in others, it helps to make up for decreases in domestic
productionM in yet others it balances or complements other sources of gas. 0onstructing
the facilities reFuired to e&tract, liFuefy and e&port gas such as (1G, including liFuefaction
trains, reFuires substantial capital investment. )ecause of the need to Bnance these facilities,
producers have historically sought to enter into longEterm contracts. Iowever, (1G is also
increasingly sold through shortEterm or 3spot’ agreements Ce.g., a single cargo may be sold2
or mediumEterm agreements Ce.g., a number of cargoes or a certain volume of (1G sold
over the course of a number of months or several years2. Wn some instances, (1G supplied
under a longEterm contract may be sold and delivered to customers in different destinations.
0ompanies may also enter into swap agreements to create eLciencies, including through
savings on shipping costs.

Iistorically, most (1G supply contracts have been in the form of longEterm sale and
purchase agreements CDHAs2 with a contract term of 6- years or more, and an option to
e&tend or renew. As noted above, the capital costs for building the facilities and eFuipment
reFuired to e&tract gas and then liFuefy, transport and distribute (1G can be many billions of
dollars. At least in part to obtain Bnancing for such pro'ects, producers wanted to contract
with buyers who would commit to purchasing substantial volumes over a long time period
]23
and who would provide regular revenues. As the longEterm contract evolves, disputes arise,
particularly as (1G DHAs are often signed many years before Brst deliveries. A 6-Eyear DHA
may be negotiated 6z years before the term of the contract will e&pire, and it is not realistic
to e&pect that every future circumstance over this e&tended time period can be foreseen
and governed adeFuately by the drafting. Today, there is far greater reliance on shorterEterm
contracts, with contracts of Bve, seven or /- years becoming reasonably common. (1G is
increasingly being sold through even shorterEterm contracts and on a spot contract basis.
Uany new (1G pro'ects are pro'ected to be brought into operation due to world events and
may be pushed forwards in some territories, further increasing the risk of disputes. This
chapter considers many of the most repeated sources of tension within these largeEscale
contractual relationships and their related operations, and how they may lead to arbitration.

DISPUTES RELATING TO FAILURES TO DELIVER LNG

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This section addresses disputes that may arise because the seller is unable, or unwilling, to
deliver (1G that it has committed to sell. Wn particularY

X if a seller misses cargo deliveries, or fails to deliver the agreed volume, including when
it has done so in order to obtain a higher price elsewhereM
X if a seller maintains that it need not deliver (1G under a longEterm contract,
because the relevant production facility is not yet commissioned and commercially
operationalM
X disputes arising from a buyer’s right to upwards 5e&ibility over the volumes of (1G
that it wishes to accept over a given time period, which the seller declines to deliver
underM
X reliance by sellers on hardship provisions to decline to deliver (1GM and
X other failures to deliver (1G.

YISSED CARGOES
Wn times of high market prices, there is an incentive for (1G sellers to reduce deliveries under
longEterm and midEterm (1G contracts if the prices under them are cheaper than those
available in alternative markets. Wf so, it has become common for sellers to consider diverting
cargoes from longEterm supply obligations in order to seek a proBt by selling those volumes
on the higherEprice, often short term, markets. ‘ther disputes have arisen whereY

X lower than agreed volumes Cshort cargo deliveries2 are suppliedM

X sellers have e&ercised downward 5e&ibility outside of the agreed operational
tolerancesM and
X operators of new facilities have delayed the declaration of terminal readiness, with
early cargos being sold on a shortEterm basis at higher prices.

Wf an (1G cargo, scheduled to be delivered under a longEterm contract, is missed and

undelivered Cor underEdelivered2 without good cause, a contractual shortfall amount is paid
to the buyer to cover the loss that will result from the short delivery. Wf included, these
shortfall Cor short delivery2 clauses operate, in effect, as a liFuidated damages provision.
They can be helpful to buyers to the e&tent that they obviate the need to prove that the buyer
has actually suffered any loss at all, or that it has sought to mitigate its loss. Wf the buyer
has not onwardEsold the cargo, or has the right to cancel the cargo, then there may be no
damages, only the shortfall amount. jithout them, the normal starting point is that damages
for breach of contract are awarded so as to compensate the innocent party for any loss
that it suffers. This claim for damages would be supported by e&pert evidence based on the
replacement cargo value and associated costs and losses. Wn circumstances where the buyer
could mitigate its loss by acFuiring substitute (1G to replace those missed cargoes under
the DHA, arbitral tribunals will usually e&pect to see evidence of meaningful attempts to do
so. Iowever, these contractually agreed shortfall amounts may not always cover the entirety
of the loss faced by the buyer. Dhortfall amounts may be based on a percentage of the cargo
value, established by reference to the contract price. Wf the contract price is not suLciently
high, this shortfall amount, when calculated, may fall below the cost of replacement (1G that
the buyer may be obliged to source in the open CshortEterm2 market. This has two effectsY
the seller can wager that it could Bnd an alternative market for the cargo, pay the shortfall
amount arising from the missed cargo and still proBt, selling at the current higher market

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price insteadM and the buyer may pay more to replace the e&pected cargo than the amount it
can recover from the seller for its shortfall.

Wf this is the case, the parties will wish to know whether the shortfall amount is the buyer’s
sole remedy or e&clusive remedy under the DHA, or if other losses of the buyer can also
be claimed. This is an area that has given rise to arbitration, as the amounts in dispute
will likely be signiBcant, carrying a threat of a heavy damages claim for loss arising from
all the original missed cargoes. (ikewise, there may be a reasonable uncertainty as to
the outcome. This uncertainty is because the language of the DHA may appear to clearly
specify that the sole remedy e&cludes actual losses faced by the buyer, yet principles of the
law governing the DHA may operate in a way that fails to e&onerate the seller for certain,
particularly intentional, breaches. Wf the seller, in making its decision to miss a cargo, has
acted solely or predominantly with the aim of making a proBt, in the face of its obligations
to the buyer, arguments arise as to whether such conduct forms the basis for wilful default
or gross negligence under the DHA. Duch provisions often void any caps or other e&clusions
on remedies, such as the sole remedy provision, and also provisions that operate to e&clude
indirect loss andVor all loss of income and proBts of the buyer. qepending on the language
used, wilful default or gross negligence provisions can be challenging to activate, as they act
as carveEouts to otherwise e&cluded losses, and can reFuire evidence that a senior manager
or representative has disregarded intentionally, alternatively consciously or recklessly, that
party’s duty under the DHA. This would reFuire proof of recklessness or knowledge that the
missed cargo was a breach of contract, which would likely need to be 'ustiBed by documents
sought during a dispute through disclosure in the arbitration.

Alternatively, a refusal to deliver without good case, or without a valid declaration of force
majeure, may arguably lead a reasonable buyer to conclude that the seller no longer intended
to be bound by the provisions of the DHA, and, conseFuently, to amount to a breach allowing
the buyer to terminate the DHA Cunder Knglish law, a repudiatory breach2. Duch a course of
conduct may likely be seen on its proper construction as not being covered by the shortfall
clause containing the sole remedy restriction, as a missed cargo arguably refers to a situation
of shortEterm unavailability due to various speciBc physical or related reasons, and does not
e&tend to a situation where the seller has available (1G to deliver and commits a repudiatory
breach, or renounces the DHA, or both. qepending on the governing law, there may also be
evidence that a decision to miss a cargo amounts to a failure to employ good faith, or similar
duty, under the longEterm DHA, which may not protect any seller that has deliberately sought
a proBt at the buyer’s e&pense.

Regardless of what the buyer’s remedies may be, this is one of the many areas within a
longEterm DHA where the buyer must be wary of seeking a selfEhelp remedy, for e&ample
withholding payment on other cargoes, in reaction to the seller’s conduct. Kven if the seller
has caused the commercial disruption in the contractual relationship, this will not likely grant
the buyer a right to breach the DHA itself. qoing so, even if the buyer feels that it is taking a
contractual step to mitigate its loss arising from the seller’s prior failure to deliver, in a way
that feels like being a purely reasonable commercial or legal reaction to the earlier breach of
the DHA by the seller, may allow the seller to rely on the buyer’s default, and to terminate the
DHA itself.

COYYERCIAL OPERATIONS DATE )CODz

‘wing to the need to replace pipeline gas following the events in ékraine, many buyers
have secured replacement (1G from sources that were not fully operational when the

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parties concluded their longEterm agreement. qisputes have arisen owing to what state of
completion is reFuired to trigger the seller’s commitment to deliver (1G under longEterm
contracts. Uore generally, it is common for parties to contract to buy and sell (1G before
the (1G facility’s commissioning, such as when the (1G facility is in an early stage of
development. The seller will be obliged to complete the facility and commission it, after
which the seller must declare the 0‘q. This will be the point at which the seller holds that all
facilities comprising the e&port facility have to be completed, commissioned and capable of
delivering (1G in suLcient Fuality and Fuantity to allow it to perform all its obligations under
the agreement.

qisputes have arisen in connection to :enture Global’s 0alcasieu Hass facility in (ouisiana,
as the seller claims that it is unable to perform its obligations under its longEterm
agreements because the plant is not yet commercially operable. :enture Global maintains
that commercial operations under its longEterm agreements have not been met, as a result
of e&tensive repairs needed to the plant’s onEsite power supply facility. The buyers from the
0alcasieu Hass facility take a different view, relying directly on the hundreds of cargos of
(1G that the facility has produced and e&ported, at or near the plant’s capacity. The buyers
maintain that :enture Global is fully capable of performing its obligations, and that :enture
Global is wrongfully using repairs as a means to continue to liberate preE0‘q (1G sales at
higher shortEterm prices than agreed under the longEterm contracts. qamages claims for
billions of dollars will be determined as a result of the facility’s e&tended commissioning
phase, and whether the facility is to be considered 3commercially operable’. Regulatory
proceedings are also proposed, as a result of a contested application to e&tend the facility’s
construction permit.

UPKARDS FLE[IBILITk
épwards 5e&ibility rights entitle a buyer to take increased Fuantities of (1G during a
particular period. )uyers will be interested in ma&imising deliveries during times of higher
than e&pected demand Cin particular, many Asian buyers periodically seek to achieve this as
part of building reserves of (1G for their winter schedule, when demand spikes occur2. Dome
buyers also seek to schedule more (1G supply at times where the contract price under the
DHA is favourable to the price of other sources of supply in the market. This is done to build
reserves of stored (1G when the price is favourable, or with the aim to onEsell any e&cess to
other markets at a proBt. These buyers can face blocks to getting their e&pected deliveries
from sellers. This is because the same market conditions that incentivise buyers to increase
deliveries will induce sellers to have the opposite ob'ective. Heriods of high demand and
high market prices will likely incentivise sellers to seek to ma&imise spot sales, seeking the
highest available price for all produced (1G in preference to their delivery obligations under
longEterm contracts.

Wt can be necessary to overcome arguments from sellers that the buyer’s upwards Fuantity
tolerance Cé“T2 rights, which allow it to increase deliveries under the DHA, are in5e&ible.
A buyer may be reFuired to provide a B&ed period of notice before being able to receive
increased Fuantities. Dchedules may be set far in advance and prove hard to alter without
agreement by the seller, which restricts the buyer’s ability to respond to sudden demand
shocks. Dellers routinely challenge the notiBcations provided, in particular whether these
reFuests are made in time, or with suLcient clarity, or whether there are any restrictions on
the use of é“T that apply. )uyers that have used downwards volume rights in recent years
to reduce deliveries over past time periods, and which are later trying to e&ercise 3make good’

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(1G deliveries, can face further restrictions. Wf the buyer is in deBcit from previous years, it
will normally be encouraged to use its rights to increase deliveries in order to catch up, but
the contractual framework to do so may be restrictive. There may be a lack of precision as to
what is reFuired of both parties under the DHA. All of these issues have given rise to disputes.

ZARDSZIP FOR SELLERS

Wf the seller is unable to produce and deliver (1G because a structural market change or
upheaval has reduced its ability to produce and deliver the (1G called for under the DHA, and
if this change is enduring Cor irreversible2, then the seller may begin to satisfy the necessary
reFuirements to rely on any provisions in the DHA dealing with hardship, or e&tra contractual
arguments under some governing laws such as fundamental change in circumstances or
frustration of purpose. These provisions are not always included in (1G DHAs or part of
applicable governing law. jhere they are present, they allow the seller to ask for a discussion
with the buyer about what reductions or changes to the seller’s obligations will release it
from its claimed situation of hardship. Iardship provisions operate to preserve the core of
the party’s contractual relationship – useful in a longEterm contract – by allocating the risk of
an event of Bnancial hardship, if economic conseFuences impact on the parties’ obligations.
Applying the doctrine of pacta sunt servanda, national legal systems usually respect and
enforce e&press provisions dealing with changed circumstances that parties have agreed to
include in their contracts, particularly if the provision contains parameters or a methodology
]53
on which to base the contractual revision.

Duch provisions, if included, will set out the triggering eventM for e&ample, many clauses will
ask for evidence to be presented of a lasting, substantial change of circumstances. These
changes are reFuired to be beyond the control of the parties, as neither party wants to take
the risk that it will bear the economic conseFuences of actions taken by or events controlled
by the other party. ‘ther provisions may add a reFuirement that the triggering event was not
predicted or predictable Cor foreseen or foreseeable2 at the time of contracting. Wn the case of
a seller, it has been argued that this would include an une&pected reduction in the realisable
gas reserves needed to produce the (1G, or a technological change Csuch as the growth of
a new source of energy2 that adversely impacts on the Bnancial position that the seller is
facing. The inclusion of a dramatic increase in the seller’s costs of production, or a decrease
in the value achieved under the DHA compared to the costs of production, has also been
argued. Wt is likely that these changes will be harder to portray as being unforeseeable, given
the regular price cycles that are well understood within the (1G industry. ‘ften, a variety
of separate factors have changed, each interacting with the others, to produce economic
effects that impact on the contractually agreed obligations of both parties.

Wt is also commonplace to reFuire that the party affected is enduring a loss, a signiBcant
loss or a loss of e&pected reward, depending on the language used or the stipulations of
the governing law. Uany disputes turn on whether hardship reFuires the seller to be in a
lossEmaking situation under the DHA. jhile this may seem obvious, on the basis that the
seller will not face hard times if it is still making money under the contract, some provisions
go further, and allow a limited e&amination of lost opportunities. qepending on the facts and
the substantive law of the contract, such hardship may involve an elimination or reduction in
margins of a party, and may also involve other harmful effects on one or both or the parties’
businesses, such as a loss of market share. Iardship may also involve circumstances that
prevent a party from performing under the contract, or even under other contracts.

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Wn the absence of an e&press provision governing hardship, there is, however, a wide and
fundamental distinction in approach among legal systems. Uany legal systems do not
permit a court or arbitral tribunal to ad'ust a contract for Bnancial hardship under any
circumstance. ‘ther legal systems provide a legal basis for doing so, one e&ample being
Article /-ó of the Algerian 0ivil 0ode, which addresses e&ceptional and unforeseeable
]43
changed circumstances threatening an e&cessive burden.

OTZER FAILURES TO DELIVER

The seller may have an obligation to use reasonable endeavours to source alternative
supplies, if it is unable to deliver itself, and to schedule delivery at a time agreed with the
buyer. Wt is rare for this duty to be any stricter than this. Wf this provision reFuired the seller
to use best endeavours, then Knglish law, which governs a reasonable crossEsection of (1G
DHAs globally, would reFuire the seller to have to source alternative (1G by e&hausting all of
a number of reasonable courses of action that could be taken to meet its duties. Wf the seller
had to use all commercially reasonable endeavours, then the seller would have to source
alternative (1G by e&hausting all of a number of reasonable courses of action, taking into
account its commercial interests when doing so, alongside those of the buyer. Wt would not,
however, have to proceed if it would disproportionately lose money doing so. Wn contrast,
reasonable endeavours would mean that the seller would have to adopt and pursue one
reasonable course of action to meet its duties, bearing in mind its own commercial interests
and the likelihood of successY a lesser obligation than the other types of obligation above.

DISPUTES RELATING TO OVERSUPPLk OF LNG

This section addresses disputes that may arise because the buyer is unable, or unwilling, to
take (1G that it has committed to purchase. Wn particularY

X the argument that the buyer’s obligation to takeEorEpay for (1G is not enforceable
against itM
X disputes arising from a buyer’s right to downwards 5e&ibility over the volumes of (1G
that it wishes to accept over a given time periodM
X reliance by buyers on hardship provisionsM and
X other failures to take delivery.

TAME-OR-PAk AS AN UNENFORCEABLE PENALTk’

)ecause sellers want buyers that will commit to purchasing substantial volumes over a long
time period and provide regular revenues, longEterm (1G DHAs will often reFuire the buyer
to take a substantial annual Fuantity and include a takeEorEpay provision, which reFuires the
buyer to pay for a certain amount of the annual contract Fuantity Csometimes /-- per cent,
but often a percentage of that Fuantity, e.g., °z or J- per cent2, whether or not the buyer takes
that Fuantity. ;or this reason, takeEorEpay provisions are a very familiar feature in (1G sales
contracts, and provide an option for the buyer to take supply of (1G, or to pay for it anyway.
Dome takeEorEpay provisions can provide for the seller to be paid by a buyer that has decided
not to take the (1G, but then also allow the seller the additional right to sell the surplus (1G
to any other interested customer at market prices, in effect receiving payment twice for the
same molecules of (1G.

Wn many legal systems, this outcome would be seen as a straightforward risk allocation,
agreed in advance with transparency between an e&perienced buyer and an e&perienced

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seller. Iowever, under Knglish law, an anomalous principle known as the 3rule against
penalties’ has given rise to disputes as to whether takeEorEpay provisions can be considered
to be unenforceable in certain circumstances. The Knglish law rule against penalties
prevents the enforcement of clauses that operate as a penalty against the party in default.
;or e&ample, where a contract stipulates that a speciBed sum is payable upon breach of an
obligation by a party to that contract, but the sum stipulated is not a genuine preEestimate
of loss suffered due to that breach Cbecause it is too high2, historically the clause will not
be enforceable. The rule against penalties is something of an anomaly within the Knglish
law of contract, as Knglish law generally allows commercial parties the freedom to contract
at will. ;or this reason, Knglish law is predisposed to enforce clauses that parties have
agreed, and only rarely Bnds that they are a penalty. This predisposition is particularly strong
in commercial contracts freely entered into between commercial parties of comparable
bargaining power, as will be the case in any (1G DHA. Knglish law has rationalised the test
as to whether a term is an unenforceable penalty over recent years, in a way that makes it
diLcult to maintain an argument that a takeEorEpay provision operates as a penalty under
]63
Knglish law. jhen disputes arise, the following factors operate to resolve the issue one
way or the other.

There are two separate obligations in most takeEorEpay contracts. ;irst, there is the obligation
on the seller to make the (1G available to the buyer. Decondly, there is the obligation on the
buyer to pay for the (1G that has been made available Ceither as well as, or instead of, taking
up the (1G2. )oth of these obligations create a beneBt for the other party. This being so,
takeEorEpay payments will be considered by Knglish law to be an amount due to the seller
as a debt for having made the (1G available, and not as damages for breach of contract by
reason of a failure on the other party to take the (1G. This is because the seller is providing
the service of making (1G available to the buyer, in accordance with the DHA, which will
create a debt owing to the seller for that service. ‘n this basis, the rule on penalties should
not apply at all, because this rule has a limited applicationY it only applies Cin this conte&t2
to stipulations for the payment of a sum of money in the event of breach of contract Cfor
]73
e&ample, damages for a breach of the DHA2. There will be no breach if the DHA is drafted
so that it provides the buyer with an option whether or not to take the (1G. A buyer with an
option to purchase ought never to be considered in breach of contract for deciding not to do
]83
so. Wf there is no breach, then the penalty doctrine cannot be engaged.

This leaves other provisions, which can be described as takeEandEpay clauses Crather than
takeEorEpay clauses2, where there is an obligation on the buyer to take a minimum Fuantity of
(1G. Although this will also normally create a primary obligation Cdebt2 as a result of the seller
making (1G available, the e&istence of a breach by the buyer if it does not take the minimum
volume demanded by the DHA makes the distinction less clearEcut. Although takeEandEpay
provisions govern the price to be paid to the seller, the occasion for their operation is also
a breach of contract due to the buyer’s failure to take the (1G. ‘f assistance to the seller,
Knglish law has re'ected the argument that a parallel breach by the buyer should entitle the
buyer to rely on the rule against penalties. ;urther, even if the rule on penalties does apply,
the restated test applied by Knglish law emphasises that to be unenforceable the payment
for breach has to be 3e&orbitant or unconscionable’ when viewed against the seller’s interest
]93
in the performance of the contract. Given the signiBcant investment by the seller in its (1G
facilities, and its interest in the secure revenue stream that the payments provide, this test
is more helpful for the seller to meet than the previous test, and such provisions will usually
re5ect a legitimate interest in covering the seller’s upEfront costs. This is made even more

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certain if a 3makeEup’ provision is included in the DHA alongside the takeEandEpay provision. Wf
so, the buyer’s payment under a takeEandEpay provision comes with an entitlement to beneBt
in future by taking makeEup (1G at a later date. jithin this sort of contractual payment
structure, the buyer is simply making a payment in advance for the future performance of an
obligation, such that it is diLcult to construe the sum paid as damages upon breach, rather
than debt. Again, if there is no breach, then the penalty doctrine cannot be engaged.

DOKNKARDS FLE[IBILITk
A full cargo of (1G on a conventional (1G tanker is a signiBcant Fuantity of gas Cmore
than suLcient to supply a small city for a year, for e&ample2. Wt takes time to load, transport
and unload a cargo. As a result, gas volumes delivered as (1G may not closely match
the demands of the buyer’s customers throughout the year Cwhich can vary substantially
depending on a number of factors, including the season2, and there may be limited storage
capacity available for the buyer to store e&cess gas. qownward 5e&ibility rights entitle a buyer
to take reduced Fuantities of (1G during a particular period. quring the covid pandemic,
these provisions, also known as 3downwards Fuantity tolerance’ Cq“T2, were commonly
operated by buyers. They were used to full effect to mitigate many buyers’ shortEterm fall
in demand from its own customers, as demand collapsed with reduced industrial activity.

Iowever, longEterm DHAs often constrain the e&ercise of these rights, and disputes arise in
relation to their operation. As with é“T rights, considered above, the buyer may be reFuired
to provide a B&ed period of notice before being able to receive reduced Fuantities. Dchedules
may be set far in advance, and prove hard to alter without agreement by the seller, which
restricts the buyer’s ability to respond to sudden market shocks. Dellers routinely challenge
the notiBcations provided, in particular challenging whether these reFuests are made in time,
or with suLcient clarity. The e&ercise of q“T can also involve a series of checks and balances
whereby, depending on the DHA, the seller’s commercial interests and logistical factors can
be raised as a reason to re'ect the buyer’s q“T reFuest. Ambiguity and sub'ectivity can be
introduced by sellers wishing to curtail the e&ercise of the buyer’s rights. All of these issues
have given rise to disputes. Wf q“T rights are successfully e&ercised, DHAs often contain
additional checks and balances that store up disputes for the future. There is often a parallel
obligation for the buyer to take increased 3makeEup’ Fuantities in later periods. There also
may be ma&imum amounts allowed for cumulative downward 5e&ibility. Wf the buyer has
relied on q“T rights in the past, its ability to do so in future may be restricted. This is not an
ine&haustible remedy for the buyer. This serves to limit the usefulness of the q“T rights.

ZARDSZIP FOR BUkERS

‘versupply situations occur when buyers who prioritise advance planning and security of
supply enter into longEterm commitments, yet une&pected events intervene in a way that
reduces the volume of (1G that they later need. The result is that the buyer has too much
(1G. This is a cyclical diLculty. Wt is particularly hard to balance in liberalising markets,
where customer demand une&pectedly 5uctuates. Wt has been a feature for several buyers in
Asia, where the une&pectedly fast deployment of renewables has reduced the forecast need
for power generated from (1G. Wn particular, market liberalisation in $apan has unsettled
customer demand, leading to a surplus of (1G for some buyers, as has the resumption of
nuclear power production following the ;ukushima incident.

Wf the buyer is unable to take (1G because a structural market change has reduced the
volume of (1G that it needs, and if this change is enduring Cor irreversible2, then the buyer

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may begin to satisfy the necessary reFuirements in order to rely on any provisions in the
DHA dealing with hardship, or e&tra contractual arguments under some governing laws such
as fundamental change in circumstances or frustration of purpose. As set out above, such
provisions, if included, can apply where there has been lasting, substantial change beyond the
control of the parties, and an enduring loss. Wn these circumstances, hardship provisions are
relied on to contend for reduced volumes under longEterm DHAs if the buyer’s own customers
demand less gas. (iberalisation may have opened up an une&pected ability of a buyer’s
customers to switch supplier, leaving the buyer with an une&pectedly reduced demand that
is outside its control. Wn these circumstances, the buyer will likely be facing a longEterm,
structural overEsupply situation, where it will be making enduring losses under the DHA. The
market may be such that the buyer cannot reasonably divert, reload or otherwise offset
its surplus commitment to take (1G under the DHA. This will make for disputes where the
parties do not agree on whether the necessary factors set out in any hardship provision are
present one way or another.

OTZER FAILURES TO TAME DELIVERk

The starting point is that the buyer will be in breach and the seller will be entitled to damages.
These damages will normally re5ect the difference between the contract price of the (1G
that should have been taken by the buyer and the market price at the time when delivery was
due. The Fuestion will be whether the seller is able to enter into a shortEterm supply contract
with an alternative contracting party. This damages assessment e&ercise, which may be
supported by e&pert testimony, will determine the e&tent to which there is a reasonably
available supply of (1G necessary to fulBl the contract Fuantities such as to amount to an
3available market’. There may be (1G purchasers available on the spot market, but there
are often real Fuestions as to whether those spot contracts will be comparable such as to
amount to an available market. The prices they pay will not likely be comparable to the DHA,
as the terms and duration are different. To establish an available market, a substitute buyer of
(1G needs to be temporally and geographically available and accessible to the seller. Wn the
event that there is no available market, then regard may be had to the loss actually suffered by
the seller, and arbitral tribunals may decide to displace the prima facie market value measure
of loss Cthe difference between the contract price and market value2 and look instead to the
loss down the contractual chain, when evaluating the e&tent of the loss actually suffered by
the seller.

Another approach is to provide that, in the event that the buyer fails to take (1G, and neither
party is able to reschedule it or sell it to any third parties, the buyer shall pay any reasonable
actual direct costs the seller incurs. 3Actual direct costs’ under Knglish law engage the
doctrine of remoteness. Generally, a party in breach of a contract will be liable for any type or
kind of loss that is not too remoteM a loss will not be too remote if, at the time of contracting
Cand on the assumption that the parties actually foresaw the breach in Fuestion2, it was
]13
within their reasonable contemplation as a not unlikely result of that breach. 3Snowledge’
has been held in later case law as actual or imputed knowledge. A sophisticated buyer
will very likely be imputed to be aware that the seller has certain industryEstandard Cor, at
least, not wholly uncommon2 upstream commitments, often under different contracts. Wn
circumstances where the buyer is aware of these upstream obligations and that these are
types of costs it envisages the seller will incur, these costs are likely to be considered 3actual
direct costs’ under Knglish law.

DISPUTES RELATING TO FORCE YAWEURE

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This section addresses force ma'eure in the conte&t of (1G sale and supply. Wn particular, two
scenarios are discussed. The Brst concerns a delay to deliveries of (1G under a longEterm
DHA due to a disruption in the production, loading, transportation or unloading of (1G. The
second concerns a delay, owing to force majeure, to the construction of (1G facilities that
disturbs the planned sale and purchase of (1G that has been contracted for in advance of
the commissioning of the (1G facility.

Wt is necessary to introduce this topic with the precursor that a one si7e Bts all analysis
is not available. To rely on force majeure where an (1G DHA is governed by common law
Cfor e&ample Knglish or Dingaporean law2, a force majeure clause must be included in the
contract. Force majeure is not a term of art under Knglish law or Dingapore law and many
other common laws. Wt is also radically different from civil law conceptions of force majeure
andrebus sic stantibus. The deBnition and scope of force majeure will be determined by the
speciBc wording of each individual contract. jhat happens when a force majeure clause is
engaged will depend on preEagreed contractual mechanisms, with the further result that it is
necessary to generalise the language and concepts that are regularly included in (1G DHAs.

FORCE YAWEURE FOR DELAkED DELIVERIES

Wt is for the party claiming force majeure to prove the facts bringing the circumstances or
events within the force majeure clause. ;or e&ample, depending on the language of the
clause, that party would typically need to prove the occurrence of one of the events referred
to in the clause, and that it had been prevented, impeded or delayed Cas the case may be2
from performing the contract by reason of that event. The party would ordinarily need to
further prove that the nonEperformance was due to circumstances beyond its control and
that there were no reasonable steps that it could have taken to avoid or mitigate the event or
its conseFuences. There are a number of factors speciBc to (1G DHAs that can make it hard
to maintain a claim to force majeure in the conte&t of a delay to deliveries or acceptances of
(1G.

SPECIFIC NOTIFICATION
énder many DHAs, the party claiming force majeure is reFuired to give notice of the event or
circumstances Cor combination of events or circumstances2 causing the failure to perform
or delay in performing and said to constitute force majeure. qisputes arise when it is claimed
that notiBcations contain unspeciBc references, or are lacking in detail in a way that fails to
satisfy the reFuirement to give speciBc notice of the event or circumstances relied upon. Wn
the conte&t of (1G DHAs, it is common to reFuire the parties to keep each other informed
of circumstances that could reasonably result in a disruption to the sale and purchase
obligations under the DHA. This obligation can arise before the event itself materialises,
by way of a need to notify of issues that may develop into force majeure events. jhen a
force majeure event arises, it is common to reFuire prompt notiBcation of the event. These
provisions can be detailed and unyielding. Wt is common for force majeure clauses to provide,
in effect, that a party cannot rely on force majeure where it fails to comply with these
notiBcation obligations, and any circumstance that may have originally amounted to force
majeure shall cease to do so. ;ollowing a number of force majeure claims made during the
covid pandemic, there has been an increase in the use of force majeure clauses under which
force majeure arises automatically, even when the trigger event is clear only in retrospect.
These provisions, therefore, do not reFuire the same degree of timely or speciBc notiBcation.

LNG YARMET ECONOYICS

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An argument based on rising costs to 'ustify the discharge of duties through force majeure
will very likely fail. Kconomic hardship or unproBtability will seldom amount to an event or
failure that prevents the performance of a party’s obligations under an DHA, as the alleged
uneconomic nature of the remaining performance does not prevent those uneconomic steps
to be taken. énder Knglish law, in the conte&t of a gas supply agreement, the position that
commercial impossibility due to changed prices could found an argument in force majeure
]j03
has been re'ected. This is made more certain if the list of e&amples of force majeure
that may be set out in the clause each involve a physical, e&ternal event or action of a
third party, rather than internal economic circumstances. Wndeed, many DHAs e&plicitly list
economic hardship as an e&clusion from force majeure. Wf so, it will be necessary to prove that
something more than adverse economic circumstances has impacted on the contractual
bargain, for e&ample that market forces have changed to the point of inversion, with (1G
terminal use 5ipping from import to e&port, or similar circumstances. Deveral leading awards
in the energy sector and leading commentary on arbitral practice conBrm thisY 3Although force
majeure clauses are often invoked in energy contracts, claims based on such clauses in
arbitration proceedings rarely succeed as their application is sub'ect to strict conditions ¶. . .ä
arbitral tribunals have ruled that neither increases nor decreases in oil prices, no matter how
]jj3
large or une&pected, can be considered to constitute force majeure.’ ‘bviously, if there was
no evidence that the party was in fact incurring signiBcant losses, the claim for force majeure
would likely also fail on that ground alone. This can often reFuire an analysis of increased
costs and, if so, even if the party’s costs did increase overall, it is often necessary to consider
whether it is still making proBts when isolating only the transaction set out in the DHA, leaving
aside any impact on it from losses from wider activities Cincluding under other contracts2.
;or all these reasons, it is commonplace for economic issues to be addressed e&pressly
in (1G DHAs through price review provisions or hardship provisions, but not through force
majeure provisions.

SCZEDULING
Although referred to by different terms, it is overwhelmingly common for (1G deliveries
to be B&ed in advance by an annual delivery plan, or a delivery schedule. There is often
a comple& mechanism of notice and counterEnotice leading to the establishment of this
delivery schedule in advance of each contract year. As a result, the parties will be reFuired
to specify a wide series of issues in good time prior to delivery. These include the volumes,
dates, source of supply, (1G vessel for the cargo, loading port for the cargo, receiving
terminal and other issues. This approach restricts the operation of force majeure, as it
narrows down the facilities Cincluding terminals, ports, vessels2 that are involved for any
particular delivery. Wn turn, this makes it harder for a party to seek relief from its obligations
unless the vessel, terminal and other speciBed facilities needed for that speciBc delivery are
impacted by the force majeure.

DELAk IN ANk EVENT

The party claiming force majeure can also face the challenge that the event of force majeure
did not cause all of the delay or disruption alleged. Wf so, these other reasons will be argued
to have been responsible for losses in any event. Wn particular, there may be grounds to
suggest that the delivery or acceptance would have been late or disrupted notwithstanding
the purported force majeure, even if force majeure is validly asserted. Wf so, disputes can
arise as to whether or not the party claiming force majeure is still responsible for the losses
suffered in respect of delayed or missed cargos. Wt can be necessary to e&amine carefully the

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3arrival window’ applicable for the scheduled cargo that has been impacted by force majeure,
and see if this was already impacted by other means prior to any event of force majeure. Wf it
can be demonstrated that, at the time of the force majeure, there was still a possibility that
the cargo could have been delivered within the scheduled 3arrival window’, it likely would be
open to the other party to suggest that there was no factual basis to maintain a claim for
force majeure.

CURRENCk
Topical for buyers of (1G from the Russian ;ederation, such as from the Dakhalin (1G
pro'ect, Qamal (1G, and 1ovatek’s Arctic (1G development, is the issue of whether sanctions
that render payment for (1G in the agreed contractual currency unlawful will give rise
to force majeure. Knglish law has held that a reFuest to make payment in an alternative
currency is not functionally eFuivalent to a payment that was agreed to be made in the
contractual currency, and that the reFuest that a different currency must be paid instead is
an impermissible reFuest for noncontractual performance. Iowever, if the applicable clause
reFuired that force majeure could not be 3overcome by reasonable endeavours’, a proposal
involving payment in an alternative currency should be accepted, if this achieved precisely the
same result Cpayment of the correct amount in a different currency2 and caused no detriment
]j23
to the receiving party. Accordingly, if the contractual currency becomes unlawful, whether
this may be considered to be a valid force majeure event will depend on the language of
the applicable provision. The payer might also have a contractual option to settle in the
alternative currency.

CONTROL
Wn circumstances where the force majeure clause reFuires a party to show that the event of
force majeure was beyond its control, a further hurdle is often faced where the party cannot
rely on events that it could have avoided acting reasonably or, as is often seen, acting as a
3reasonable and prudent operator’. This hurdle impacts even circumstances that superBcially
have little connection to the parties to the DHA, for e&ample, if costs increase because of an
increase in oil prices and associated costs, or the weakening of the contract currency, or due
to the failure of a component, or because a contractor or aLliate has been poorly selected
or poorly monitored. jhile these events were essentially outside of the party’s control, if
their impact can be shown to have been foreseeable, it will be necessary to prove whether
these impacts were within their power to insulate against in some reasonable way. Uany
participants in the (1G industry are stateEowned, and if actions of the state contributed to
the event of force majeure, this will open up an analysis as to whether the event was entirely
e&traneous, or whether it was contributed to by the state’s actions or inactions.

SOURCES OF SUPPLk
The effects of force majeure on the seller’s relevant production facility are further limited if
the seller is a large integrated concern, which owns and operates other production facilities or
sources of supply, or both. An area of considerable dispute concerns whether the complete
inability of a relevant terminal to produce or to receive (1G, or the complete inability of an
(1G vessel from loading and delivering a cargo that has been scheduled for delivery, can
found a claim for force majeure, where the seller has available alternatives. énder certain
DHAs, cargoes are contracted to be delivered from the seller’s (1G supply pool, or similar
terminology. Wn other DHAs, where the seller aggregates supplies from a mi& of sources,
including thirdEparty sources, there is an alternative formulation similar to 3seller shall obtain

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]j53
all 0argoes to be delivered under this Agreement from a speciBed pool of suppliers’. Wf
there is an event of force majeure at one facility, the nonEaffected party will often assert that
it is not aware of any reason why a cargo could not have been delivered from elsewhere
within the (1G supply pool, meaning that there is no relief for force majeure.

The counter to this argument would likely be that this provision imposes an obligation on a
seller to obtain the cargoes it supplies to the buyer from a speciBc source, i.e., the (1G supply
pool, so that this source can be checked and approved in advance by or for the buyer. ‘n
this basis, it would be argued by the seller that this provision does not impose an obligation
on the seller to supply cargoes from the (1G supply pool if there has been a force majeure
event affecting its chosen supply or supplier in respect of a speciBc cargo. The source of
the seller’s supply might be at its discretion, giving rise to the argument that it was either
not an obligation, or alternatively not possible, to secure any alternative source for the cargo.
Any other (1G that might be available to the seller from the (1G supply pool or otherwise is
relevant only to the e&tent that potential mitigation efforts are possible, as discussed further
below.

YITIGATION
Wf a force majeure event has occurred, the impacted party may very likely be under a
marketEstandard obligation to use reasonable endeavours to mitigate the effect thereof
under the DHA, and to proceed with due diligence to take such steps as would be taken by
a reasonable and prudent operator to remedy the failure as soon as possible and to resume
normal performance. 0onnected with the point above, this might be argued to involve steps
such as, for e&ample and without limitation, the supply of replacement cargoes from any
(1G supply pool referred to in the DHA. Wf so, even if the seller was not obliged to deliver from
any (1G supply pool referred to in the DHA, the argument identiBed above often resurfaces,
that is, that the seller may still have a duty in any event to do so by way of mitigation.
The seller might argue that it has discharged this duty to mitigate by approaching other
aLliate companies, terminals and users of the facilities to assess the feasibility of obtaining
replacement cargoes from them. Wf these efforts were not successful, it is likely that the buyer
would argue that they had been insuLcient, and reFuire that the seller obtain replacement
cargoes from the market to supply to the buyer under the DHA. This is a position that the seller
may not agree with, as it can often appear that obtaining replacement cargoes in this manner
would likely result in the seller making a substantial loss. This may be particularly the case
in highEpriced market conditions Cwhich can be made worse if there has been as assertion
of force majeure events by other suppliers at the same time2. Wf so, it may be argued that the
seller’s obligation only e&tends to a duty to use reasonable endeavours to mitigate the event
of force majeure, such that this obligation does not reFuire the seller to go to the market
to source replacement (1G, if doing so would subordinate its own Bnancial interests. This
obligation would likely reFuire the seller to see whether it could meet the delivery obligation
from another reasonably available source.

FORCE YAWEURE FOR DELAkED FACILITIES

(1G facilities are often constructed in territories that are at higher risk of weatherErelated or
political instability. ;or e&ample, there may be a severe deterioration of the security situation
in the region in which the (1G facility is to be constructed and made operational. Wf so, there
may be a long intervening period during which no signiBcant steps towards the construction
of the planned (1G facility can be conducted. ;or pro'ect Bnancing reasons, (1G DHAs are
often signed in advance of the facility being available for use. After an agreed period of

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delay due to force majeure, it is common to include a provision allowing the nonEaffected
party a right, in its sole discretion, to terminate the (1G DHA on notice for prolonged force
majeure. There are a number of factors speciBc to (1G DHAs where disputes relating to such
provisions can arise.

LONG-STOP DATES
The longEstop dates that give a right to terminate the DHA, if included, are often set
conservatively, so the delay to commissioning often has to be very signiBcant before any right
to terminate for prolonged force majeure arises. Wn the meantime, market conditions may
change, giving rise to doubts about the original pro'ect economics. Wt may prove tempting
for the developer to rely on force majeure to mask a wish to defer capital e&penditure on the
pro'ect during a cycle of low prices or other unfavourable events. Wf so, the other party will
have many months to assess the ongoing validity of the claim for force majeure relief that
has been asserted. As matters become clearer over time, it may decide to challenge whether
force majeure has been validly asserted.

CZALLENGING VALIDITk
The longer the period of force majeure, the harder it may be, in practice, to maintain that force
majeure has impeded all activity on the path to development of the (1G facility. qevelopers
are often sophisticated and e&perienced oil and gas industry companies used to operating in
areas of comple&ity or tension. qisputes can arise where the nonEaffected party challenges
the event of force majeure and whether the event relied on truly falls under the ambit of
the deBnition of force majeure under the DHA. Knglish law, in an oil and gas conte&t, has
conBrmed that it is necessary for a party relying on force majeure to show that the force
majeure was the only cause of delay, rather than having other, possibly commercial, motives
]j43
to delay performance. qisputes can also arise over whether there are additional measures
that could have been taken by the developer or operator to continue work at the site of the
(1G facility. Wf there is an insurgency, for e&ample, could additional measures have been
taken to enable work to continue work at the site despite the insurgency#

NOT KAITING FOR TZE LONG-STOP DATE

As time passes, with limited development towards commissioning, the nonEaffected party
may 'ump the gun and Cwithout waiting for the longEstop date to arrive2 attempt to terminate
the DHA. Wt may become transparent prior to the longEstop date that progress on the (1G
facility, and the needed activity in advance of this date, have been so delayed that it is
impracticable for the developer to be in a position to be ready at the longEstop date. Wt may
likely prove possible for specialist delay consultancies to map out the needed steps on a
critical path analysis and reach the conclusion that the longEstop date cannot be met, as a
result of facts available to them about the Clack of2 progress as at a date well in advance of
the longEstop date itself. Wt can also be possible to rely on pessimistic public announcements
made about progress at the facility to demonstrate that it cannot be ready in time.

OTZER PROVISIONS
Dome (1G contracts may also contain material adverse effect clauses, for e&ample
language such asY 3Dince the date of this Agreement there shall not have been any Uaterial
Adverse Kffect and no event, change, development, state of facts or effect shall have
]j63
occurred that would reasonably be e&pected to have a Uaterial Adverse Kffect’. These
provisions can provide a further remedy to avoid performance due to changes since

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the pro'ect was conceived. Dometimes these provisions are FualiBed by reFuiring that
performance under the contract will have had to be made especially onerous, over and above
any wider disruption that occurs to the wider industry.

;inally, the applicable law may provide additional relief, even where no provision has been
included by the parties when contracting. ;or e&ample, the common law principle of
frustration applies by the automatic operation of law. ;rustration generally terminates a
contract where an e&traneous event beyond the control of the affected party, which could
not reasonably have been foreseen when contracting, renders performance impossible or
radically different than what the parties contemplated. Wf an (1G DHA incorporates a force
majeure clause Cas will likely be the case2 and that clause already caters for the event
complained of, Knglish law will hold that protection granted by the law of frustration will
not be available. The risk of the event occurring will be taken to have been allocated by
the parties in advance, through the language of any force majeure provision. qepending on
the circumstances, this can make reliance on frustration in many Knglish law (1G DHAs
e&tremely challenging.

DISPUTES RELATING TO RESCZEDULING, DIVERSIONS AND DESTINATION

RESTRICTIONS
This section addresses rescheduling disputes in the conte&t of (1G sale and supply,
including disputes concerning the diversion of cargoes from the primary or original receiving
terminal to an alternative or secondary receiving terminal. Wt includes disputes concerningY

X the right to reschedule (1G cargoes from time to timeM

X the right to ask for diversions to different receiving terminalsM
X destination restrictions in (1G DHAsM and
X the impact of cargo reloadings.

RESCZEDULING
As set out above, although referred to by different terms, it is overwhelmingly the case
that (1G deliveries are B&ed in advance by an annual delivery plan, or a delivery schedule,
set by agreement in advance of each contract year. ‘nce the delivery schedule is set,
cargo rescheduling options may be available under many DHAs. Harties may be permitted
to reschedule cargoes to later in an e&isting annual programme, or to move a cargo
from the current delivery schedule into a subseFuent delivery schedule. Reasons why any
rescheduling should take place are routinely reFuired. These may include reasons of an
operational nature declared by either of the parties, including events such as planned
maintenance. jider reasons may include unplanned maintenance, or any other situation
where a party, acting as a reasonable and prudent operator, needs to make changes to the
delivery schedule. ;urther operational reasons may include insuLcient (1G storage tank
space, if a delay to the delivery schedule is reFuested, or a shortfall that impacts on the
security of supply, if an acceleration to the delivery schedule is reFuested. There may also
be far wider reasons allowed, including those that allow rescheduling solely for commercial,
nonEoperational reasons.

Rescheduling is an obvious way of managing demand 5uctuations from time to time,

but normally reFuires the agreement of both parties. A reFuest for a change to the
delivery schedule often imposes a duty on the other party not to unreasonably withhold

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its consent to the reFuested change. A host of logistical and practical counterEarguments
are often witnessed in order to resist a rescheduling, commonly including diLculties with
shipping times and shipping distances, the need to make multiple unloadings at different
terminals Crestricting the ability to change deliveries at one location without pre'udicing
those elsewhere2, or unavailability of vessels at the time the rescheduling is sought. These
counterEarguments are more compelling if the reFuest for a rescheduling is made late in the
day, so there is little time for either party to plan for the change reFuested. ;or this reason,
many DHAs set out a different framework for agreeing a change to a cargo that is due in the
near future, as opposed to one that is due in several months’ time.

;or notiBcations given far in advance, there may be 'oint reasonable endeavour obligations
for both the buyer and seller to reB& the delivery date by agreement or to revise the volumes
or delivery date, or both, by agreement. This would impose a duty to work together to try
avenues to allow a rescheduling. ;or more imminent notiBcations, the framework may be
more restrictive, and there may be an obligation not to unreasonably withhold consent,
which would allow the party receiving the reFuest to present reasonable ob'ections to the
reFuest to reschedule. Wn both cases, there may also be an e&press duty of good faith
in considering such reFuests. quring the months of peak demand, or towards the end of
the relevant contract year Cif the DHA restricts rescheduling to moving cargoes within the
same annual programme2, similar strict restrictions can also apply. All of this may make the
accommodation of a reFuest to change the agreed delivery schedule contentious. The views
of the buyer and the seller may differ as to whether the reasons relied on, for e&ample future
shipping capability, are limited or not. The wording of the DHA will set out the constraints on
rescheduling, and whether a reFuest to do so triggers any duty to consider the reFuest, or
reFuires 'ust the goodwill and coEoperation of the other party.

DIVERSION RESTRICTIONS IN LNG SPAS

qiversion rights allow a buyer to take delivery of a cargo at a different receiving terminal.
The option to sell (1G cargoes in alternative destinations may be an opportunity to create
additional value for the buyer and the seller. Wn addition to obtaining a higher price, sending
a cargo to a new destination may result in substantial savings in shipping costs. )ecause
of this, parties often cooperate in identifying and sharing the beneBts from diversion
opportunities even if there is no provision in their DHA reFuiring that they do so. Iowever,
sellers and buyers can have different views as to whether diversions should be permitted as
a right in an DHA and, if so, under what circumstances a buyer should be permitted to divert
cargoes to other destinations.

(1G DHAs will include a provision identifying the delivery point and shipping terms that
stipulate that title, custody and risk transfer from the seller to the buyer at that pointM both
title and shipping terms are relevant to determining how much destination 5e&ibility a buyer
has. The allocation of costs and risk between the seller and buyer is usually speciBed by
reference to the Wncoterms shipping rules published by the W00. The most commonly used
delivery terms in (1G DHAs are delivery free on board C;‘)2 and delivered at terminal CqAT2
or delivery at place CqAH2, which replaced delivery e& ship CqKD2 in more recent agreements.
Wf (1G is delivered ;‘), title and risk will shift to the buyer when the (1G is loaded on to
the ship, and the buyer is responsible for arranging the vessel. Accordingly, unless there
are other contractual provisions that purport to limit the buyer’s ability to resell or send the
(1G to whatever destination it chooses, under an ;‘) contract, the buyer may have almost
complete destination freedom Csub'ect to shipping and other commercial constraints2. )y

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contrast, if (1G is delivered qAT or qAH, the seller retains title and risk until the (1G is
unloaded at its destination, and the seller is responsible for shipping costs. Wn such a case,
the DHA will identify a speciBc delivery port Coften in the buyer’s home market2 and the buyer
may have no destination freedom at all, unless the parties have added provisions providing
that the buyer may reFuest delivery to other destinations, often referred to as diversions Cor
deviations2, which are discussed below.

Hrovisions addressing the possibility of diverting cargoes in (1G DHAs help parties structure
diversion rights to accommodate their competing commercial interests. The Uodel Uaster
(1G Dale and Hurchase Agreement of the Association of Wnternational Knergy 1egotiators
]j73
CAWK12 contains an optional diversion provision. Dome diversion provisions are very brief,
while others are very detailed. There is a wide range of approaches to such provisions,
includingY

X permitting the buyer a certain number of diversions Cand some also permit the seller
to divert2M
X setting out circumstances in which the buyer may reFuest diversions and the seller
must agreeM and
X providing that either the buyer or the seller may propose diversions, and the parties
will discuss such proposals in good faith.

Uany DHAs provide for a combination of these options.

qiversions can be operated where the primary receiving terminal is unable to operate, but
where an alternative terminal is available. qiversions also occur if it makes sense to try
to supply an area e&periencing increased demand. qiversion provisions may also include
limitations or conditions, such asY

X limiting the volume of cargoes that a purchaser may send to alternate marketsM
X constraining the number of diversions to which a party is entitledM and
X limiting the particular destinations to which cargoes may be diverted.

The parties may also agree on other conditions as to when diversions may be permitted or
refused. ;or e&ample, the parties may stipulate that the buyer may not be entitled to divert
cargoes to alternate markets unless the market price for gas in the designated market falls
below the contract price. Uore commonly, the parties may stipulate that the buyer may not
have a right to divert a cargo unless the diversion will not increase the shipping distance or
costs, or impair the seller’s vessel from returning to the loading port in time to make its ne&t
scheduled delivery. The parties may also stipulate that the buyer is obligated to pay for any
additional costs that the seller incurs in order to deliver (1G to an alternate destination.

There are different approaches to pricing or sharing the economic beneBt from diverted
cargoes. ;or e&ampleY

X the parties may have an agreed proBtEsharing mechanism for diverted cargoesM
X the parties may need to agree on a price Cor a proBtEsharing mechanism2 each time
a cargo is divertedM or
X

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where the parties have identiBed permitted diversion destinations in the DHA, they may
also include pricing provisions for cargoes delivered to speciBed markets Cand these
price formulae can be very different from the contract price for nonEdiverted (1G2.

These pricing provisions may also be sub'ect to revision in the event of a change in the
diversion market Cand the price review provision for the diversion markets may have different
standards2.

As the (1G market has grown, and as shortEterm changes in demand and supply have
created more opportunities for price arbitrage by sending (1G to other markets, there have
been an increasing number of price disputes relating to deliveries to other destinations and
diversions. Wn some instances, sellers have argued that a buyer’s use of diversions 'ustiBes
revising the DHA’s price formula. Wn these cases, the seller may argue that the contract price
was negotiated in light of the parties’ mutual understanding that the gas sourced from the
(1G supplied under the contract would be sold only in a particular market, such that a
destination restriction effectively constitutes an implied element of the parties’ bargain. The
seller may therefore contend that the diversion of cargoes to other markets alters the bargain
reached by the parties. Harties also have sought ad'ustments to the price formulae used in
some DHAs to price (1G delivered to alternate destinations Coften on the same or similar
grounds as in other pricing disputes, including that formulae based on competing sources
of energy should be revised to include gas market prices in the new market2. There have
been a range of other disputes, including as to whether the seller has the right to refuse
a diversion proposal and whether Cand how2 the parties have agreed to share proBts on
cargoes delivered to other destinations.

Wn the dispute concerning diversions between a Trinidad producer, Atlantic (1G, and a
Dpanish buyer, Gas 1atural, which was made public as part of court proceedings in the éD,
the parties had negotiated their contract price 3on the assumption that the (1G would be
delivered to and sold in Dpain’, including by modelling the contract price on various aspects
]j83
of the Dpanish energy market. The DHA nevertheless permitted Gas 1atural to divert some
or all of the (1G cargoes to 1ew Kngland in the éD, but it did not provide for any change
to the contract price if Gas 1atural did so. jhen a price difference made selling to the
éD suLciently attractive, Gas 1atural elected to divert cargoes to 1ew Kngland. Atlantic
(1G claimed that these diversions entitled it to a price review under the terms of the DHA
Cwhich referred, without specifying which market, to the Fuestion of whether the contract
price 3re5ected the value of 1atural Gas in the end user market’2 because the contract price
re5ected the Dpanish market and not the 1ew Kngland market. The tribunal agreed and
imposed a revised price formula that was intended to 3be adaptable depending on the )uyer’s
end user market at the time’. The revised price formula reFuired Gas 1atural to pay a 1ew
KnglandEbased price in the event that it elected to divert a speciBed percentage of cargoes
to the 1ew Kngland market. This re5ects some of the issues that can arise concerning
diversions, particularly where the parties have not included detailed diversion provisions.

DESTINATION RESTRICTIONS IN LNG SPAS

Wn addition to designating the delivery point, historically, many longEterm (1G DHAs contained
destination restriction clauses. Duch provisions restricted the buyer from reselling the (1G
outside of a designated geographic market Cusually, the buyer’s home market2. A seller may
want to prevent a buyer from being able to deliver cargoes to other destinations because
the seller does not want the buyer to compete with it in other markets or to compete with

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its other buyers. A seller may also be concerned about the costs of delivering to alternate
destinations and the potential disruption to its transportation logistics and schedule, or that
delivery to a different market than the one designated in the contract may violate trade
restrictions or the terms of the seller’s Bnancing. Wn contrast, a buyer may view the right to
deliver (1G cargoes to different destinations as essential to mitigating the takeEorEpay risk
created by its volume commitment Cbecause it may not have suLcient customer demand in
the designated delivery market to sell gas there at a proBt or to avoid a takeEorEpay liability2.
A buyer may also have obligations to supply customers or its own facilities in different
locations Cfor e&ample, a buyer may own facilities such as combined cycle gas turbines in
other places2 and it therefore may want to have the contractual right to deliver to multiple
destinations. Uore generally, a buyer may want destination 5e&ibility to manage its overall
portfolio Cwhich may include different sources of supply with different pricing and other
terms2 and to pursue arbitrage opportunities.

qestination restrictions have become less common in (1G DHAs. They are less common in
shorterEterm contracts. The Kuropean 0ommission has also said that such provisions are
not permitted in contracts for the sale of (1G to Ké buyers. quring a number of investigations
Cinvolving both (1G and pipeline gas contracts2 the Kuropean 0ommission has said
that 3territorial restriction clauses CreEe&port prohibitions2 and mechanisms having similar
effects’, including the effect of reducing the opportunity for the buyer to pursue arbitrage
]j93
sales, constitute a 3severe restriction’ on competition. The Kuropean 0ommission has
made clear that it considers such provisions in contracts that impact on trade within the Ké to
constitute a serious breach of Kuropean competition law because they prevent crossEborder
trade and undermine the goal of a single integrated gas market in Kurope, because they
limit the number of potential sources of supply within each country, and act to divide up
rather than harmonise the single Kuropean market. The Kuropean 0ommission has entered
into a number of settlements reFuiring gas and (1G producers to change the terms of
their supply contracts. Wn 6-/ó, the Kuropean position was reaLrmed in the Kuropean
0ommission’s ;ollowEup Dtudy to the (1G and Dtorage Dtrategy, as followsY 3qestination
clauses are contrary to Ké internal market and competition rules, and are contrary to the
Treaty establishing the Ké. qestination clauses are therefore banned in pipeline gas and (1G
]j13
contracts for all supplies to any KKA country.’

The Kuropean 0ommission has also stated that proBtEsharing mechanisms where 3the
buyerV importer ¶hasä to share a certain part of the proBt with the supplierVproducer if the
gas is sold on by the importer to a customer outside the agreed territory’ have been used as
]203
an alternative to territorial restriction clauses and may restrict competition by dissuading
purchasers from selling cargoes outside a designated market, even if such provisions do not
]2j3
e&pressly prohibit such sales. The impact of the buyer having to share part of the proBt
obtained from the diversion is seen by the Kuropean 0ommission to have an anticompetitive
effect, if it removes or reduces the importer’s incentive to attempt the diversion. This would
act to maintain low prices in the original market and high prices in the proposed diversion
market by hampering the connection between the two. The Kuropean 0ommission has
stated that proBtEsharing mechanisms are not permissible for (1G sold on a ;‘) basis.
The 0ommission has indicated, however, that the use of proBtEsharing mechanisms may be
permitted where an DHA provides for delivery on a qAT or qAH Cpreviously qKD2 basis and
]223
3title of the gas remains with the seller until the ship is unloaded’. qestination restrictions
are thus generally not included in (1G DHAs with Kuropean buyers, and diversion provisions

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reFuiring proBt sharing are generally understood to only be permissible while the seller
]253
retains title of the (1G.

The $apan ;air Trade 0ommission has also indicated that destination restrictions combined
]243
with ;‘) provisions likely violated $apan’s antitrust laws and $apan has also signed
a Uemorandum of 0ooperation on the Global (1G market with the Kuropean énion with
its ob'ectives including 3accelerating efforts in facilitating more 5e&ible (1G contracts in
terms of destination – aiming at avoiding related restrictions – and of reEselling, duration,
]263
price setting and review’. Wt is not clear whether destination restrictions or proBtEsharing
mechanisms in ;‘) contracts violate antitrust or competition laws in other 'urisdictions.

(1G arbitrations involving markets within the Ké increasingly include submissions on Ké

law. These submissions are made in support of positions taken by the parties about the
proper interpretation of the DHA. Wf there is ambiguity as to how the language of an DHA
reFuires a party to operate a right to divert a cargo, submissions as to Ké law would focus
on the need for any delays or restrictions not to act as a restraint of trade within the Ké.
The arbitrators would be asked to consider whether a particular contract provision violated
antitrust or competition laws, in which case it should be considered void, releasing the
disputed restriction. Alternatively, if there are two available interpretations as to the legal
effect of the offending provision, submissions would be made that it should be interpreted in
a manner that made it lawful Ca limited application2, rather than unlawful Ca wide application2.

DISPUTES RELATING TO RELOADING OF LNG

Wf diversions are not permitted, or not desirable, the alternative means to access an
alternative market is through a reloading. (1G terminals are often capable of both unloading
and loading (1G. The (1G is delivered and unloaded as reFuired by the DHA. The buyer
then reloads some of the (1G onto another vessel. The buyer makes arrangements to sell
and deliver this (1G to another market. Wn order to e&port (1G, the buyer may be able to
make a shipEtoEship transfer Cusually to smaller vessels2. (1G also may be unloaded and
sent to storage facilities at the (1G terminal, where it is commingled with (1G in the storage
tanks. A buyer may then use the commingled (1G from several deliveries Cor purchase (1G
from other importers2 to load a cargo onto a vessel or vessels to sell to another destination.
Reloading is less eLcient than diversions. énlike a diversion, where it may be possible to
reduce shipping costs, loading (1G typically involves incurring additional shipping costs and
unloading costs Cbecause the (1G is delivered twice2. que to the 3boilEoff’ of (1G while it is
transported, unloaded and stored, there will often not be suLcient (1G from one cargo to
load a full cargo onto another (1G tanker. There are also the costs of storing and loading
the (1G, which can be substantial. Wn addition, there can be other logistical constraints that
limit a buyer’s ability to e&port (1G Cincluding having suLcient (1G, timely access to the
(1G terminal and available shipping capacity2. The result is that reloadings occur only when
there are substantial price differences between markets, allowing for enough uplift to cover
the costs involved.

jhere the DHA does not permit diversions or limits their availability, a seller may argue
that reloading (1G is inconsistent with the parties’ e&pectations or an attempt to evade
contractual limitations. Iowever, in many DHAs, there are no limits on what the buyer may
do after it takes title to the (1G. Uoreover, the rationale for sharing the beneBt gained when
parties agree to divert a cargo does not apply when (1G is loaded by the buyer after title
has shifted to it, and the buyer bears all the costs and risks of the loading and subseFuent
saleY the (1G has been sold to the buyer, and the buyer has discharged its obligations to the

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seller. jhether it uses the (1G at the unloading port, or sells it elsewhere, it is likely to argue
that this is its (1G, to do with as it pleases.

DISPUTES RELATING TO TERYINAL CAPACITk AND USE

This section addresses disputes relating to the use of terminals by parties to an (1G sale
and purchase transaction and the division of liabilities for doing so, including liability of the
buyer and the seller to the operator of the terminal for any damage to the terminal caused
by the vessel.

Wn terms of delivery of (1G to a receiving terminal, it is standard for the buyer Cas the party that
enters into the contract with the terminal2 to be liable to the terminal for any loss or damage
caused by either the buyer or the vessel, even though it is more likely that any damage done
will be caused by the vessel Cor the pilot2 rather than the buyer itself. ;or this reason, terminal
access rules regularly provide for either an uncapped indemnity or unlimited liability on the
part of the buyer Cas capacity holder2 for loss or damage caused to the receiving terminal.

This indemnity cover also often addresses whether conseFuential or indirect losses by
the receiving terminal Csuch as loss of proBts2 are covered or not, which may put such
arrangements at odds with the division of risks under (1G DHAs, which very regularly do not
allow for claims for conseFuential losses in any circumstances. Wn most cases, the receiving
terminal will also reFuire the vessel to sign a terminal operating procedures document,
access code, or conditions of use, which gives the (1G terminal a direct contractual right
against the vessel in the event of damage to the receiving terminal. This will likely be entered
into between the receiving terminal and the vessel, and will address items such as insurance,
safety, pollution prevention and remediation, public health or similar reFuirements. Wt will
also regularly address the liability and remedies for any claims, liabilities, losses, costs and
e&penses Cincluding in respect of pollution2, in each case, in connection with the use by the
vessel of the receiving terminal. Wt will be appropriate to ensure that adeFuate insurance cover
and creditworthiness are established in the case of an incident. The DHA will often provide
that the seller Cif it is the vessel owner2 has insurance cover, including environmental cover.
Wt may be necessary to negotiate a higher level of insurance cover, either in relation to all
cargoes or in relation to speciBc cargoes, if there are concerns about a particular vessel or
voyage. Wn e&treme circumstances, if the receiving terminal imposes liability for thirdEparty
claims, and there are concerns about insurance, the seller or the buyer would need to be
asked to accept liability for thirdEparty claims, or claims from the receiving terminal, and build
this into the division of risks in the DHA.

DISPUTES RELATING TO TZE PRICE OF LNG

This Bnal section introduces disputes relating to the price of (1G as agreed by parties to an
]273
(1G sale and purchase transaction. These issues are considered elsewhere in this work.
Wn many markets, buyers are considering entering into discussions to sign new midEterm or
longEterm (1G volumes. This is in light of market developments, to balance portfolios or to
mitigate against disruptions in pipeline gas supplies from the Russian ;ederation. These new
(1G supply arrangements are being signed in order to replace e&piring longEterm supplies, or
to provide an alternative source of supply to increase security of supply or to replace pipeline
gas from Russia.

Uany of these buyers are considering taking supplies of (1G from the éD, which has been
rapidly increasing (1G e&ports and which is one of the territories with surplus (1G available
for commitment. Hricing under éD (1G supply contracts is typically different to many other

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sources of supply. The price is routinely linked to the éD gas hub price, with a commercial
ad'ustment, and with a provision for transportation costs. As éD (1G e&ports increase,
these cargoes of hubEpriced (1G are disrupting price patterns in some e&isting markets,
particularly where these markets have no hub price of their own, that can adapt instantly
to the introduction of (1G brought in at a different price, to smooth over the variances.
Wn markets without e&isting hubs, the price of éD cargoes may provide an additional price
marker that may be used as a benchmark for seeking to vary the price under e&isting
longEterm supplies. éD (1G prices are more transparent than other supplies, lifting a shadow
from the evaluation of the impact of these deliveries that can be present where the price
formation methods are less clear and less publicly available. éD e&ports also introduce to
new markets a different governing law of the DHA, as standardEform éD e&port contracts are
often governed by the law of one of the states of the éD, such as 1ew Qork law or Te&as law.
These governing laws incorporate the éD’s éniform 0ommercial 0ode Cé002, which applies
]283
to the sale of natural gas. éD e&porters, who are themselves in contract with other éD
parties to secure the feedstock gas needed to produce the (1G for e&port, are resistant to
efforts to disrupt these backEtoEback arrangements by agreeing to nonEéD law as the law of
the DHA.

Uodern price review and hardship provisions, which have signiBcantly evolved through the
e&perience learned from the previous waves of price review arbitrations, allow parties to
build into their ad'ustment provisions everything that has been learned from these past
disputes, when allocating the risks of future changes. jhenever there are unbalanced prices,
sellers also consider seeking upwards price reviews under longEterm contracts. After years
of paying more than market price, which was the reality when buying on a )rentEbased (1G
price or on a hybrid price rather than a hub price, despite hub prices in Kurope having been
volatile and hitting historic highs as a result of supply disruptions and dislocations following
the invasion of ékraine, longEterm buyers are resisting any price rise. A number of buyers
are now responding to sellers’ upwards price review reFuests, seemingly heralding the latest
wave of (1G and gas price review arbitrations.

ENDNOTES
]j3
)en Iolland and Dteven Dparling are partners at SP( Gates. The authors gratefully
acknowledge Dteven H ;ini7io and his colleagues at jilmerIale, whose chapter on
3qestination Restrictions and qiversion Hrovisions in (1G Dale and Hurchase Agreements’,
published in the third edition of this work, provided the framework for sections of this chapter.
]23
)en Iolland and Hhillip Dpencer Ashley 31atural Gas Hrice ReviewsY Hast, Hresent and
;uture’, Journal of Energy & Natural Resources Law, :ol 9-, 1o./, p. 6J C6-/62.
]53
George von Uehren and )en Iolland 3)eyond Hrice ReviewsY Ad'udicating 0laims of
;inancial Iardship’, Leading Practitioners’ Guide to Oil & Gas Arbitrations, $U Gatis ed.
]43
Article /-óC92 of the Algerian 0ivil 0odeY 3d’événements exceptionels, imprévisibles’and
3l’obligation devenue excessive’.
]63
Cavendish Square Holdings BV and Another v. Talal El Makdessi ¶6-/zä éSD0 4ó.
]73
Knglish law sees a 3primary obligation’ as being a duty to perform an action agreed under
a contract, and a 3secondary obligation’ as being a duty to pay damages upon default of that
primary obligation. The rule on penalties only applies to secondary obligations.

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]83
)en Iolland 3Knforceability of takeEorEpay provisions in Knglish law contracts – resolved’,
Journal of Energy & Natural Resources Law, :ol 9x, 1o.x, p.xx9–xz9 C6-/42.
]93
Cavendish Square Holdings BV and Another v. Talal El Makdessi ¶6-/zä éSD0 4ó at ¶6zzä
C(ord Iodge2.
]13
I )eale Ced.2, Chitty on Contracts C9xth edn., 6-662, > 9-E/9-.
]j03
Thames Valley Power Ltd v. Total Gas and Power Ltd ¶6--zä KjI0 66-° C0omm2 at para.
¶z-ä.
]jj3
W00 Wnternational 0ourt of Arbitration )ulletin :ol. 6- 1o. 6, p. z/.
]j23
MUR Shipping BV v. RTI Ltd ¶6-66ä éS0A 0iv /x-4. This decision rested on the precise
language of the clause. The 0ourt of Appeal was split on this issue, and the Iigh 0ourt and
the arbitrators had also come to different conclusions.
]j53
Dample clause used for illustration only.
]j43
Seadrill Ghana Operations Ltd v. Tullow Ghana Ltd ¶6-/°ä KjI0 /4x- C0omm2.
]j63
Dample clause used for illustration only.
]j73
The Association of Wnternational Hetroleum 1egotiators’ Uodel 0ontract Uaster (1G Dale
and Hurchase Agreement C6-/62.
]j83
Dee Gas Natural Aprovisionamientos SDG, SA v. Atlantic LNG Co of Trinidad and Tobago,
1o. -° 0iv. //-J, 6--° j( x9xxz6z, CDq1Q /4 Deptember 6--°2.
]j93
Kuropean 0ommission press release, 30ommission settles investigation into territorial
sales restrictions with 1igerian gas company 1(1G,’ dated /6 qecember 6--6, WHV-6V/°4J.
]j13
httpsYVVec.europa.euVenergyVsitesVenerVBlesVdocumentsVfollow=up=study=lng=
storage=Bnal=-/.pdf.
]203
Dee Kuropean 0ommission press release, 30ommission and Algeria reach agreement on
territorial restrictions and alternatives clauses in gas supply contracts,’ dated // $uly 6--ó,
WHV-óV/-óx.
]2j3
Wn doing so, the 0ommission speciBcally referred to clauses that restrict (1G buyers from
selling (1G 3into terminals located in a different member state’. Dee Kuropean 0ommission
press release, 30ommission secures changes to gas supply contracts between K.‘1 Ruhrgas
and Ga7prom’, dated /- $une 6--z, WHV-zVó/-.
]223
Dee Kuropean 0ommission press release, 30ommission and Algeria reach agreement on
territorial restrictions and alternative clauses in gas supply contracts,’ dated // $uly 6--ó,
WHV-óV/-óx. Dee also K j+ktare, 3Territorial restrictions and proBt sharing mechanisms in
the gas sectorY the Algerian case’, 9 0omp Hol 1ewsletter /J, 6- dated 6--ó.
]253
Wn 6-/°, the Ké 0ommission opened an investigation into restrictions to the
free 5ow of gas sold by “atar Hetroleum in Kurope. Dee Kuropean 0ommission
press release, 3AntitrustY 0ommission opens investigation into restrictions to the free
5ow of gas sold by “atar Hetroleum in Kurope,’ dated 6/ $une 6-/°, WHV/°Vx69J.
AccessY httpYVVeuropa.euVrapidVpressErelease=WHE/°Ex69J=en.htm. The investigation was
subseFuently closed in 6-66 after a 3thorough analysis of all relevant evidence’.

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]243
The $;T0 stated that companies should not include competitionErestraining
clauses when negotiating new contracts and should review e&isting contracts for
3competitionErestraining business practices which lead to restrictions of resale’. Dee
Durvey on (1G Trades of $apan ;air Trade 0ommission, Durvey, $une 6-/ó, available atY
httpsYVVwww.'ftc.go.'pVenVpressreleasesVyearlyE6-/óV$uneV/ó-46°=BlesV/ó-46
°E6.pdf.
]263
httpsYVVwww.eumonitor.nlVJ9z9---V/V'xnvgszk'g6ókof='Jvvikóm/c9gy&pVvkfhóbtv
rxwgVf[V/-z9x=/ó.pdf.
]273
Dee the 0hapter on 3The Kvolution of 1atural Gas Hrice Review Arbitrations’.
]283
éniform 0ommercial 0ode, Article 6.

Ben Zolland [email protected]

Steven Sparling [email protected]

599 Lexington Avenue, New York, NY 10022, United States

Tel: +1 212 536 4065

http://www.klgates.com

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Upstream Oil and Gas

Disputes
Abubaéar AnaJ, Chime–ie Onu–uliée, Fidelis Oguche and Owen Umeh
G Elias & Co

Summary

INTRODUCTION

CONTRACTUAL LANDSCAPES GIVING RISE TO DISPUTES

GROUNDS

REDUCING RISM OF UPSTREAY DISPUTES

RESOLVING UPSTREAY DISPUTES Æ E[ISTING YECZANISYS AND FORA

UPSTREAY ARBITRATION Æ COYYERCIAL ARBITRATION VERSUS TREATk

ARBITRATION

TZE ENERGk CZARTER TREATk

CORRUPTION AS GROUNDS FOR CZALLENGING ENFORCEYENT OF AKARDS

OTZER TRENDS AND OUTLOOM

FUNDING AN UPSTREAY DISPUTE RESOLUTION EFFORT

CONCLUSION

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INTRODUCTION
The potential for disputes in the upstream subsector of the global oil and gas industry
is substantial. 0omple& contracts, ha7y procurement and governance regimes, resource
control policies, environmental issues, geopolitics, and price volatility combine to make the
oil and gas industry in general, and its upstream subsector in particular, a ma'or source of
disputes.

This paper has two aims. ‘ne is to describe the conceptual, contractual and statutory
conte&ts in which such disputes occur. The other is to identify and evaluate some of the
more signiBcant themes that have started to shape and in5uence such disputes.

CONTRACTUAL LANDSCAPES GIVING RISE TO DISPUTES

Wn the upstream oil world, there are three broad participants, namely the government, the
pro'ect parties and service providers. Government, as broadly intended in this sense for
a 'urisdiction or market, encompasses the sovereign, regulators, government departments
and stateEowned or stateEcontrolled oil companies Csuch as Russia’s Ga7prom and Algeria’s
Donatrach2. Hro'ect parties include pro'ect sponsors such as oil companies Cwhich range
from small indigenous players to global superma'ors2, their investors and Bnanciers.
Dervice providers here would include the specialists that produce, instal, maintain or repair
eFuipment or other hydrocarbon assets belonging to or operated by the government or a
pro'ect party.

Dometimes the line that separates these categories of entities gets murkier than usual.
The governmentEowned or governmentEcontrolled entities in commercial relations with
counterparties often act like ordinary companies by being incorporated under general
municipal corporate law instead of being created directly by statute as a public corporation.
;or instance, the 1igerian 1ational Hetroleum 0orporation, a longstanding oil company
of the 1igerian federal government, was recently reconstituted as a private company
]23
organised under the 1igerian general company statute. Uunicipal company law may treat
governmentEowned or governmentEcontrolled entities as regular companies with separate
corporate identities from the government, but counterparties and indeed international law,
]53
with good reason, often do not see them as such.

Wn many oilEproducing countries including 1igeria, ownership of oil and gas rights usually
vest in the government. jhether the government with the vested right is central or regional
is ultimately a matter of constitutional law. jhile, for e&ample, in 1igeria, 3the property and
ownership of petroleum within 1igeria and its territorial waters’ is vested in the 1igerian
]43 ]63
state, in 0anada, the provinces retain proprietary rights.

)ecause the state often owns all hydrocarbons, private actors can only participate in
operations under a number of statutorily or contractually enabled structures. ‘ne of them is
through concessions permitting companies to e&plore and produce oil and gas over a period
in respect of an oil block or series of oil blocks indicated in the terms of the concession.

Wn consideration for granting the concession, the awarding government receives royalties,
ta&es, licensing fees and other such beneBts provided under the terms of the concession
or applicable law. Wn 1igeria, the prevailing forms of concession under the hydrocarbon law
]73
are C/2 a petroleum e&ploration licence Ca renewable concession for an initial term of three
]83 ]93
years 2, C62 a petroleum prospecting licence Canother form of concession for three to ten

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]13
years depending on the location or nature of the oil acreage 2, and C92 a petroleum mining
]j03 ]jj3
lease Cwhich may be granted for up to 6- years 2. Dimilar licensing regimes apply in
other oilEproducing 'urisdictions around the world.

The production sharing contract CHD02 structure is another notable framework for the
e&ploration, by pro'ect parties, of stateEowned oil blocks. A HD0 is essentially a contract
between the government Coften represented by the stateEowned or stateEcontrolled oil
company2 on the one hand and one or more pro'ect parties on the other.

A HD0 typically relates to one or more oil blocks owned by the government and appoints a
pro'ect party to e&plore and mine hydrocarbons at its own cost. Typically, HD0s provide that
3proBt oil’ Cthe portion of the mined hydrocarbons to be distributed between the contractor
and the state after the contractor has recovered the 3cost oil’, which, in HD0 conte&ts, is
that part of the mined hydrocarbons that represents the contractor’s production costs2 is
distributed among the parties. They also set out the principles governing royalty and ta&
payments from the HD0 proceeds and do not, unlike a concession, grant the contractor a
proprietary interest in the hydrocarbons or the licence. The contractor’s interest is restricted
to what it is entitled to get by way of cost oil and proBt oil under the terms of the HD0. Wn
some 'urisdictions, legislation, not 'ust contract, stipulates how accruals from the HD0 are
]j23
distributed between the contractor and the government.

jhen a pro'ect party is granted a concession over an oil block, given the capitalEintensive
and the highlyEtechnical nature of upstream efforts, it is not uncommon for a pro'ect party to
enter into a 'oint venture with other pro'ect parties or even the state Cagain often represented
by the relevant stateEowned or stateEcontrolled oil companies2 in respect of the concession.
This 'oint venture generally takes either of two formsY an incorporated 'oint venture CW$:2 or
an unincorporated 'oint venture Cé$:2.

Wn an W$:, the parties incorporate a fresh company to own and operate the hydrocarbons
block, with their interests in the block being only indirect and to the e&tent of their
shareholding in the W$:. The rights and responsibilities of the parties in relation to the W$:
Cincluding regarding the distribution of dividends, the constitution of the W$:’s board and
management teams, and rules governing the transfer of shares between the 'oint venturers
or to third parties or the fresh allotment of the W$:’s shares2, and by e&tension the block, are, in
this case, deBned in multiple documents – some contractual and others statutory – such as
the W$:’s constitutional documents Clike its articles of association2, shareholders’ agreement
and formation agreement.

Wn a é$:, the parties retain direct interests in the assets to the e&tent of their 3participating
interests’ in the hydrocarbons block. Iere, one of the 'oint venturers is e&plicitly appointed to
operate it. The central contractual document in a é$: is the 'oint operating agreement C$‘A2.
$‘As provide for how cash calls are made by the operator, the distribution of the proceeds of
the production as between the parties, and the constitution of a pro'ect management team
to oversee the operator’s production efforts.

GROUNDS
Given the elaborate and comple& nature of the relationships that e&ist in the upstream
segment of the oil and gas industry, it is not surprising that disputes are rife. These come
in various forms depending on the nature of the relationship and how the rights and
responsibilities of the participants are deBned legally and contractually.

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jhere the government is a participant in a hydrocarbons arrangement by, say, having granted
a concession to a pro'ect party, then there is a risk of e&propriation, especially in 'urisdictions
with domanial regimes or where national institutions are weak and investorEprotections are
sub'ect to the whims of the government. K&propriation may take place directly or indirectly.
An e&propriation is direct where the government compulsorily and e&plicitly nationalises
assets Cthe acreage, installations, bank account balances2 a pro'ect party has an interest in.
An e&propriation may be indirect Cor 3creeping’2 where the government takes measures that
have the effect of depriving a pro'ect party of the en'oyment of its beneBcial interest in the
]j53
asset even where the legal interest in or title to the asset is not affected.

The government may e&propriate a pro'ect party’s interest in a hydrocarbons asset for
many reasons. Dome of these may be ideological Cfor instance, as happened in Amoco
]j43
International Finance Corporation v. Iran 2 or simply economic Cwhere the state changes
course and deems the terms of the grant or e&isting arrangement as too favourable to the
]j63
pro'ect party, as was the case in Kuwait v. Aminoil 2. Wn Zhongshan Fucheng Industrial
]j73
Investment Co Ltd v. Federal Republic of Nigeria, acts of a subnational government in
1igeria in relation to individuals associated with a 0hinese investor designed to result in the
investor’s vacation of a special economic 7one was held by an arbitral tribunal as constituting
e&propriation.

Iowever, not all government acts that a pro'ect party Bnds inconvenient to its economic
]j83
interest count as e&propriation. As seen in Feldman v. Mexico, where a tribunal considered
the Ue&ican government’s decision not to provide ta& rebates to a pro'ect party as consistent
with the government’s enduring Bscal policy in the affected economic sector and therefore
did not count as e&propriation. Dimilarly, regulation does not generally count as e&propriation
]j93
to the e&tent that its purpose is to control how a hydrocarbons asset is e&ploited.

Aside from e&propriation, there are other instances of disputes between the government and
pro'ect parties. These may arise under a HD0, for e&ample as to how the proBt oil or other
accrual from the HD0 is metered and distributed between the HD0 parties. qisputes may
also arise from regulations of government or from the imposition or collection of ta&es or
other Bscal charges from, a pro'ect party.

épstream disputes arise not only from hydrocarbons pro'ects involving the government
but also e&tend beyond that. Kven in 'oint ventures, disputes can arise from the governing
technical service agreement, meeting of cash calls, transfer or encumbrance of shares or
participating interests in the 'oint venture, or the constitution of the management team or
the valuation of assets. 0ontractual disputes can also arise as between the government and
pro'ect parties and service providers, including with respect to fees payable under the terms
of the governing operation and management contract or the Fuality of service or material
supplied.

REDUCING RISM OF UPSTREAY DISPUTES

There are timeEtested means to reduce the risk of disputes in the upstream segment of the
oil and gas industry. K&propriation risks can be reduced by pro'ect parties Cespecially the
foreign parties2 dealing with host states taking steps toY

X choose a neutral 'urisdiction to govern the disputeM

X choose a neutral country for the settlement of disputesM
X ensure that the documentation includes industryEstandard stabilisation provisionsM

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X be mindful of local cultural and political dimensions to the pro'ect parties’ investmentM
X incorporate in host countries with treatyEbased investment protectionsM and
X procure that new statute is passed in the country of the pro'ect with provisions
protecting the investment.

Generally, robustly drafted contracts that preEempt disputes and stipulate how they can be
managed are certainly helpful.

RESOLVING UPSTREAY DISPUTES Æ E[ISTING YECZANISYS AND FORA

The platforms most freFuently used to resolve disputes arising from the upstream
subsector are litigation and arbitration. jhile other dispute resolution mechanisms Csuch as
]j13
negotiation, conciliation and mediation2 are available, they are sparingly used for various
reasons, including their C/2 relative lack of sophisticated codiBed rules, C62 lack of suitability
for highly speciBc technical matters Cfor e&ample e&pert determination2 or C92 dependence
]203
on the parties’ cooperation and willingness to reach a compromise.

Wn principle, all upstream disputes are resolvable by the courts unless parties contractually
agreed on dispute resolution by arbitration or other means, or the dispute is not arbitrable
or, as a matter of law, not capable of being resolved by means other than litigation. The
relevant parties, especially the host country, often decide to go to national courts to resolve
disputes. 1igeria’s constitution, for e&ample, grants the national courts inherent 'urisdiction
to ad'udicate 3all matters between persons, or between government or authority and to any
]2j3
persons in 1igeria’. Uunicipal laws often grant specialised courts 'urisdiction to ad'udicate
over upstream disputes. Wn 1igeria, the ;ederal Iigh 0ourt is constitutionally empowered to
]223
entertain disputes relating to 3oil Belds, oil mining, geological surveys and natural gas’.

;or an arbitral tribunal to have 'urisdiction in a commercial arbitration, there must be an

]253
agreement to that effect. Duch agreement may be a separate contract altogether or may
]243
be embodied in a clause in the wider contract.

UPSTREAY ARBITRATION Æ COYYERCIAL ARBITRATION VERSUS TREATk

ARBITRATION
épstream disputes are commonly referred to commercial or investment treaty arbitration.
There are key distinctions between treaty arbitrations Ctechnically understood as a form
of arbitration that enables foreign investors to pursue legal claims against a host country2
and commercial arbitration Cwhich is between commercial parties in respect of an actual,
ongoing or anticipated contractual breach2.

;or instance, unlike commercial arbitration, C/2 public interest issues and legislative policies
of host countries, C62 the provision of state consent to arbitration through bilateral or
multilateral investment treaties, and C92 the usual absence of counterclaims by a host
]263
country against a foreign investor are all topical features of treaty arbitrations.

The selection of arbitration as the dispute resolution mechanism in contracts between host
countries and investors means that either of the parties may refer any resulting dispute to
commercial arbitration under the arbitration rules of one of the ma'or arbitral institutions
such as the Wnternational 0hamber of 0ommerce CW002 or the (ondon 0ourt of Wnternational
Arbitration C(0WA2 or to ad hoc arbitration under the é10WTRA( Rules. K&propriations and
]273
nationalisations witnessed in the worldwide oil and gas industry in the /Jó-s and /J°-s

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made investment treaties a necessary precondition for a foreign investor’s participation in

the domestic hydrocarbons market of a host country.

The e&istence of a bilateral or multilateral investment treaty between the host country and the
investor’s country also enables treaty arbitration under the rules of the Wnternational 0entre
for Dettlement of Wnvestment qisputes CW0DWq2.

TZE ENERGk CZARTER TREATk

The Knergy 0harter Treaty CK0T2 provides for arbitration under the W0DWq Rules and the
é10WTRA( Rules, among others. The K0T is an investment treaty in respect of the global
hydrocarbons industry. Wt recognises the 3necessity for the most eLcient e&ploration,
]283
production, conversion, storage, transport, distribution and use of energy’. Wts provisions
are wideEranging and e&tend to such matters as the promotion of competitive behaviour,E
]293 ]213
fostering access to capital, compensation for losses arising from armed con5ict or
]503 ]5j3
unrest and environmental issues.

1otably, the K0T provides for the resolution of disputes between an investor and a
]523
3contracting party’. The K0T regards a contracting party as a state or an organisation
]553
constituted by states for which the K0T is applicable. An 3investor’ as conceptualised by
the K0T may be a natural person or an entity whose origin is traceable to either a contracting
]543
party or a different state. The dispute resolution provisions in the K0T are in respect
of 3investments’, which the K0T technically understands as any asset owned or controlled
directly or indirectly by an investor, which may be tangible or intangible, eFuity securities Cor
associated rights2, receivables and monetary claims, returns on investment or intellectual
]563
property.

The K0T contemplates, as a Brst measure, amicable settlement of a dispute between a

contracting party and an investor in respect of the investor’s investment in the contracting
]573
party’s territory. ;ailing an amicable settlement within three months, the investor may
submit the dispute for resolution to the court or administrative tribunals in the territory of the
]583
contracting party or refer the dispute to any previously agreed dispute resolution platform.

The K0T also provides a framework for the submission of a dispute to W0DWq where the home
country Cthe country of the investor’s origin Cor incorporation22 and the contracting party are
]593
both parties to the W0DWq 0onvention. The K0T further provides for a dispute to be referred
to W0DWq even where one of the home country or the contracting party is not a signatory to
the W0DWq 0onvention, under the rules governing the Additional ;acility for the Administration
]513
of Hroceedings by the Decretariat of the 0entre.

A dispute may also be submitted to a sole arbitrator or ad hoc arbitration tribunal established
under the é10WTRA( Arbitration Rules or an arbitral proceeding under the Arbitration Wnstitute
]403
of the Dtockholm 0hamber of 0ommerce. An arbitral award made under a contracting
partyEinvestor dispute may include an award of interest and shall be Bnal and binding on
]4j3
the disputants. jhere an award relates to a subnational government or authority of a
contracting party, such award shall provide that the affected contracting party may pay
monetary damages in place of any provided remedy.

Also within the domain of the K0T is resolution of stateEstate Cor

]423
contractingEpartyEcontracting party2 disputes. jhere there is a dispute concerning any
matter provided by the K0T, the Brst is for diplomatic channels to be deployed to resolve such
]453
dispute. jhere diplomatic channels are unable to resolve the dispute within 3a reasonable

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]443
period of time’, either party may submit the dispute to an ad hoc tribunal for resolution.
]463
The K0T provides for how such tribunal shall be constituted, the applicability of the rules
]473 ]483
and principles of international law and the binding nature of the arbitral award.

The general attitude of the K0T towards the resolution of disputes Cespecially where an
investor is in dispute with a state2 is to ensure that the investor and its investments are
protected from the arbitrary power of sovereigns. Wt is for this purpose that the K0T, for
instance, C/2 reserves an investor’s right to refer a dispute to municipal court, C62 makes
arbitration the primary form of dispute resolution, C92 preserves the binding nature of any
arbitral award and Cx2 confers liability on the state for the acts and omissions of even
subnational authorities. This mirrors the general disposition of treaty arbitrations on foreign
investments.

CORRUPTION AS GROUNDS FOR CZALLENGING ENFORCEYENT OF AKARDS

]493
The increasing prominence of energyErelated disputes in international arbitrations has
given rise to several trends in arguments presented to courts opposing the enforcement
of awards. ‘ne notable trend involves raising allegations of corruption. The 1ew Qork
0onvention provides that a court may refuse enforcement of the award where it would be
]413
contrary to public policy. The arguments brought under this ground in energy disputes
freFuently involve allegations of fraud or corruption.
]603
Iowever, despite its common use by parties, this ground is rarely successful. ‘ne of the
]6j3
ma'or reasons being the high bar for parties making such a defence to enforcement. ;or
e&ample, in 6-66, a subsidiary of General Klectric Hower was ordered to pay an W00 award
issued in a dispute over a (ithuanian power plant pro'ect after the Dwedish Dupreme 0ourt
]623
refused to hear its Bnal appeal that the underlying contract was tainted by corruption. Also,
the 1ational Wranian ‘il 0ompany recently failed to halt the enforcement of a éD86.x billion
award in Rotterdam despite its belated call to qutch prosecutors to investigate the Kmirati
]653
award creditor for alleged corruption.

Iowever, a successful attempt was recently made by the ;ederal Republic of 1igeria to
challenge a éD8// billion arbitral award obtained by a )ritish :irgin Wslands company,
Hrocess and Wndustrial qevelopments (imited CHPWq2, against the state on the basis of
]643
corruption. Wn Nigeria v. P&ID, the dispute centred around a 6-/- agreement between
1igeria and HPWq, an offshore company owned by two Wrish businessmen with no prior
e&perience in the oil and gas sector, where HPWq was granted the rights to process billions
of dollars of natural gas. ;ollowing 1igeria’s failure to deliver the promised infrastructure
and gas, HPWq initiated arbitration in 6-/6, ultimately securing an award of éD84.4 billion in
damages in 6-/ó, plus interest at ó per cent. The Knglish court, in setting aside the award,
held 3without reluctance’ that the awards were obtained 3only after and by practising the most
]663
severe abuses of the arbitral process’.

1onetheless, these cases underscore the importance of bringing relevant arguments early
]673
in the arbitral process to avoid them being considered lost at the enforcement stage.
;urthermore, Nigeria v. P&ID highlights the signiBcance of meticulously choosing both the
applicable rules and the arbitration seat. Arbitral rules that authorise tribunals to proactively
oversee proceedings play a pivotal role in preventing process abuses. Wn instances where a
tribunal is unable to prevent due process violations, opting for a robust arbitral seat becomes
crucial, providing access to a strong court system with 'udges empowered to intervene and
]683
'udiciously e&ercise their authority.

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OTZER TRENDS AND OUTLOOM

There are several trends and developments in the upstream subsector of the global oil and
gas industry that have implications for the future of disputes in that space. The muchEdecried
Russian aggression in ékraine had signiBcant impact in relation to upstream oil blocks. ‘n
one side of the spectrum are entities and sector players whose upstream contracts were
impacted by sanctions imposed on petroleum products from the Russian federation in a bid
]693
to target the Russian war machine. ;or e&ample, in early 6-66, the énited Dtates and the
]613
énited Singdom imposed a ban on Russian oil and gas imports. Dimilarly, the Kuropean
]703
énion, in qecember 6-66, imposed an embargo on Russian oil products.

‘n the other side of the spectrum are entities and players aggrieved by the alleged
e&propriation of their oil and gas assets by the Russian government. ;or e&ample, K&&on’s
interests in the DakhalinE/ oil and gas pro'ect were 3unilaterally terminated’ by the Russian
]7j3
government sometime in 6-66. K&&on is reportedly mulling pursuing international
]723
arbitration against Russia in this regard.

The e&istence of these realities makes for a fertile ground for upstream subsector arbitration
Cin appropriate cases2 pursued by anguished players.

Another trend with implications for disputes in the upstream subsector is with respect to the
new decarbonisation drive of many governments and corporations. Dome countries have
]753
even now reportedly reached net 7ero emissions. The mass adoption of green laws and
policies is not without controversy and can precipitate disputes between host countries and
producers of fossil fuels.

This was the case in RWE AG and RWE Eemshaven Holding II BV v. Kingdom of the
]743
Netherlands, where RjK accused the qutch government of e&propriation by virtue of
the qutch government’s adoption of a raft of measures to phase out coal plants to reduce
emissions by 6-9-, consistent with the terms of the Haris Agreement to the énited 1ations
;ramework 0onvention on 0limate 0hange. As pressures mount on global governments
to adopt more measures to protect the climate, upstream disputes could arise as a
conseFuence where the rights and obligations of key actors are not properly managed.

FUNDING AN UPSTREAY DISPUTE RESOLUTION EFFORT

qispute resolution e&ercises in the upstream segment of the petroleum industry can
be notoriously e&pensive. This is hardly surprising given the stakes involved. ésually,
the disputes feature wellEheeled professional advisers, travel and accommodation and
arbitrators’ charges – all of which rarely come cheap.

ThirdEparty funders have emerged as a resource to claimants. Reservations about

champerty and maintenance have long plagued thirdEparty funding, but recently the global
]763
attitude on the sub'ect has certainly softened. This can be evidenced by the 6-69 énited
]773
Dtates qistrict 0ourt case of Petersen Energia Inversora v. Argentine Republic. Wn that case,
the court recognised and demurred to fault the litigation funding received by the plaintiffs,
making the case that the plaintiffs were within their rights 3to trade a substantial part of their
potential recovery to secure the Bnancing necessary to bring their claims and litigate their
]783
claims to conclusion’ against the sovereign.

Uany oil and gas entities are prosperous enough to fund their litigation or arbitration
e&penses. Iowever, procuring thirdEparty funding may be practically advantageous. ;or

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instance, the leading thirdEparty funders are advised by internal and e&ternal specialists that
may bring further highElevel insights and e&pertise than may otherwise be available to the
disputant. Wn some 'urisdictions, the ta& and accounting treatment of the thirdEparty funder’s
fees may be even advantageous.

CONCLUSION
qisputes in the upstream segment of the oil and gas industry are endemic. These disputes
can arise in a number of ways under the various forms of relationships that e&ist in the
sector, including the delicate relationships between the controllers of resources Cinvestors
and other private parties2 and their 3landlords’ Cthe states2. Treaties such as the K0T and
W0DWq 0onvention play a critical role in protecting investors and their investments from the
overwhelming might of the host states, with arbitration unsurprisingly continuing to be the
dispute resolution platform of choice for the most signiBcant, highEstakes disputes in the
space. The increased acceptance of innovative disputeEfunding methods and the resulting
emergence of boutiFue funders will both contribute to the continued robustness of the
disputes scene in the upstream subsector.

ENDNOTES
]j3
Abubakar AnaB is a partner, 0hime7ie ‘nu7ulike is a senior associate, and ;idelis ‘guche
and ‘wen émeh are associates at G Klias.
]23
(awal, T, 3Iow qifferent Ws 1igeria’s 1ew 1ational ‘il 0ompany#
And jill je Dee an WH‘#’ The Africa ReportV, available at
httpsYVVwww.theafricareport.comV69z69óVe&plainerEhowEdifferentEisEtheEnewEn
npcV.
]53
Dee, for e&ample, article xC/2 of the Responsibility of Dtates for Wnternationally jrongful
Acts, 6--/.
]43
Dee Hetroleum Wndustry Act, 6-6/ CHWA2, s. /. Dee also, for e&ample, article /.6 of the
Russian (aw on the Dubsoil 1o. 69JzEW dated 6/ ;ebruary /JJ6.
]63
Dection J6A of the 0onstitution Act, /°4ó.
]73
HWA, s. ó/C62.
]83
HWA, s. ó/C92.
]93
HWA, s. ó6C/2.
]13
HWA, s. óóC/2 and C62.
]j03
HWA, s. °/C/2.
]jj3
HWA, s. °4C/2.
]j23
Wn 1igeria, for e&ample, the qeep ‘ffshore and Wnland )asin Hroduction Dharing 0ontracts
Act Cas amended2 regulated HD0s for certain inland basins with water depth beyond 6--
metres. This statute has been repealed by the HWA in respect of concessions issued under
the HWA.
]j53
Qounesi, IR, 3Wndirect K&propriation in the Hetroleum WndustryY The Response of
Wnternational Arbitrations’ Hetroleum )usiness Review, :ol. zE1o. x p. 6, Autumn 6-6/.

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Available at
target[ =blank httpsYVVeprints.whiterose.ac.ukV/°9óxxV/VH)R=:olume=z=Wssue=x=Hages=/=/-.pd
f .
]j43
6ó W(U /9/x C/J°°2.
]j63
W(U 6/ C/J°62.
]j73
;inal arbitral award rendered on 64 Uarch 6-6/ under the é10WTRA( Arbitral Rules, 6-/9.
]j83
Marvin Feldman v. United Mexican States, Award, C/4 qecember 6--62, W0DWq 0ase 1o.
AR) CA;2VJJV/.
]j93
SD Myers Incorporated v. Canada, ‘rder, 6--x ;0 9°, C6--x2 6xx ;TR /4/.
]j13
Wn 1igeria, for e&ample, Hart WW of the Arbitration and Uediation Act, 6-69 CAUA2 provides
generally for mediation. The AUA has been assented to but is yet to be ga7etted.
]203
Wn Wndia, for instance, it is only where there is a 3mediated settlement agreement’ resulting
from the mediated resolution of contentious issues that the mediation shall bind the parEties.
Dee the Wndian Uediation Act, 1o. 96 of 6-69, s. 6ó.
]2j3
0onstitution of the ;ederal Republic of 1igeria, /JJJ Cas amended2, s. 4C42Cb2.
]223
0onstitution of the ;ederal Republic of 1igeria, /JJJ Cas amended2, s. 6z/C/2Cn2.
]253
Dee, for instance, Volt Info. Scis., Inc. v. Bd. of Trs. of Leland Stanford Junior Univ. C/J°J2
x°J é.D. x4°, xó°.
]243
Uunicipal laws on arbitration may impose certain minimum reFuirements that an
arbitration agreement must comply with. ;or e&ample, s. 6 AUA reFuires an arbitration
agreement to be in writing.
]263
Hieter Harmentier, 3Wnternational 0ommercial Arbitration v Wnternational Wnvestment
Arbitration – Dimilar Game but Domehow qifferent Rules’, available at
httpsYVVssrn.comVabstract[96--4x°.
]273
Dee, for instance, Biloune and Marine Drive Complex Ltd v. Ghana Investments Centre
¶/J°Jä Award 6ó ‘ctober /J°J, Jz W(R /°9, 6-J.
]283
Dee the preamble to the K0T.
]293
K0T, art. 4.
]213
K0T, art. J.
]503
K0T, art. /6.
]5j3
K0T, art. /J.
]523
Dee generally K0T, art. 64.
]553
K0T, art. /.
]543
ibid.
]563
ibid.
]573
K0T, art. 64C/2.

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]583
K0T, art. 64C62.
]593
K0T, art. 64Cx2Ca2Ci2.
]513
K0T, art. 64Cx2Ca2Cii2.
]403
K0T, art. 64Cx2Cb2Cc2.
]4j3
K0T, art. 64C°2.
]423
Dee generally K0T, art. 6ó.
]453
K0T, art. 6óC/2.
]443
K0T, art. 6óC62.
]463
K0T, art. 6óC92Ca2ECf2.
]473
K0T, art. 6óC92Cg2.
]483
K0T, art. 6óC92Ch2.
]493
Knergy disputes consistently dominate the caseloads of the main arbitration centres. ;or
e&ample, in 6-69, 69 per cent of the Wnternational 0entre for Dettlement of Wnvestment cases
were related to the oil, gas and mining industry, while /6 per cent were related to electric
power and other energy cases. Dee ?The WD0Wq 0aseload=Dtatistics, Wssue 6-6xE/%, available
at httpsYVVicsid.worldbank.orgVsitesVdefaultVBlesVpublicationsVK1G=The=W0DWq=
0aseload=Dtatistics=Wssue~6-6-6x.pdf.
]413
Article :C62Cb2 of the 1ew Qork 0onvention.
]603
Kwelina Sa'kowska, 3Knforcement of energy arbitration awards’, (e&ology. C/9 $uly 6-692
]6j3
There are enforcement proceedings where unfounded allegations of corruptions have
been made, with the effect of, at the very least, delaying the enforcement of a legitimate
award.
]623
Natura Furniture v. GE Power Sweden.
]653
Crescent Petroleum Company International Limited and Crescent Gas
Corporation v. National Iranian Oil Company in the Rotterdam qistrict
0ourt. The underlying H0A caseY H0A 0ase 1o. 6--JE6-, available at
httpsYVV'usmundi.comVenVdocumentVdecisionVnlE/EcrescentEpetroleumEcompanyEi
nternationalElimitedEandE6EcrescentEgasEcorporationEvEnationalEiranianEoilE
companyEuitspraakEvanEhetErechtbankErotterdamEmondayEzthEdecemberE6-66]deci
sion=x66z°.
]643
The Federal Republic of Nigeria v. Process & Industrial Developments Limited ¶6-69ä
KjI0 649° C0omm2.
]663
Haragraph z/4 of the $udgment, available at
httpsYVVwww.'udiciary.ukVwpEcontentVuploadsV6-69V/-V1igeriaEvEHWqE'udgment.
pdf.
]673
Kwelina Sa'kowska, n. xJ above.
]683
Dimon Dloane, Kmily jyse $ackson, Qin Qee 1g C;ieldBsher2, 3Tackling
0orruption in the Arbitral HrocessY Re5ections on 1igeria v. Hrocess and Wndustrial

Upstream Oil and Gas Disputes K&plore on GAR

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qevelopments (imited’, Sluwer Arbitration )log C9 Uarch 6-6x2, available at

httpsYVVarbitrationblog.kluwerarbitration.comV6-6xV-9V-9VtacklingEcorruptio
nEinEtheEarbitralEprocessEre5ectionsEonEnigeriaEvEprocessEandEindustrialEd
evelopmentsElimitedV.
]693
$ames Holiti, 3éD and éS )an Russian ‘il and Gas Wmports in
qrive to Hunish Hutin’ ;inancial Times CJ Uarch 6-662, available at
httpsYVVwww.ft.comVcontentV6e-b/d°xEezJzExczaEbexeEJ6°x/óbJcócc.
]613
ibid.
]703
)en jilliams et al. 3The Kuropean énionERussia Knergy
qivorceY Dtate of Hlay’ )ruegel C66 ;ebruary 6-6x2, available at
httpsYVVwww.bruegel.orgVanalysisVeuropeanEunionErussiaEenergyEdivorceEstate
Eplay.
]7j3
Dabrina :alle, 3K&&on K&its Russia KmptyEhanded with ‘il Hro'ect
?énilaterally Terminated%’ Reuters C/ó ‘ctober 6-662, available at
httpsYVVwww.reuters.comVbusinessVenergyVe&clusiveEe&&onEe&itsErussiaEemptyE
handedEwithEoilEpro'ectEunilaterallyE6-66E/-E/óV.
]723
$ustin $acobs, 3K&&onUobil Accuses Russia of ?K&propriation% as
Wt K&its ‘il Hro'ect’ ;inancial Times C/ó ‘ctober 6-662, available at
httpsYVVwww.ft.comVcontentV9fx4cfb-E4°d6Exd6JEbJ°eE/dó46°dx49°a.
]753
Dee the report of the jorld Kconomic ;orum of /4 qecember 6-66, available at
httpsYVVwww.weforum.orgVagendaV6-66V/6VtheseEcountriesEachievedEnetE7eroEem
issionsV
]743
W0DWq 0ase 1o. AR)V6/Vx.
]763
Dee for e&ample, s. 4/ of the 1igerian Arbitration and Uediation Act, 6-66 which rendered
inapplicable the tort of maintenance and champerty in relation to thirdEparty funding of
arbitration. 0ompare with ss. /9 and /x of the 0riminal (aw Act /J4ó which abolished
the doctrines of champerty and maintenance in Kngland and jales and 1ew Douth jales’
Uaintenance 0hamperty and )arratry Abolition Act, /JJ9 which has a similar effect in the
Australian state of 1ew Douth jales.
]773
/z 0iv. 6ó9J C(AH2 CDq1Q Uay 6x, 6-692.
]783
ibid.

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Abubaéar AnaJ [email protected]

Chime–ie Onu–uliée [email protected]
Fidelis Oguche [email protected]
Owen Umeh [email protected]

https://www.gelias.com/

Read more from this Jrm on GAR

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The Evolution of Natural

Gas Price Review
Arbitrations
Stephen P Anway, George Y von Yehren, Yichelle Glassman Bocé and
Yax Rocéall
SQuire Patton Boggs

Summary

TZE ZISTORICAL DRAYATIS PERSON

TZE PRICE REVIEK CLAUSE

TZE FIRST KAVE OF PRICE REVIEKS

TZE SECOND KAVE OF PRICE REVIEKS

TZE TZIRD KAVE OF PRICE REVIEKS

NEK EUROPEAN PRICING TRENDS

ASIA: TZE FUTURE IS NOK

TZE OUTLOOM FOR PRICE REVIEKS NOK AND IN TZE FUTURE

CONCLUSION

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Hrice review arbitrations are, as a collection of cases, the highestEvalue commercial disputes
in the world today. The amounts at stake begin in the hundreds of millions of dollars and
often climb into the billions.

The authors of this chapter have been involved in price review arbitrations since their
inception. quring this time, the Beld has evolved in e&citing and une&pected ways. This
chapter seeks to map that evolution by providing an overview of the past, the present and
the future of price review arbitration.

As the chapter makes clear, the twists and turns in the evolution of price review arbitrations
have generally not been driven by changes in contractual provisions, legal rights or the
acts or omissions of the parties involved. Rather, it has been e&ternal events – such as
the liberalisation of national gas markets, the global economic crisis and the maturation of
certain gas hubs – that have paved the evolutionary path.

Harties to longEterm gas supply contracts have therefore been forced to react – availing
themselves of the 3price review’ provisions in longEterm contracts to recalibrate their price
formulas to re5ect changed market conditions. The margin for error, however, is ra7or thin.
0hanging 'ust a few cents per unit of gas can shift hundreds of millions of dollars between
the parties because of the very substantial volumes delivered during the life of a longEterm
gas contract.

Arbitrators deciding these disputes, therefore, have a weighty and diLcult task. Hrice revision
provisions imbue the arbitrators with e&ceedingly broad authority to modify the pricing
formula with strangely little direction on how to do so. Qet despite this awesome power and
freFuent lack of direction, arbitrators have done a laudable 'ob – by and large – of getting it
right.

As discussed below, the story of natural gas price reviews has been, until recently, largely a
Kuropean one. Although this chapter starts at the beginning of that story, it is by looking back
that we see the positive and important role of international arbitration in the development of
gas pricing during the past 6- years or so in Kurope. And it is by re5ecting on the past that
we are able to identify developing trends and make predictions for the future.

These trends and predictions are particularly important for Asia, where the gas markets
today largely resemble those in Kurope two decades agoY markets in transition, where pricing
is still largely tied to oil products, and where the disputes are now progressing, for the Brst
time, to international arbitration. Karlier editions of this chapter predicted that, 'ust as price
review arbitrations emerged in Kurope to address changes in the gas markets not re5ected
in contract prices, Asia would soon e&perience its Brst wave of price review arbitrations. As
this chapter e&plains, those predictions, while slow to be realised, have now proven true.

TZE ZISTORICAL DRAYATIS PERSON

The parties to price review arbitrations tend to be repeat players. Iistorically in Kurope,
sellers are typically the producers of natural gas and entities that are governmentEowned,
or formerly governmentEowned, with strong state participation. ;or e&ample, there are only
a handful of producers around the world who historically sold to the continental Kuropean
marketsY Ga7prom CRussia2, Donatrach CAlgeria2, “atargas C“atar2, 1igeria (1G C1igeria2,
KFuinor Cformerly Dtatoil2 C1orway2 and Atlantic (1G CTrinidad and Tobago2.

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)uyers, by contrast, are often formerly stateEowned companies in countries that do not
produce signiBcant gas domestically, but have the infrastructure to accept delivery of gas,
transport it through an e&isting transmission network and distribute it to wholesalers or
endEuser consumers in the downstream market. )efore the liberalisation of the Kuropean
¶6ä
gas markets, these companies were predominantly stateEowned monopolists. jhen the
Kuropean gas markets were liberalised during the 6---s, competitors entered these markets
and the list of buyers grew. Kdison in Wtaly, for e&ample, was not a market incumbent but has
become a ma'or buyer in the liberalised Wtalian market.

These, then, were historically the usual parties to gas price review arbitrations. They signed
with each other a very particular type of contractY a longEterm, takeEorEpay contract for
pipeline gas or liFueBed natural gas C(1G2. And it is in this type of contract that the price
review clause is typically found.

TZE PRICE REVIEK CLAUSE

The history of the price review clause can be traced back to the early days of the 1orth Dea
gas industry. The upstream suppliers – the sellers under longEterm contracts – often needed
Bnancing for the investment necessary to bring the gas to commercial production. To ensure
that the producers would be able to repay the money borrowed, the sources of Bnancing
reFuired the producers to obtain a guaranteed, longEterm revenue stream from downstream
buyers.

Hroducers did so by signing longEterm, takeEorEpay contracts with buyers, which obliges
buyers to pay for a predetermined volume of natural gas, whether or not the buyers actually
take that volume. This volume commitment – often worth tens of billions of dollars over the
life of the contract – gives the sellers the guaranteed revenue stream, providing longEterm
cash 5ow to support the pro'ect economics even at a relatively low contract price.

)uyers were willing to undertake the volume commitment, but they needed to be assured
that the price paid to the sellers would remain viable in the long term – even as changes in
market conditions affect the price that they can obtain when onEselling downstream in the
endEuser markets.

The problem is simpleY if, for e&ample, the price that the buyer is paying upstream to the
supplier is more than the price that the buyer can receive downstream from the end users,
then a price decrease is reFuired because otherwise there is no margin, there are losses
and the buyer will Fuickly go out of business. 0onversely, if the price that the buyer is paying
upstream to the supplier is too low relative to the price that the buyer can receive downstream
from end users, the seller may not be en'oying the beneBt of its bargain.

The parties, therefore, must reach a balance. That balance is achieved when the contract
price is deBned by reference to the price that end users pay for natural gas in the market
where the gas is delivered. The ob'ective is that the contract price the buyers pay to the
sellers will selfEad'ust, according to a formula, as endEuser prices evolve over time.

And here is the cru& of the issueY how do sellers and buyers arrive at a contract price formula
– one that will govern for decades to come – such that it will adeFuately track the changing
value of gas in the endEuser market# The answer, in general terms, is through a netback
formula.

A netback formula references a reliable natural gas price marker Csuch as a hub price, a
reliable published price or a portfolio evaluation2 and then deducts certain costs and allows

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for a margin. ;or e&ample, gas sold to the éD gas market has been sold at a price tied to éD
traded gas prices – such as Ienry Iub – thereby ensuring that the price remains aligned
with the conditions under which the gas can be sold into the downstream market.

Iistorically, however, this option was not available in many gas markets. jhen Kuropean and
Asian importers began contracting for natural gas supplies, there were no developed natural
gas markets in their countries. The importers – the buyers Ctypically governmentEowned
monopolists2 – were creating demand downstream by importing gas and selling it to
consumers in competition not with other natural gas Cbecause they were the monopolist
gas companies and there was no gasEtoEgas competition2 but, rather, with other competing
fuel products – primarily oil products and coal.

To gain market share, therefore, gas needed to be priced at a discount to those competing
fuels. Hrices for gas were commonly deBned by the government on the basis of supply costs
– that is, the price that the buyers paid the sellers under longEterm contracts. As a result, there
was no independent gas price reference in the destination market. jhen the buyer and the
seller were at the negotiation table discussing what price the buyer would pay to the seller
during the life of the contract, they could not simply put into the price formula a gas price
referenceM there was none. Wnstead, they often included a reference to the price of competing
oil products. Wn this monopolist market, displacement of oil and other competing fuels would
allow the monopolist to sell the gas downstream.

Wn short, pricing by reference to these competing fuels was the best option to track the
competitive dynamics of the downstream natural gas market. ‘il and oilEderived products
served as a pro&y for the 3value’ of natural gas.

To establish this pro&y pricing, buyers and sellers often agreed to a contract price with
two fundamental componentsY Brst, a B&ed base value referred to as 3H-’M and second, an
inde&ation component tied to the evolution of oilEderived products. This latter component,
called an escalator clause, is a multiplier to the base value that allows the contract price to
5uctuate during the term of the contract in accordance with the price movement of the oil
products.

Hro&ies, however, are necessarily imperfect. 0ommodity markets do not remain static, and
there will be changes in the gas market that will not be re5ected in, and therefore not captured
by, the imperfect oil pro&y in the price formula.

Thus was born the price review clause. Wt allows either party to seek revision of the contract
price if the conditions underlying the commercial bargain signiBcantly change over time. This
is the fundamental tradeEoff between the takeEorEpay commitment of the buyer and the right
to realign the contract price periodically to conditions in the destination market.

Although the terms of speciBc price review clauses differ, they often Cbut do not always2Y

X specify the intervals at which regular price reviews can be initiated at the reFuest of
either party on speciBed datesM
X specify a certain number of 3wildcard’ price reviews, which can be initiated by either
party at any timeM
X reFuire that a price review be initiated by Bling a price review notice with the other
partyM
X provide for a mandatory negotiation period Cusually three, four or si& months2M

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X impose certain reFuirements that must be satisBed before the price formula can be
modiBed, often a signiBcant change in a speciBed market that has occurred since the
current price formula last became effective and thatY

X affects the value of natural gasM

X is nonEtemporary in natureM and
X reFuires an ad'ustment to the contract price Ci.e., the economic effect of the
change is not already re5ected in the current price formula2M

X if these preconditions are satisBed, specify that the price formula should be revised
in accordance with certain reFuirements, namely, the revisionY

X should take into account the economic effect of the changes that gave rise to
the price reviewM
X must allow the gas to be sold competitively in the market, at a reasonable
marketing margin, or such that the buyer may market the gas economically in
its endEuser marketM and
X should assume sound marketing and eLcient management by the buyerM

X specify that the revision is retroactive to the date of the price review noticeM
X specify that the parties must calculate the difference between the revision and the
former price Calready paid by the buyer2 for that periodM
X if the revision results in a price reduction, provide that the seller owes the difference
to the buyer for that periodM
X if the revision results in a price increase, provide that the buyer owes the difference to
the seller for that periodM and
X if the parties cannot reach agreement within the mandatory negotiation period,
provide that either party may submit the matter to international arbitration.

0ontracts that include price review clauses typically include arbitration provisions of the
Wnternational 0hamber of 0ommerce, the Arbitration Wnstitute of the Dtockholm 0hamber
of 0ommerce, the (ondon 0ourt of Wnternational Arbitration, the Dingapore Wnternational
Arbitration 0entre or the énited 1ations 0ommission on Wnternational Trade (aw, and provide
for three arbitrators. The seat of arbitration is often 1ew Qork, (ondon, Geneva, Haris,
Dtockholm or Dingapore. Arbitral awards revising a contract price or re'ecting a reFuest
for revision are enforceable under the 0onvention on the Recognition and Knforcement of
;oreign Arbitral Awards Cthe 1ew Qork 0onvention2 – although enforcement is rarely reFuired
¶9ä
because of the parties’ ongoing commercial relationship.

These price review clauses started to become standardised in the /J°-s, when contracts
were signed concerning the 1orwegian Troll gas Beld. These 3Troll contracts’ were organised
through a centralised process, by which all producers Cand the 1orwegian government2 and
all buyers Cwhich operated through a consortium2 were involved in the negotiations. As a
result, a standardised agreement was used, which included the price review language. Wn the
decade that followed, other buyers and sellers adopted the same or similar language in other
longEterm supply contracts, and the price review clause became more or less an industry
standard in Kurope.

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These price review clauses – now in place in longEterm gas contracts across Kurope – set
the stage for what happened ne&t.

TZE FIRST KAVE OF PRICE REVIEKS

‘n 66 $une /JJ°, the Kuropean 0ommission – following years of preparation – promulgated
qirective J°V9-VK0 relating to the liberalisation and deregulation of the natural gas markets
of Ké Uember Dtates. The qirective sought to encourage competition in the then largely
monopolistic Kuropean gas markets. Wt sought to do so by C/2 allowing third parties open
access to natural gas transmission facilities and C62 permitting consumers to choose their
natural gas supplier and to negotiate prices. The Kuropean 0ommission stated that the
liberalisation of the Kuropean natural gas markets would lead to increased competition and
that, 3¶aäs competition increases with the progressive development of the internal market for
¶xä
gas, prices are e&pected to fall’.

Wn the years that followed, Ké Uember Dtates took a variety of measures in their national
legal orders to implement the qirective. Wn many countries, the national legislation sought to
achieve 3unbundling’ Cthe process of functionally segregating gas marketers from operators
of gas delivery and storage facilities2, which enabled competition by giving competitors
nonEdiscriminatory access to the gas system. (iberalisation proceeded at a different pace in
each Uember Dtate.

0hange was afoot. The liberalisation efforts started to move the Ké gas markets from a
system with only one monopolistic buyer in each country selling downstream, to a system
in which numerous competitors participated in the market, signed contracts with suppliers
such as Ga7prom and Donatrach, and competed with other buyers to sell to the downstream
market, underbidding each other to gain market share. The aim was that the downstream
price paid by the end users would not be set by the supply price but, rather, by the competitive
dynamics in the endEuser market itself.

There also was another, more subtle change. jhereas buyers had previously sold gas
downstream in competition with oilEbased fuel products, they were now selling the same gas
downstream in competition with other natural gas suppliers Ci.e., gasEtoEgas competition2.
This caused a problem for buyers. jith the barriers to market entry crumbling, competitors
could enter the market for the Brst time and offer prices at a discount to what the incumbent
had been charging. At the same time, the prices that buyers were paying to sellers under
the longEterm contracts were still tied to oil prices that were agreed before gasEtoEgas
competition e&isted. This disconnect between what buyers were paying upstream and what
buyers were receiving downstream created the archetypical situation that the price review
provisions were intended to address.

Arbitration commenced. The authors represented the winning party in the Brst price review
arbitration in the world. ;iled in the early 6---s, the claim was that the liberalisation of
the relevant Kuropean gas market broke up the importer’s monopoly and, for the Brst
time, created gasEtoEgas competition when new competitors entered the market and began
offering prices at a discount to the previously prevailing prices. je therefore sought the
addition of a new component to the pricing formula to re5ect the development of competition
in the relevant gas market.

The tribunal agreed. Wt signiBcantly lowered the contract price formula by introducing a
correction factor, to correct for the decrease in the market gas price that the oilElinked
contract price did not track. Wmportantly, however, the tribunal left the pricing formula tied to

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oil products because, at that time, there was still no true price signal in the relevant market
that could reliably represent the price for natural gas. The tribunal, therefore, left the price
formula tied to oil products but changed the price level to re5ect gasEtoEgas competition
price in the market.

‘ther arbitrations followed, most resulting in signiBcant price decreases for the buyer.

TZE SECOND KAVE OF PRICE REVIEKS

A second wave of price reviews began in the wake of what many described as a 3perfect
storm’ of priceEdepressing events that occurred from 6--° to 6-/-. Two events in particular
converged to create this situation.

;irst, the global economic crisis caused gas demand to decline relative to pro'ected growth
and e&panded import capacity, leaving gas companies under takeEorEpay obligations to
compete Bercely with each other in a desperate attempt to sell their oversupplied volumes.

Decond, new and une&pected volumes 5ooded the Kuropean market through the éD shale
gas boom, which resulted in (1G destined for the éD market being diverted to Kurope. )ased
on higher prices in Kurope and transportation limitations, companies – under takeEorEpay
obligations – began unloading volumes in Kurope, which became a 3sink’ market. This
supply–demand imbalance led to a gas glut.

These market changes accelerated the development of gas hubs. The in5u& of new
Fuantities of gas into Kurope increased liFuidity in the Kuropean natural gas hubs. And with
the in5u& of gas being traded at these Kuropean hubs, the hubs began to mature rapidly.

1evertheless, prices in many Kuropean markets still remained largely tied to oil products. As
a result, most Calthough not all2 of the price reviews in this second wave resulted in a decrease
in the contract prices to re5ect the reduced level of gas prices, but still left the prices tied to
oil products.

This was no small event. The buyers that achieved downward revisions to their supply
prices included )ulgarga7 C)ulgaria2, 0entre& CAustria2, 0onef Knergy CRomania2, q‘1G
Cqenmark2, KconGas CAustria2, Kdison CWtaly2, Kni CWtaly2, K.‘n CGermany2, Gas 1atural CDpain2,
GasTerra C1etherlands2, Gq; Due7 C;rance2, HG1iG CHoland2, RjK CGermany2, Dhell Knergy
C1etherlands2, jWKI CGermany2 and jW1GAD CGermany2.

Kach of these buyers obtained price reductions in their longEterm contracts based on the
evolution of the Kuropean markets. The prices paid by end users were now no longer set by
supply costs. Rather, the reverse had happenedY the supply costs were set by the endEuser
prices through the price reviews.

TZE TZIRD KAVE OF PRICE REVIEKS

Deveral years later, buyers argued that gas hubs had developed and matured in much of
Kurope to the point that they had signiBcant traded volumes and transparent prices. This
allowed several Kuropean hubs to act as a priceEsetting mechanism in the markets that they
serve.

As a general principle, the more signiBcant the volumes traded on a hub, the more liFuid –
and reliable and transparent – its price reference becomes. A 3liFuid’ price is one that is not
easily in5uenced by a small number of trades because of the large overall volumes traded.
An 3illiFuid’ hub, by contrast, is more prone to price volatility because of the ability of a small

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number of trades to in5uence the average price more Fuickly. The growth of liFuidity at a
trading hub also facilitates increasingly transparent prices because of the higher number of
trades made at the hub.

The Title Transfer ;acility CTT;2 in the 1etherlands became the most liFuid continental
Kuropean hub during this period. )y 6--J, traded volumes at the TT; had grown to the e&tent
that the TT; was regarded as an open and liFuid gas trading hub. Dince 6-/6, the price
formation mechanism for many gas contracts throughout Kurope has been the TT; price.

Uany buyers in this third wave of price reviews, therefore, asked for the pro&y of oil products
in the formulas to be replaced by gas hub inde&ation. Wt is a matter of public record that
suppliers such as KFuinor C1orway2 and Ga7prom CRussia2 have increasingly agreed to
¶zä
include gas hub inde&ation or re5ect gas hub price levels in their supply contracts. The
two largest supply contracts into Kurope – which are contracts that Kni and éniper have
¶4ä
with Ga7prom – were revised to include gas hub inde&ation Cit is public information that
¶óä
the Kni contract is now /-- per cent hubEinde&ed2. ;urther, nearly all of KFuinor’s contracts
¶°ä
to northEwest Kurope have some level of hub inde&ation.

The result of this third wave of price reviews was that, in many cases, parties and tribunals
either partially or entirely replaced oil inde&ation with hub inde&ation in pricing formulas.
Uost jestern Kuropean gas contracts are now partially or entirely hubEinde&ed.

NEK EUROPEAN PRICING TRENDS

As the foregoing shows, the evolutionary path of price review arbitration has been marked
by three epochs. quring this time, the Kuropean gas markets have e&perienced growing
pains, and players in the Beld have struggled to cope with the evolving energy landscape.
Wnternational arbitration has played an important part in that evolution.

;ocus now turns to the future. Herhaps the most interesting Fuestion is whether price review
arbitrations in Kurope will continue or will slowly die out. As Kuropean hubs continue to
mature, hub inde&ation will be increasingly substituted, through party agreement or arbitral
awards, for the pro&y of oil products. And that means that, as a general rule, the supply
price formulas will better react in real time to natural gas prices in downstream markets,
and capture market changes in a way that the oil prices could not – and the need for price
reviews will be reduced. Wn other words, hub inde&ation will signiBcantly diminish the need
for the very mechanism that was an important part of the emergence of hub inde&ation in
the Brst placeY the price review clause.

Wn these circumstances, the Fuestion must be askedY is there still a reason to include a price
review clause if the formula is wholly tied to a gas hub inde&# Those who say 3no’ believe
that hub inde&ation is the cure for everything – and that market prices will stay in alignment
with contract prices that are tied e&clusively to hub inde&ation. There is, however, a more
nuanced viewY price review clauses are still important because there is no guarantee that
hub pricing will re5ect market prices – particularly if the destination market is different from
the hub reference.

A simple hypothetical illustrates the point. Duppose companies contracting for the German
market wish to include in the contract price a /-- per cent hub reference to the TT; in the
1etherlands. They wish to do so because they believe the TT; is sending the price signal for
market prices in Germany. The parties may therefore change the contract price formula to
include /-- per cent TT; hub inde&ation.

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Ws there a need for a price review clause in this hypothetical# Wn short, yes. The TT; may not
always be a reasonable measure of market prices in Germany. Rather, it may be that the TT;
ceases to be a price signal for market prices in Germany at some point in the future and that
the German hub, or other price signal, becomes the new price setter in the market. The price
review provision remains capable of addressing this change in market conditions.

Wn any event, the Kuropean price review story is far from over. Hrice reviews under the
remaining fully or partially oilElinked contracts continue – particularly in central and eastern
Kurope Cand, to some e&tent, in western Kurope as well2. Wndeed, Ga7prom commenced a new
¶Jä
price review against HG1iG, the Holish state gas utility, as recently as $anuary 6-66. Wt is
¶/-ä
reported that a price review arbitration recently concluded between éniper and GasTerra.
Wnternational arbitration, thus, will continue to play an important part in the evolution of the
central and eastern Kuropean gas markets.

Uore generally, the traditional Kuropean pricing model described above – which gave rise to
the three waves of price reviews – has changed. Those changes were caused in large part
by the increased Kuropean procurement of (1G, which typically has different practices and
pricing from pipeline gas supply. These changes were greatly accelerated by the dramatic
cut in Russian pipeline gas supply to Kurope in the summer of 6-66, which caused a boom
in Kuropean (1G procurement. These changes will affect the future evolution of price review
disputes in Kurope.

;irst, the énited Dtates – as a relatively new e&porter of gas – offers signiBcant destination
5e&ibility, with few, if any, restrictions on where the gas can be delivered. As a result, it is
increasingly diLcult for traditional suppliers for delivery to Kurope to continue to demand
destination restrictions. Wt is also increasingly diLcult for suppliers to demand destination
restrictions because government bodies, such as the Kuropean 0ommission, have stated
that destination restrictions violate applicable competition law. Wn addition, liberalisation
efforts in markets around the world, which make reEgas facilities more accessible, mean that
the buyer now has more options for where gas can be delivered.

Decond, with the énited Dtates now e&porting large volumes of (1G, Kuropean buyers are
now contracting with éD suppliers, with the price tied to Ienry Iub. Wn these new contracts,
the price is now set by point of origin rather than destination. This dynamic puts pressure on
the traditional suppliers to rethink the traditional Kuropean models, because now Kuropean
buyers purchase (1G from the énited Dtates and have greater freedom in the destination
to which they will deliver the gas, paying a éD price. Uany of these contracts contain no
price review clauses, which puts pressure on the pricing arrangements in other contracts in
a company’s portfolio.

Third, certain Kuropean contracts are now being signed with /-- per cent volume 5e&ibility
Calthough there is still a takeEorEpay obligation for the liFuefaction fee2. This dramatic
reduction in takeEorEpay liability offers signiBcantly more 5e&ibility than the traditional
models.

;ourth, much like the éD practice, there is a move towards shorterEterm and more 5e&ible
contract structures. ;or e&ample, Kurope has seen an increase in portfolio sales, rather than
anchor contracts, for locationEspeciBc sources. Traditional Kuropean contracts often specify
the e&act gas Beld from which the gas must be supplied. Uany of the newer contracts, by
contrast, impose no reFuirement concerning the source of supply. énder these portfolio

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contracts, the sellers simply commit to deliver _ Fuantities of gas to Q location, without
specifying the source.

These shorter contracts reduce, or may altogether eliminate, the need for price reviews.
énder the traditional Kuropean model, price reviews often were available every three years.
énder the new paradigm, however, if gas contracts are for only three years Cor shorter2, the
interval during which the parties will be 3stuck’ with the contract price is roughly the same Cor
less2 – and the parties may not need a price review clause at all.

Wn conclusion, these changes in global (1G contracting practices, primarily from the énited
Dtates, are having a signiBcant effect on the traditional Kuropean model that spawned the
three waves of price reviews. 0ertain elements of the traditional riskEreward balance are
changing, because the contracts on which that riskEreward balance is based are changing.
1evertheless, although there are new contracts that have these new features, there are still
Kuropean contracts that do not. The Wnternational Gas énion reports that ó4 per cent of (1G
imports to Kurope are priced on a 3gasEonEgas’ basis, meaning that 6x per cent remains
¶//ä
oilEbased. Those oilEbased contracts, along with many of the 3gasEonEgas’ contracts,
depending on their speciBc pricing mechanisms, will still have price reviews.

ASIA: TZE FUTURE IS NOK

Wn earlier editions of this chapter, the authors had predicted that Asia would be the ne&t
battleground for (1G price review arbitrations. Asia is home to the world’s largest importers
of (1G and natural gas. The region includes 0hina, $apan and Douth Sorea, which are the
world’s three largest (1G importers.

The history of (1G imports into Asia began in the late /J4-s and /Jó-s, when importers
signed longEterm contracts for delivery of (1G into $apan. 0hina and Douth Sorea Brst
entered the market in the late /J°-s and early /JJ-s. ;rom the outset, oilEinde&ed pricing
was, and remains, the dominant pricing model for (1G in Asia.

jhen we wrote the Brst edition of this chapter, it was our belief that, although the number of
Kuropean price reviews was diminishing, Asia would become the ne&t Kurope. ‘ur prediction
was borne of good reasonY the Asian markets today are where Kuropean markets were two
decades ago – markets in transition, where pricing is still largely tied to oil products. ;or this
reason, we predicted that the ne&t ma'or battleground in price review arbitration would be
Asia, which was, and remains, largely unliberalised and where endEuser prices are largely set
by the supply costs.

Wn the years following our initial prediction, however, only a small handful of buyers
commenced arbitrations, rather than the droves that many e&pected. Dome speculated that
the lack of new cases was borne of a business culture that eschewed contentious dispute
resolution. ‘thers e&plained the inactivity by noting that some Asian gas contracts do not
contain a price review clause, and those that do provide for less freFuent price reviews Cfor
e&ample, every Bve years rather than every three years as typically seen in Kurope2.

Hrice review arbitrations have oLcially launched in Asia – not 'ust one case, but many. ;rom
$apan to 0hina to Douth Sorea, many buyers under longEterm, takeEorEpay contracts are now
moving forward with price reviews in arbitration. The authors are involved in several of these
new arbitrations and numerous recently commenced price review negotiations.

The move towards arbitration appears to have been prompted by a combination of factors.

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;irst, it is clear that the widely held view that these disputes could never proceed to arbitration
because Asian companies seek to avoid dispute resolution is wrong. The notion that there
is an Asian business practice in this regard has been fully put to rest – business practices
and attitudes towards litigation vary. Wt is impossible to make blanket generalisations about
business practices spanning an entire continent, where attitudes toward dispute resolution
vary greatly by 'urisdiction and by company.

Decond, even in business cultures traditionally identiBed as avoiding disputes, there has
been a gradual realisation that moving the resolution of price disputes out of commercial
negotiations and into the hands of neutral thirdEparty decision makers also has beneBts for
longEterm partners. Rather than damaging the commercial relationship, market players have
seen that arbitration can help facilitate and foster that relationship.

Uany of these Asian price reviews underwent commercial negotiations for a period of
several years at a time, giving rise to frustration and concern about the good faith conduct
of a commercial counterparty. The move towards neutral decision makers and away from
protracted, and sometimes fruitless, commercial negotiations has given rise to numerous
Asian price reviews in recent times, including price review arbitration.

qo7ens of Asian price reviews have taken place in the past few years alone. jhether most of
these price reviews ultimately proceeded to formal dispute resolution is not a matter of public
record, but it is known that several of them did, indeed, proceed to arbitration. ;or e&ample,
in 6-/°, Australian e&porter 1orth jest Dhelf (1G commenced arbitration with Sorea Gas
¶/6ä
0orporation CS‘GAD2 over price. The following year, a price review arbitration between
¶/9ä
‘saka Gas and K&&on Uobil 0orporation’s H1G (1G in Hapua 1ew Guinea began.
(ikewise, we are aware of other parties to Asian gas contracts that commenced conBdential
price review arbitrations.

Third, buyers have shown an appetite to overcome what may have been previously perceived
as 'urisdictional issues or hurdles under their longEterm sale and purchase agreements.
Uany Asian longEterm contracts contain an e&press reference to arbitration within the te&t
of the price review clause, while others neither e&pressly refer to nor e&pressly e&clude
arbitration within the clause’s te&t. Wn the past, price reviews under clauses without an e&press
reference to arbitration within the price review clause itself sometimes gave rise to early
resolution on less favourable price terms because sellers were able to leverage buyers’
concerns about potentially having to litigate a 'urisdictional Fuestion prior to reaching the
merits phase.

This negotiated outcome is increasingly no longer the case. Today, more than ever, buyers
are devising strategies to ma&imise dispute resolution options and to overcome perceived
bifurcation challenges, even where a price review clause does not e&pressly mention
arbitration. The issue has now been litigated in several ma'or international arbitrations,
including by the authors of this chapter.

;ourth, as with the Kuropean story, market changes in the ma'or import markets have
contributed to a rise in price review cases in Asia. Wn $apan, for e&ample, utilities
traditionally contracted to purchase large volumes of (1G under longEterm contracts,
typically linked to oil prices. ;ollowing the Uarch 6-// Great Kast $apan earthFuake and the
subseFuent ;ukushima nuclear accident, electricity and gas market liberalisation intensiBed,
prompting an evolution in the way $apanese (1G buyers contract for (1G. jithin $apan,
increasing market competition and energy eLciency improvements, combined with growth

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in renewable energy, has resulted in market shares for incumbent $apanese energy suppliers
being eroded. Wn addition, these market changes have reduced domestic electricity demand
and prices, while creating greater uncertainty about current and future power demand.

;ifth, a decline in longEterm (1G prices since 6-/6 caused by an increase in (1G supply
from the énited Dtates, Russia, “atar and Australia as well as growth in shortEterm and spot
(1G trading, increased competition among (1G suppliers, and the introduction of pipeline
gas in certain markets, increasing gasEtoEgas competition, has played an important role in
the uptake of price reviews. Wn the conte&t of these market changes, buyers are eager to
ensure their market competitiveness under their respective longEterm contracts by securing
a competitive price, re5ecting prevailing gas and (1G market prices, not a price set in the
past decade under a contract that is still delivering but that is now unavailable in the market.

;inally, in recent years, a series of unprecedented events have created a highly changeable
energy market, in which market players have been left in a permanent reactive state,
BreBghting each new market crisis. This has prompted a crucial behavioural change in
the Asian market, whereby buyers have readily consulted their contracts to confront these
issues, thereby enhancing the understanding of how valuable these price review provisions
can be and, by conseFuence, removing any hesitation in seeking to invoke them. Uoreover,
the Russian gas cuts to Kurope caused shortEterm price spikes around the world, which
encouraged some market players to consider not delivering to certain buyers depending
on differentials between contractual prices and spot market prices. This gave rise to a
wave of missed cargo, force majeure and underdelivery disputes, several of which ended
up in arbitration. jhile not directly related to price reviews per se, this set of events caused
several of the ma'or Asian buyers to become much more familiar and comfortable with the
arbitration process than previously.

These new price reviews have now become common business practice in the ma'or markets
across Asia. And, indeed, if the Asian gas markets are to progress and mature as the
Kuropean markets have done in the past two decades, international arbitration will again play
an important role.

TZE OUTLOOM FOR PRICE REVIEKS NOK AND IN TZE FUTURE

As we noted in the previous edition, in the past few years, the world has confronted a variety
of consecutive market events that, separately and together, have placed substantial pressure
on the global energy markets. Wn 6-66, the Russian–ékrainian con5ict came immediately
after two other important events that contributed to ma'or stress and tension in the global
gas market.

;irst, the widespread conseFuences of the covidE/J pandemic included (1G prices hitting
record lows during the 6-6- lockdowns across the world, then surging to allEtime highs in
6-6/. Decond, the e&istence of reduced Russian gas 5ows and depleted Kuropean storage
levels in the second half of 6-6/ caused rising gas prices and increased concern about
supply security. These events created real and enduring stresses in the global energy market.

The impact of the Russia–ékraine con5ict itself provoked an unprecedented energy crisis in
6-66–6-69, with signiBcant supply shortages, soaring gas prices, the introduction of various
international sanctions, a followEon increase for other fuel prices, an increased focus on the
role of gas storage, and oftErepeated concerns about whether Kurope would have enough
gas in the winter. The ripples of the con5ict, however, also resonated in the éD, where e&ports
became critical, and in Asian markets. K&tensive price arbitrage and market price volatility

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began to test the elasticity of global markets and the contractual arrangements that operate
within them. Wn times when the sands in the global gas market were constantly shifting,
parties to long and shortEterm gas supply contracts needed a clear understanding of the
protections and the risks inherent in their e&isting contracts.

At the time of this writing, uncertainty still e&ists regarding the stability of Kuropean gas 5ows,
the future role of Russian gas Cwhether by pipeline or (1G2, market price sensitivity, further
sanctions on international (1G facilities and the availability of future global gas supply.
Uoreover, with importers having already supplemented, and still looking to supplement their
supplies from other sources on the shortEterm and midEterm market, where price protection
in the form of a price review clause is often not available, the value and importance of a price
review clause under a longEterm contract increases signiBcantly.

)earing this in mind, importers of gas are consulting their contracts to identify what remedies
may be available to secure against future energy price shocks. Wt follows that changing
market dynamics and price and supply volatility in recent years have placed additional focus
on price review clauses. Wn 6-69, many (1G buyers were inhibited from starting price reviews
because sellers applied strategic pressure, notably based on this volatility. Iowever, with
spot prices having fallen to more normalised levels in 6-69, the ability to rely on spot market
prices in price reviews is anticipated to reduce further this year. ‘f course, the availability
of a price review will still depend, as discussed above, on the temporal, procedural and
substantive reFuirements set out in the contract. 1evertheless, market participants – both
buyers and sellers – have started to turn to their price review clauses to address the ongoing
impacts of the Russian gas cuts. Wn 6-69, Asian price reviews were used not only to address
pricing but also to seek improved commercial currencies such as revised downward and
upward Fuantity tolerance rights, additional receiving terminals, revisions to the prescribed
delivery mode and negotiating other nonEprice terms. jhether the con5ict and its economic
conseFuences will continue to give rise to another new wave of price reviews in 6-6x, and
what effect these might have, remains to be seen.

CONCLUSION
Although the evolution of price review arbitration in Kurope has been marked by three periods
of increased activity, it has been a roughly linear evolution, as gas markets have matured
away from oil inde&ation and towards hub inde&ation. Wnternational arbitration has been one
of the primary vehicles by which pricing disputes have followed that evolutionary path. 1ow,
a period of price review development is well on its way in Asia. As we re5ect on the Kuropean
'ourney and make predictions for the future in Asia, the road forward appears to be one of
similar battles but with new challenges, in particular the fact that in the present day, the gas
market is truly global, and events in one part of the world have effects everywhere, within a
short time.

ENDNOTES
]j3
Dtephen H Anway, George U von Uehren and Uichelle Glassman )ock are partners at
DFuire Hatton )oggs CéD2 ((H and Ua& Rockall is a partner at DFuire Hatton )oggs CéS2 ((H.
The authors thank qouglas Hilawa, associate at DFuire Hatton )oggs, for his assistance with
this edition of the chapter.
]23
K&amples of former stateEowned monopolists include Kni in Wtaly, Knagas in Dpain and
Geoplin in Dlovenia.

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]53
‘ne notable e&ception is Gas Natural Aprovisionamientos, SDG, S.A. v. Atlantiz LNG
Company of Trinidad and Tobago ¶6--° j( x9xxz6z D.q.1.Q.ä, in which the authors
successfully represented the enforcing party.
]43
Kuropean 0ommission, Opening Up to Choice: Launching the Single European Gas Market,
‘Lce for ‘Lcial Hublications of the Kuropean 0ommunities, 6---, p. /ó.
]63
$ason )ordoff and Trevor Iouser, 3American gas to the rescue# The impact of éD (1G
e&ports on Kuropean security and Russian foreign policy’, 0olumbia DWHA, 0enter on Global
Knergy Holicy CDeptember 6-/x2, p. /ó.
]73
ibid., Table 6, p. /ó.
]83
ibid., Table 6, p. /óM 3éHqATK 6EWtaly’s Kni wins /st non oilEinde&ed gas deal from Russia’,
Reuters C69 Uay 6-/x2.
]93
3Dtatoil breaks oilElinked gas pricing’, Financial Times C/J 1ovember 6-/92M $onathan Dtern,
3The qynamics of a (iberalised Kuropean Gas Uarket – Sey determinants of hub prices, and
roles and risks of ma'or players’, The ‘&ford Wnstitute for Knergy Dtudies Cqecember 6-/x2,
p. /6M )ordoff and Iouser Cop. cit. note z, above2, p. /4.
]13
3Ga7prom K&port seeks arbitration against HG1iG over contract price’, Reuters C/x $anuary
6-662.
]j03
0ast list for éniper gas pricing disputes emerges’, Global Arbitration Review C° ;ebruary
6-6x2.
]jj3
Wnternational Gas énion, 3jholesale Gas Hrice Durvey’, 6-69 Kdition, p. /-.
]j23
3$apan (1G )uyers Talk Tough as Dpot Hrices qrop to 9EQear (ows’, Reuters Có August
6-/J2.
]j53
id.

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Stephen P Anway [email protected]

George Y von Yehren [email protected]
Yichelle Glassman Bocé [email protected]
Yax Rocéall [email protected]

30 Rockefeller Plaza, New York, NY 10112, United States

Tel: +1 212 407 0146

https://www.squirepattonboggs.com/en

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Expert Evidence
Woe Séilton and Abi Zarris
Secretariat

Summary

ROLE OF TZE E[PERT KITNESS

INTERACTIONS BETKEEN E[PERTS

GETTING TZE YOST OUT OF E[PERTS

CONCLUSION

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The purpose of e&pert evidence is to assist the tribunal on technical matters that may lie
outside the tribunal’s e&pertise. A 6-66 survey by “ueen Uary éniversity of (ondon on the
future of international arbitration in the energy industry found that ó4 per cent of respondents
considered the technical e&pertise of the tribunal, counsel and e&perts to be of paramount
]23
importance.

Knergy arbitrations tend to be comple&, freFuently involving myriad areas of disagreement

particular to the case that a tribunal and the parties themselves will need to understand and
consider. Duch factors may include the cause of delay, amount of costs incurred, the Bscal
or legal terms under which the contract is governed and the effect of a party’s actions Cor
inactions, as the case may be2. 1aturally, e&pert evidence can be of great assistance in such
cases.

K&pert evidence can be adduced on a multitude of different topics, involving numerous

e&perts with e&pertise spanning the full gamut of factors that may be in dispute. The need to
rely on e&perts from different disciplines is particularly pertinent in energy arbitrations, which
tend to relate to largeEscale, capital intensive, highly valuable and comple& investments.

qone well, e&pert evidence can be highly informative to the tribunal and assist in its
decisionEmaking process. Iowever, for evidence to be considered useful to the tribunal,
e&perts must be independent and impartial, providing clear and transparent written and oral
evidence. qeviations from this standard can undermine the tribunal’s trust in both the e&pert
and, more importantly, their evidence.

This chapter discusses the highs and lows of e&pert evidence in terms of the role e&pert
witnesses play in international arbitration, the interactions between e&perts over the life of
the dispute and how to make the most of e&pert evidence.

ROLE OF TZE E[PERT KITNESS

K&pert witnesses provide their independent opinion on matters they have been instructed
to consider. An e&pert should only provide their opinion on matters that are within their
e&pertise. Duch matters may include the calculation of damages, valuation, technical
matters or speciBc legal issues relevant to the case.

K&pert witnesses can be engaged and instructed by the tribunal, claimants or respondents.
Regardless of the instructing party, however, an e&pert witness’ overriding duty is to assist
the tribunal.

An e&pert’s obligation to the tribunal is widely accepted in international arbitration. Iowever,

concerns around the independence and impartiality of e&pert evidence are especially
relevant to partyEappointed e&perts. Tension may arise between the e&pert’s obligations to
the tribunal and the interests of their instructing party. This may be further e&acerbated, or
even encouraged, by the adversarial nature of the arbitral process.

As e&perts are most commonly engaged by the parties, certain arbitral bodies have issued
rules and guidance for the adoption of e&pert evidence. ;or e&ample, the 0hartered Wnstitute
of Arbitrators’ protocol for the use of partyEappointed e&pert witnesses emphasises that
3e&perts should provide assistance to the ¶aärbitral ¶täribunal and not advocate the position
]53
of the ¶päarty appointing them’. Dimilarly, the Wnternational )ar Association’s rules on the
taking of evidence reFuire that partyEappointed e&perts aLrm their 3independence from the

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]43
¶päarties, their legal advisors and the ¶aärbitral ¶täribunal’ in any e&pert report. Wt is common
practice for e&pert witnesses to include such declarations in their reports.

The independence and usefulness of e&pert evidence can also be tested during an
oral hearing. 0rossEe&amination and tribunal Fuestions can allow participants to better
understand the limits of an e&pert’s evidence, demonstrate an e&pert’s independence and
pinpoint areas of agreement. This applies for all types of e&pert appointments, whether by
the parties individually, 'ointly or by the tribunal itself.

Above all, however, the independence of e&pert evidence is incumbent on the e&pert
themselves. Wt is eFually critical that all participants in an arbitration recognise the
importance of an e&pert witness’s obligation to the tribunal Brst and foremost.

0oncerningly, z/ per cent of respondents to a 6-6/ survey by )ryan 0ave (eighton Haisner
C)0(H2 on e&pert evidence in international arbitration agreed that partyEappointed e&perts
]63
are 3hired guns’ or 3advocates in disguise’. Any perceived advantage to the parties of
deploying hired guns seems Fuestionable. Wn the same survey, J9 per cent of respondents
considered that tribunals should place 3limited weight’ on evidence put forward by a
partyEappointed e&pert who failed to remain independent and breached their obligation to
]73
assist the tribunal.

Kvidence from e&pert witnesses is more likely to assist the tribunal if it isY

X independent and impartial, meaning that the e&pert reaches their opinion after
ob'ectively considering the available evidence and does not act as an advocate for
their client’s interestsM
X transparent, meaning that the e&pert discloses any relevant limitations to their opinion
or the effect of relevant alternative assumptions, or bothM and
X clear, meaning that the e&pert identiBes their instructions and assumptions, and that
their evidence is as easy to follow as possible.

An e&pert witness’s duty to assist the tribunal does not mean that two e&perts working
on a matter will always agree. The topics on which e&perts are asked to opine are often
sub'ective or open to professional 'udgement, meaning that two eFually FualiBed individuals
could reasonably disagree on the 3right’ answer given the same facts. qifferences in e&pert
evidence also commonly arise due to the arbitral process itself, which can result in the
followingY

X information asymmetry, where one e&pert may have greater access to relevant
information than anotherM and
X reliance on contested evidence, as put forward by each side to the arbitration.

Duch evidence encompasses both factual evidence and evidence from other e&perts within
the same arbitration.

K&perts can further assist the tribunal by identifying and e&plaining the source and nature of
their disagreements in their reports. To do so, e&perts may consider how best to demonstrate
the effect on their conclusions of particular instructions or assumptions they adopted in the
course of their analysis. ;or e&ample, a damages e&pert could perform sensitivity analyses
on certain inputs to their calculations or potentially even adopt the other party’s position in
respect of other aspects. jhere practical, such sensitivities may help inform the tribunal of

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the Fuantum of certain disagreements between the e&perts as well as allowing both parties
to focus on the highestEvalue issues at stake. As discussed below, 'oint statements can be
an eFually valuable tool in this regard.

Kngaging in e&ercises of this type helps to demonstrate the e&pert’s commitment to

independence and impartiality, particularly where a difference in opinion arises from
differences in instructions as to matters of fact or technical inputs, rather than differences
in professional 'udgement. These sensitivity analyses also assist the tribunal by Fuantifying
the effect on the e&pert’s conclusions of certain factual or technical areas of disagreement,
as well as the effect of the differences in their professional opinion.

Wn certain cases, it may not be practicable to perform such analyses. ;or e&ample, it may
be unreasonable or unhelpful for an e&pert to present sensitivities in their report if the
number of possible permutations of instructions and assumptions at issue would make such
calculations burdensome or where altering assumptions involves a disproportionate amount
of work. As an alternative, e&perts may consider discussing the effect of adopting different
inputs Fualitatively rather than Fuantitatively. ;or e&ample, e&perts may disagree on a point
of principle that, if changed, would not signiBcantly alter their ultimate conclusions. Duch
discussions still act to inform the parties and tribunal as to the materiality or magnitude of
the disagreement without reFuiring an unrealistic volume of work in the time available.

INTERACTIONS BETKEEN E[PERTS

Wn international arbitration, e&pert witnesses typically need to be adept at working not only
with e&perts with knowledge and skills distinct from their own e&pertise, but also, in the case
of partyEappointed e&perts, with their direct counterparts. Wnsights that may be developed
from dialogue between the e&perts, whether from the same or different specialities, can
tease out the cause of or even resolve disagreements between the e&perts.

Knergy disputes, more commonly than other types of disputes, tend to reFuire the
engagement of multiple e&perts with speciBc e&pertise in the matters at issue in the
arbitration. Kvidence may be adduced on a broad spectrum of issues from Fuestions of
foreign law to technical complications to the assessment of loss. 0onseFuently, in energy
disputes, it is common to see legal, technical and economic or Bnancial e&perts giving
evidence.

Kngaging multiple e&perts necessitates interactions between them to produce a cohesive

and consistent set of evidence. A crossEdisciplinary approach to assessing damages can
contribute to a more reBned and compelling case, particularly where comple& issues
intersect across different specialities.

Iowever, it is important to dedicate suLcient time and oversight to allow for e&pert dialogue
if a crossEdisciplinary approach is adopted. Wdeally, e&perts would be involved from early
enough in the process to ensure there is ample time to understand and contribute to shaping
the case. Wf e&perts are unable to work together effectively, they risk coming to a nonsensical
answer, ultimately to the detriment of the tribunal, their instructing party and their own
reputation. Dimilarly, if e&perts are unable to understand the evidence from others, valuable
insights that could be crucial to the case could unfortunately be lost in the wider confusion,
rather than brought to the fore.

The need for e&pert dialogue is perhaps greatest for e&perts in valuation or Fuantifying
damages, who regularly Bnd their conclusions and analyses 3downstream’ of the opinions

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of other e&perts. Wt is commonplace in energy arbitrations to see e&perts with valuation

skills relying e&tensively on the opinions of other e&perts with industry knowledge for inputs.
This situation arises typically due to the widespread use of the discounted cash 5ow Cq0;2
methodology to assess damages. q0;s often reFuire cash 5ows to be forecast well into the
future, meaning that technical e&perts may opine on Fuestions of market forces affecting
prices, demand and supply over the short, medium and long term. qepending on the speciBcs
of the claims set forth, such Fuestions can be further complicated by the need to consider
what would have happened in a counterfactual scenario assuming certain events had or had
not happened, sometimes across multiple scenarios.

The need for e&perts to work closely together means that, in energy arbitrations, it is essential
that parties ensure they have built in suLcient time to hand the 3baton’ of evidence from one
e&pert to another. ;urthermore, the parties themselves are typically reFuired to take an active
part in facilitating effective and timely collaboration between different e&pert groups. ;rom
a practical perspective, planning and coordinating e&perts is particularly necessary when
parties have engaged e&perts from different Brms.

Knsuring that e&perts work cohesively together can create an advantage to one side over
the other. Wn international arbitration, factual and e&pert evidence form the base on which
the legal arguments lie. Generally, the stronger this matri&, the more convincing it will be.
Kffective e&pert collaboration can ensure that the e&perts’ specialist knowledge is deployed
more successfully because the e&perts involved should have a better understanding of the
evidence on which they are relying.

Wn contrast, inadeFuate preparation and poor time management can be a diLcult hurdle to
overcome and may lead to poorer Fuality e&pert evidence. Wn a worstEcase scenario, it can
mean that one party remains consistently on the backfoot compared to their betterEprepared
counterparty, a particularly undesirable position to Bnd oneself in given the adversarial nature
of disputes.

KFually, partyEappointed e&perts may also be reFuired to work effectively with the e&pert
appointed by the other side. Arbitrations now often include some kind of 'oint e&pert process,
during which the partyEappointed e&perts on each side are e&pected to liaise to produce a
'oint statement, outlining areas of agreement and disagreement. The scope and timing of
such 'oint processes are usually deBned in advance. jithoutEpre'udice meetings between
the e&perts are typically essential to this 'oint processM the e&perts attend these meetings
without either of the parties or instructing counsel and with the overriding ob'ective of
assisting the tribunal by narrowing the issues.

The usefulness of such a process depends on the time available and level of cooperation.
WnsuLcient time and an unwillingness to cooperate by any participant will likely compromise
the overriding ob'ective of the process, namely to assist the tribunal by narrowing areas of
disagreement.

GETTING TZE YOST OUT OF E[PERTS

The comple& nature of energy disputes necessitates the involvement of e&perts. The
Fuestion for the parties and their legal advisers is simplyY when and how to involve the
e&perts#

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K&pert evidence is generally focused on answering Fuestions of Fuantum, rather than liability
or causationM however, in energy disputes, e&pert evidence can be relevant to the merits of
the case.

Wn energy arbitrations, both claimants and respondents commonly discuss their own Cand
the counterparty’s2 motivations, seeking to 'ustify the actions they did or did not take. Wt is
often helpful for the tribunal to understand the underlying motives of the parties at relevant
points in time. K&perts can assist by opining on the potential economic incentives of certain
contractual terms or the Bnancial beneBts en'oyed by one or other party. Dimilarly, the tribunal
may be interested in testing the contemporaneous evidence as disclosed in the arbitration.
K&pert evidence can inform the tribunal by helping to interpret and evaluate the analyses
that were produced by the parties at relevant points in time. Wn other cases, the tribunal
may consider whether the deal struck by the parties was at market value or within industry
e&pectations. K&pert evidence can help the tribunal assess whether an agreed price falls
within industry norms in the applicable time period.

K&pert evidence, therefore, can help to inform the parties and the tribunal beyond Fuantifying
damages, if counsel so chooses.

Wn selecting one or more e&perts for a case, counsel should bear in mind the areas of dispute
and on which areas of e&pertise they are likely to reFuire e&pert evidence and input. The
particular knowledge and skill set of an e&pert is likely to be highly relevant to counsel when
considering what evidence is necessary for their case and may inform whether multiple
e&perts will be reFuired, as is typical in energy disputes.

The decision as to what topics and Fuestions the parties should ask the e&perts may not be
straightforward. Wt certainly cannot Cand should not2 be regurgitated from one case to the
ne&t.

‘f course, one principal beneBt of partyEappointed e&perts is that counsel can discuss the
issues at hand with their appointed e&perts and develop appropriate instructions. Wnvolving
an e&pert at a relatively early stage means that they can help to identify the issues that will
likely arise in the course of the arbitration.

jhere instructions relate to an e&pert’s area of e&pertise or past e&perience, counsel should
consider reBning instructions with input from the e&pert. These instructions are likely to
be tested during the arbitration. ;or e&ample, an e&pert with a specialism in valuation may
have an opinion on the appropriate basis of loss, particularly where this intersects with the
approach to assessing value. Wt is generally important to ensure consistency between the
standard of value as claimed and the valuation approach adopted by the e&pert. qiscussing
such issues early on in the case, and before issuing instructions, can avoid inconsistencies
that could create diLculties as the matter progresses.

0ounsel should also discuss the effect on Fuantum of possible valuation or assessment
dates. The volatility of energy prices means that even a small change in the date at which
damages are assessed may have a material impact on damages. The choice of date may
not be straightforward, particularly depending on facts that may be disputed between the
parties, and naturally the relevant date depends both on the nature of the alleged breach and
the applicable law.

As well as potential differences in valuation date, the parties may adopt alternative positions
on other matters that affect an e&pert’s opinion. This may result in the e&perts being

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instructed to adopt different approaches, methodologies or fact patterns. To the e&tent

practicable, it can be helpful to the tribunal for the e&pert to consider their counterpart’s
instructions and potentially even demonstrate the effect of adopting these alternative
positions. Duch efforts can help reduce the risk of ships passing the night.

CONCLUSION
ésed effectively, the specialist knowledge that e&pert evidence offers can both enhance
the persuasiveness of the case and facilitate informed decisionEmaking by the tribunal.
K&pert witnesses can provide critical insights that can elucidate the types of comple& legal,
technical, Bnancial or economic issue that are common in energy disputes.

K&pert evidence in energy arbitrations is not fundamentally different from e&pert evidence
in other types of international arbitration in terms of either the duty that is owed to the
tribunal or the form the e&pert evidence generally takes. K&pert witnesses should take care
to fulBl their obligation to the tribunal regardless of the industry to which the case relates.
The ongoing concerns regarding the independence of partyEappointed e&perts indicates that
e&pert witnesses should ensure they comply and, importantly, are seen to comply with this
obligation. 0oncerns that e&pert witnesses can be hired as advocates risks undermining
the trust tribunals need to place in e&pert evidence as well as the legitimate professional
differences that may arise between e&perts.

Knergy arbitrations can be seen as distinct from arbitrations in other industries because the
energy industry tends to generate some of the highestEvalue disputes worldwide. The nature
of energy arbitrations more broadly creates both challenges and opportunities for the e&perts
engaged in these types of cases, as well as for counsel. The tendency for energy arbitrations
to involve more e&perts places greater emphasis on the need for cohesive working practices
to ensure a smooth running of the case. ‘n the other hand, involving e&perts with different
specialisms should create more robust evidence if deployed effectively. Wt is ultimately the
responsibility of all parties in international arbitration to ensure that highEFuality e&pert
evidence is deployed effectively, recognising both the beneBts it can bring in shaping and
bolstering the case, as well as assisting and providing specialist information to the tribunal.

ENDNOTES
]j3
$oe Dkilton is a managing director and Abi Iarris is a director at Decretariat Wnternational.
]23
“ueen Uary éniversity of (ondon, ;uture of Wnternational Knergy Arbitration Durvey Report
6-66, 6- $anuary 6-69, pages 9/ to 96.
]53
0hartered Wnstitute of Arbitrators, Hrotocol for the ése of HartyEAppointed K&pert
jitnesses in Wnternational Arbitration, Deptember 6--ó, page 6.
]43
Wnternational )ar Association, W)A Rules on the Taking of Kvidence in Wnternational
Arbitration, 6-6-, page /4
]63
)ryan 0ave (eighton Haisner, Annual Arbitration Durvey 6-6/Y K&pert Kvidence in
Wnternational Arbitration, page J.
]73
)ryan 0ave (eighton Haisner, Annual Arbitration Durvey 6-6/Y K&pert Kvidence in
Wnternational Arbitration, page J.

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Woe Séilton [email protected]

Abi Zarris [email protected]

1175 Peachtree Street NE, 100 Colony Square, Suite 400 Atlanta, GA 30361, United States

Tel: +1 856 396 8217

https://secretariat-intl.com/

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Quantum: Valuing
Pre-operational Assets
Bennet Berger and Wacé Stir–aéer
The Brattle Group Inc

Summary

FRAYEKORM: TZE VALUE LADDER

YODELLING RISM

QUANTIFkING RISM

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Arbitration claims can involve assets before they become operational. Duch assets can pose
challenges for a valuation e&ercise, as earlyEstage assets may face additional or uniFue risks
and do not possess an operational history to benchmark pro'ections against.

These issues are not uniFue to arbitration and valuations of such assets are routinely
performed in the normal course of business – investors buy and sell preEoperational pro'ects,
and pro'ect developers will have considered all risks when making the initial decision to
invest.

This chapter discusses the framework for preEoperational risks and provides a methodology
for how to account for them in a valuation.

FRAYEKORM: TZE VALUE LADDER

The fundamental value of an asset is forwardElooking, resting on the cash 5ows it can
generate for investors in the future. The value of a preEoperational asset is no different.
Iowever, the value will need to consider two factors not relevant to operating assetsY the risk
that an asset may not become operational, and the costs reFuired to reach the operational
stage. All else being eFual, the value of a preEoperational asset will be less than the value of
its operating eFuivalent.

Wt is Brst useful to consider the parties’ perspectives of a transaction involving a

preEoperational pro'ect. The buyer would not typically pay a substantial premium over
eLciently incurred costs if they could develop a comparable pro'ect themselves or Bnd
another in development. Dimilarly, a seller would not typically sell for less than the eLciently
incurred costs plus a return, acknowledging that a buyer’s alternative would be to incur
similar costs and take the same time and risks to develop another pro'ect.

Applying this perspective, ;igure / illustrates the evolution of a stylised, successful energy
pro'ect, such as a photovoltaic power station, a combinedEcycle gas turbine plant or a gas
production platform.

FIGURE j: ILLUSTRATIVE VALUE EVOLUTION - DEVELOPYENT STAGES

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The Bgure traces value through three broad phasesY

]23
X DevelopmentY Hro'ect value typically starts at 7ero and grows as the pro'ect
incurs costs and passes initial development milestones, such as obtaining permits,
securing land rights and conducting environmental impact assessments, as well as
completing studies conBrming technical and Bnancial feasibility.
X ConstructionY Kntering the construction phase, pro'ect value grows as it incurs the
capital costs of building infrastructure and resolves related risks.
X OperationY ;or pro'ects with a B&ed life, pro'ect value levels off once the pro'ect
commences operations and performance tests are satisfactory, and then declines
]53
over time as the remaining useful life of the asset runs down.

The main pro'ectEspeciBc drivers of value creation in the Brst two phases are invested costs
and risk resolution. Hast investments enhance pro'ect value to the e&tent that they reduce
prospective outlays. Hut simply, a buyer of a halfEBnished asset would appreciate that they
would need to spend less to complete the pro'ect than if they bought it on day one.
]43
jith respect to risk, a pro'ect may face binary or FuasiEbinary hurdles, particularly in the
development phaseY for e&ample, if permits become unobtainable, the value is 7ero. This
same effect means that pro'ect value can 'ump as the pro'ect passes ma'or development
milestones that increase the chance of success.

Taking the analogy of a coin 5ip, assume the chance of passing a milestone is z- per cent
and that the payEoff on success is /--. )efore the milestone, the pro'ect faces two scenarios,
one in which its value is /-- and another in which it is 7ero. Wn e&pectation, pro'ect value is
z- Cz- per cent & /-- z- per cent & -2. ;lipping the coin resolves the risk and assigns one
of the two possible outcomesY pro'ect value 'umps to 7ero or /--.

The preEoperational phase can be likened to a series of coin 5ips of different value and
importance as the pro'ect advances along the value ladder towards the operational phase.
That is not to say that outcomes are random. The key point is that development milestones
are associated with ex-ante probabilities that subseFuently translate into certainties Cor even
changes in the probability going forward2 and e&plain value increases or decreases.

;igure 6 e&pands on ;igure /, separating the overall value into the two pro'ectEspeciBc
sources discussed above and illustrating the 'umps in value on passing development
milestones. At the beginning of a pro'ect’s life cycle, investments are usually relatively
small, arising from development e&penses for pro'ect scoping, permits and environmental,
]63
technical or Bnancial assessments. The greenEshaded area represents value increases
]73
from past investments. The blue shaded area represents value increases from risk
resolution. Hassing development milestones increases the chance of pro'ect success.

FIGURE 2: ILLUSTRATIVE VALUE EVOLUTION - RISM AND INVESTYENTS

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qoes this mean that the value of the asset can always be eFuated to incurred costs plus
compensation for risk and time# énfortunately, it is not that simple. The stylised Bgures
shown above focus on successful development and resolution of pro'ectEspeciBc risks.
Wf a pro'ect incurs higher than e&pected costs, completion takes longer than e&pected,
production turns out lower than anticipated or market discount rates increase, the pro'ect
value on the commencement of operations could fall below the value during an earlier stage
]83
of development, or even below invested costs.

Uoreover, some assets face particular e&posure to changes in market conditions, such as
commodity prices. An investment into infrastructure for the e&traction of shale gas deposits,
for e&ample, may become uneconomic if gas prices decline, even if the pro'ect evolves
smoothly. Dimilarly, an e&ploration licence before any investment can become more valuable
if gas prices increase.

1evertheless, ;igure 6 illustrates why invested amounts can be a useful crossEcheck for
analysing market value. Wn a highly competitive or regulated market with limited intangible
assets, we would e&pect the value of an eLcient pro'ect to have a strong correlation to
the amounts e&pended with ad'ustments for time and risk. jhere a valuation leads to a
signiBcant departure from the above diagram, the valuer should be able to e&plain the source
]93
of the divergence.

To properly account for these types of market changes in a valuation, it is necessary to value
the operational phase using a forwardElooking approach. The key Fuestion is then how to
account for the remaining unresolved risks faced by the asset.

YODELLING RISM
je develop a framework for accounting for risk within the discounted cash 5ow Cq0;2
method. A q0; analysis forecasts the e&pected stream of future cash 5ows and discounts
them back to a given date at a rate that re5ects risks and the time value of money. Wn our
e&perience, q0; is the most common approach to valuing assets in the energy industry,

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operational and preEoperational alike. Wn a q0;, risks are accounted for in the discounting or
]13
the cash 5ows, or both.

:aluing a preEoperational pro'ect using a q0; starts with developing a forecast of revenues
and costs for an operational asset. Herforming q0; analysis for operational energy assets
can draw on a wealth of available data. jhen pro'ecting operations of energy assets, the
valuer typically has access to detailed analysis of technical characteristics of the asset,
such as estimates of production, operating costs and capital costs. This includes technical
data from decades of e&perience conducting engineering and Bnancial due diligence in the
industry.

The energy industry is also characterised by e&tensive market data. ;or commodities such
as oil and gas, forward contracts reveal price e&pectations several years into the future.
Deveral international agencies and many private companies publish longEterm forecasts of
commodity and energy prices looking 6- or 9- years ahead.

The ne&t step of the valuation accounts for the two realities discussed earlier that
characterise preEoperational assetsY uncertainty in reaching the operational phase and
capital costs to be incurred.

PRE-OPERATIONAL RISM
Risks are inherent in pro'ect development. Te&tbooks on corporate Bnance refer to this type
of uncertainty as 3nonEsystematic’, meaning they are pro'ectEspeciBc and not correlated with
the wider economy. Te&tbooks caution that discount rates should re5ect only systematic risk,
]j03
and that pro'ectEspeciBc risks should be re5ected in the forecast of the future cash 5ows.

The value ladder described above e&plains that a preEoperational pro'ect faces several
development hurdles. ;or e&ample, if environmental permits cannot be obtained, or a test drill
reveals it is not economic to e&tract natural gas reserves, the pro'ect could be abandoned. Wn
valuation terms, there is an ex-ante probability that the pro'ect will pass the ne&t development
]jj3
milestone successfully and a probability that it does not.

Above, we likened the development phase to a series of coin 5ips. ;igure 9 illustrates how
more sophisticated probabilistic modelling can be implemented in practice. Assume passing
the Brst development hurdle – for e&ample obtaining a permit – has an °- per cent chance
of success. The second development hurdle – for e&ample, agreeing on land lease rights
on economic terms – has a J- per cent chance of success. Assume that, without an
environmental permit and a lease agreement, the developer would not be able to pursue
the pro'ect further, in which case it has a value of 7ero. Abstracting from other risks, the
two probabilities representing development risk would combine into an overall success
]j23
probability of ó6 per cent C°- per cent & J- per cent2.

FIGURE 5: PROBABILISTIC YODELLING OF PRE-OPERATIONAL RISMS

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The success and failure probabilities are applied directly to all the pro'ect’s subseFuent
]j53
future cash 5ows. Applying a ó6 per cent chance that the pro'ect would reach operational
stage and generate cash 5ows is eFuivalent to applying a 6° per cent discount to all cash
5ows. 0ash 5ows ad'usted for risk in this way are also referred to as e&pected, mean or
probabilityEweighted cash 5ows.

The timing of these milestones can have important implications for value. Wmagine two
pro'ects that will each cost 8/- million to complete, and each has a milestone with a z-Vz-
probability of success or failure. Duppose further that for the Brst pro'ect, success or failure
materialises during the early development stage that reFuires an initial investment of 8/
million. Wf the investor Bnds the pro'ect will fail, the investor can then abandon the pro'ect,
limiting their total loss to 8/ million. ;or this pro'ect, an investor would reFuire an ex-ante
]j43
e&pected payEoff of at least 8// million.

Duppose for the second pro'ect, success or failure materialise only at the end, after having
invested the full 8/- million. Wn this case, the e&pected ex-ante payEoff must be at least 86-
]j63
million for the pro'ect to proceed.

These e&amples illustrate the concept of value at risk C:aR2, which provides a Fuantitative
measure of the e&posure and likelihood of loss for a particular pro'ect. Wn the Brst pro'ect,
the investor had a z- per cent chance of losing a ma&imum of 8/ million, whereas in the
second it is the full 8/- million. The higher the :aR, the greater the compensation reFuired
for a successful outcome.

RealEworld e&amples would be a photovoltaic CH:2 power plant versus an oil well. The H:
installation can determine success or failure early in the development where the primary
risk is securing the necessary permits. Iowever, oil wells can entail greater risk, as the
investor can only know for certain if the well is productive after drilling. A successful well
will, therefore, tend to have a higher value when compared to invested costs than a H: plant
because the investment has a higher :aR.

Iaving ad'usted cash 5ows for nonEsystematic preEoperational risk, no further ad'ustment
to the discount rate is needed. Ad'usting both the cash 5ows and the discount rate would
doubleEcount the impact of the nonEsystematic risks.

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REYAINING CAPITAL INVESTYENTS

The second signiBcant distinguishing feature of a preEoperational asset is the remaining
capital investment. These e&penses have a clear effect in that they represent large negative
cash out5ows for the pro'ect. Iowever, in addition to the pure cost, the e&istence of large
capital investments can create leverage due to the relatively B&ed nature of the payments.

‘utlays for development and construction are often more certain and closer in time than
the e&pected cash 5ows once the pro'ect commences operations. ;or e&ample, a common
arrangement for energy pro'ects involves engaging outside contractors for engineering,
procurement and construction. The contractual arrangement often involves a largely B&ed
price, which does not vary, or only to a limited e&tent, with market conditions.

The B&ed payment commitments during development and construction magnify the impact
of 5uctuations in the future value of the operating asset on the value of the preEoperational
asset, similarly to the way the e&istence of debt obligations magniBes the impact of
5uctuations in future pro'ect value on eFuity holders today. 0orporate Bnance theory refers
to this as operating or capital leverage.

The relatively B&ed nature of capital costs suggests applying a relatively low discount rate.
)ecause the construction costs are negative cash 5ows, applying a low discount rate
increases their present value and in turn decreases pro'ect value.

;igure x illustrates that this approach is conceptually similar to the inclusion of a premium in
the pro'ect’s overall discount rate, which re5ects the leverage effect of construction. ;igure
x assumes a 9 per cent discount rate applied during an assumed 6Eyear construction period,
and a 4 per cent discount rate applied during an assumed /-Eyear operating period, illustrated
]j73
by the dark blue line. Wn this illustration, the effect of applying a low discount rate during
the construction period produces the same result as applying a 4.z per cent discount rate
overall, indicated by the light blue line.

FIGURE 4: EFFECT OF OPERATING LEVERAGE ON OVERALL PROWECT DISCOUNT RATE

0ombining different discount rates depending on the nature of cash 5ows raises the overall
]j83
discount rate because of the risks resulting from operating leverage. )ut although an

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eFuivalent discount rate can always be calculated, it always relates to the cash 5ows at issue,
so no standard premium can be added to a discount rate to account for capital leverage.

A COYYON SZORTCUT
Wn practice, a common shortcut to account for the range of preEoperational risks is to add
premiums to the discount rate, similar to the effect of capital leverage discussed above. A
higher discount rate reduces the present value of future cash 5ows, which can appear to
re5ect the higher risk.

Iowever, while providing a more straightforward approach, te&tbooks on corporate Bnance

]j93
typically advise against the use of such discretionary risk premiums. K&plicit risk
ad'ustments to cash 5ows reFuire the valuer to carefully consider the particular risks at hand
and design an approach to account for those risks in the analysis. They can be converted
into a risk premium, but it is more likely that cash 5ow ad'ustments inform risk premiums
]j13
than the other way around.

QUANTIFkING RISM
jhile the approaches to risk described above may reFuire sub'ective assumptions, such
as probabilities of permit acFuisition, a valuer can employ methods that can increase the
ob'ectivity of the inputs and, therefore, the accuracy of a valuation. The choice of approach
typically depends on available information and data.

A primary source that a valuer should e&amine is the e&istence of transactions in the target
asset. Wt is relatively common for energy infrastructure assets to be bought and sold, as
]203
different developers specialise in certain phases of a development cycle. ‘ften, a party to
]2j3
a dispute will only have acFuired the asset at an earlier stage of development.

jhere this type of data e&ists, analysis can calibrate a valuation model directly to the
transaction price to obtain relevant preEoperational risk discounts or success and failure
probabilities. Wn very simple terms, if the transaction price was /-- and the valuer determines
the pro'ect’s value at operating stage at 6-- Cthat is, before accounting for preEoperational
]223
risks2, then the transacting parties must have assigned a success probability of z- per
cent.

Wf the dispute arose relatively close in time to the pro'ect’s acFuisition and little to no
development occurred before the valuation date, the transaction price itself would represent
an obvious benchmark for a valuation. This does not mean that the pro'ect’s value should
eFual the transaction price, as changes in market conditions – among other factors –
can affect pro'ect value. Rather, the valuation would involve updating the pro'ect’s value at
operating stage Cpreviously 6--2 and then applying the z- per cent success probability to
obtain the updated valuation for the preEoperational pro'ect.

Dome suLciently large assets, or potentially the parent company, may have a traded share
price, which shows the development of value day by day. These prices can also be analysed
to understand developments in the value of a pro'ect.

AssetEspeciBc prices should usually be the preferred data source, as the information revealed
will capture the speciBc feature of a pro'ect. 1evertheless, in the conte&t of arbitration, the
valuer must be careful to ensure that the transactions are not contaminated by the issues
related to the dispute.

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Another method of using market data is to identify transactions involving suitably

comparable companies. Wn ideal circumstances, the valuer may Bnd a transaction that is
suLciently comparable so that it can be used directly as a value benchmark for a particular
]253
asset. Uore commonly, valuers will Bnd a sample of companies and take an average of
their values. Wmportantly, in increasing the sample si7e, the valuer will face a tradeEoff as
assets in the sample potentially become less comparable to the asset being valued. The
primary downside to a comparables analysis is that the valuer’s 'udgement of what asset is
comparable may be too sub'ective. The identiBcation and selection process should be clearly
described to avoid issues of bias.

éseful valuation data can also be determined from sources other than transactions. ;or
assets lacking the relevant permits, parties may agree on a payment schedule where some
or all instalments are conditional on the pro'ect reaching future development milestones.
(ike transaction prices, the seFuence of payments and their relative magnitudes can provide
insights into preEoperational risk discounts and relative probabilities of failure and success.E
]243

;or e&ample, assume the purchase agreement involved a payment of 6- on closing the
transaction and a further /- on obtaining permits. Assume we can establish the value of
the fully permitted pro'ect at x-. The uncertainty surrounding the permits brings about two
possible scenariosY one in which the pro'ect fails to obtain permits, which results in a payEoff
to the buyer of negative 6- Cthe upfront payment2, and another scenario where the pro'ect
succeeds, which results in a payEoff of /- CeFual to the value of the permitted pro'ect less the
upfront payment of 6- and the milestone payment to the seller of /-2. ;or the buyer to break
even in e&pectation, the success scenario must, therefore, have a probability of at least 4ó
]263
per cent, see ;igure z. Resolving the uncertainty around permits adds value and e&plains
the 'umps along the value ladder.

FIGURE 6: ILLUSTRATION OF CONTINGENT YILESTONE PAkYENTS AND SUCCESS

PROBABILITk

‘ther sources to consider are market publications and academic literature. The importance
of the energy market in the economy has stimulated wide bodies of research devoted to
analysing risk. Academic literature typically centres around speciBc topics with good data
availability. ;or e&ample, there have been multiple studies analysing past e&perience of
hydropower pro'ects, which have been in use for over /-- years, and many have been
sponsored by global development banks that published data on the costs and time it took to
build them. The data allows researchers to develop metrics of cost overruns and schedule
delays, which can be used to inform any assessment of risks, particularly during construction
]273
phase.

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Regulators must also think carefully about developer and construction risk when designing
incentive regimes for new investments. ;ailing to provide adeFuate compensation can result
in shortfalls from targets while providing too high a return imposes costs on consumers.

As an e&ample, a study commissioned by the éS qepartment of Knergy and 0limate 0hange

surveyed development and construction risk premiums as applied in 3hurdle rates’ for various
renewable energy technologies, Bnding that premiums can range from -.z per cent for solar
H: and onshore wind assets in construction to 4 per cent for offshore wind pro'ects in
]283
development. The scale of the various premiums provides a broad measure of the scale
of risk that the pro'ects face at the outset, as well as the compensation that investors reFuire.
There are ways to convert such risk premiums into success and failure probabilities, which
]293
may be desirable as risk premiums have certain theoretical and practical shortcomings.

jhile literature can provide an ob'ective input, care must be taken when applying Bndings
based on statistical averages and distributions to any given pro'ect.

jhichever data the valuer has available to drive the FuantiBcation, the basic framework is
the same. The valuer must develop a q0; analysis of the pro'ect at the operational stage,
which ultimately drives the value of the asset. The valuer should then factor in preEoperational
risk, including success and failure probabilities, considering the best available evidence. As a
Bnal step, the valuer should be able to e&plain the valuation results in relation to the pro'ect’s
e&pected position along the value ladder and the evolution of value over time.

ENDNOTES
]j3
)ennet )erger is a senior associate and $ack Dtir7aker is a principal at The )rattle Group.
]23
A net present value C1H:2 of 7ero means the present value of future cash 5ows from
the pro'ect’s operations eFuals the present value of investment costs after a fair market
rate of return. Harticularly eLcient pro'ects, or pro'ects that have beneBted from market
developments, may have positive 1H:. 1egative 1H: pro'ects would not typically go ahead.
]53
Hro'ect value can change both before and during operation due to in5ation effects,
changes in e&pected market rates of return or growth forecasts.
]43
)y binary development hurdles we refer to forkEinEtheEroad issues, such as obtaining a
permit or failing to do so. ‘ften the outcome is not discreteM for e&ample, permits can be
conditional or come with reFuirements that entail additional costs or risks that can give rise
to a range of outcomes rather than success or failure.
]63
;or some assets, e&penses during an early stage can be a relatively larger share of total
investments than depicted in ;igure /, such as in the case of concession payments for the
right to develop.
]73
The chart assumes all investments are eLcient. A pro'ect would not be worth 6-- 'ust
because the investor spent 6-- if other market participants could reach the same stage by
spending /--.
]83
Uore generally, pro'ect value at any given stage of development can drop below the value
of a previous stage if risks resolve negatively to destroy value more than sunk investment
costs increase it.

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 RETURN TO CONTENTS RETURN TO SUYYARk

]93
These can include speciBc eLciencies or intangible value for the pro'ect in Fuestion, or
changing market conditions such as interest rates or commodity prices.
]13
As a te&tbook reference for the valuation of operational and preEoperational assets, see,
for e&ample, )realey, R. A., Uyers, D. 0., and Allen, ;., Principles of Corporate Finance, Tenth
Kdition, 1ew Qork UcGrawEIill, C6-//2, p. 666E669.
]j03
Dee, for e&ample, )realey, R. A., Uyers, D. 0., and Allen, ;., Principles of Corporate Finance,
Tenth Kdition, 1ew Qork UcGrawEIill, C6-//2, p. 666.
]jj3
‘ther development hurdles may not be binary but can still be modelled in a probabilistic
way. ;ollowing a technical feasibility study, the valuer can test the pro'ect’s viability in high
and low case scenarios, for e&ample. Wt may reFuire technical input to assess the likelihood
of the respective scenarios.
]j23
Wn practice, care must be taken when combining probabilities.
]j53
1ote that this can include capital investmentsM if a pro'ect fails to get permits, investments
would not go ahead.
]j43
The 1H: is the weighted average of the potential outcomesY Hfailure & 0;failure HE
Duccess & 0;Duccess, where 3H’ is the probability and 30;’ are the cash 5ows. ;or the Brst
pro'ect the value that sets the 1H: to 7ero is 8// millionY z- per cent & E8/ z- per cent &
CE8/- 8//2.
]j63
z- per cent & E8/- z- per cent & CE8/- 86-2.
]j73
;igure x assumes an investment of 8/z- million and operating cash 5ows of 86z- million,
each spread evenly across time. The pattern of cash 5ows determines the effective discount
rate associated with a certain combination of discount rates applied to construction costs
and operating cash 5ows.
]j83
0apital e&penditure does not stop when the construction phase ends, of course. The
effect of ongoing capital e&penditure on pro'ect risks must therefore be re5ected in the
discount rate applied to cash 5ow generation of the operating asset.
]j93
Dee, for e&ample, )realey, R. A., Uyers, D. 0., and Allen, ;., Principles of Corporate Finance,
Tenth Kdition, 1ew Qork UcGrawEIill, C6-//2, pp. 66zE664.
]j13
Dimilarly, we can ad'ust for operating or capital leverage by increasing the discount rate
as shown in ;igure x. jhile it is possible to mimic leverage through the inclusion of a risk
premium in the discount rate, it is preferable to establish the magnitude of the premium using
Brst principles.
]203
jhere no transactions have occurred, and the owner has developed the pro'ect since
inception, the owner may have prepared models supporting the initial decision to invest,
which will typically re5ect all the risks that the pro'ect was e&pected to bear at the time. This
can provide an upper bound on the risk measure for the pro'ectEspeciBc risks, assuming that
risks have not changed.
]2j3
qata from transactions not only e&tend to sale and purchase of interests but also can
include rounds of eFuity issuance as a fundraising process.
]223
Detting aside the costs involved in reaching the ne&t milestone.

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 RETURN TO CONTENTS RETURN TO SUYYARk

]253
;or e&ample, a valuer may collect data on a sample of pro'ects in the same industry
and at a similar development stage from which they would derive a value metric to enable
comparisons. The valuer may observe that fully permitted and readyEtoEbuild photovoltaic
power station trades at a price of 8-.x million per Uj of installed capacity on average, which
the valuer would scale up to the si7e of the pro'ect to obtain an estimate of its value.
]243
étilising information on the seFuencing of payments does not necessarily reFuire the
disclosure of the actual purchase agreement as relevant intelligence can be purchased from
specialised industry consultants and publishers.
]263
This illustration also assumes that development e&penses in the relevant period are
negligible.
]273
Dee, for e&ample, )aur7han, D., $enkins, G.H., ‘lasehindeEjilliams, G.‘. 3The Kconomic
Herformance of Iydropower qams Dupported by the jorld )ank Group, /Józ–6-/z’,
Knergies 6-6/, /x, 64ó9M and Hlummer )raeckman, $, qisselhoff, T., Sirchherr, $. 30ost and
Dchedule ‘verruns in (arge Iydropower qamsY An Assessment of Hro'ects 0ompleted since
6---’, Wnternational $ournal of jater Resources qevelopment 6-/J.
]283
httpsYVVwww.gov.ukVgovernmentVpublicationsVneraE6-/zEhurdleEratesEupdateEfo
rEgenerationEtechnologies, p. 9J. ;or the avoidance of doubt, the authors of the study do not
e&press any views as to how their Bndings should be used in the conte&t of a q0; valuation.
]293
je note that the study commissioned by the éS qepartment of Knergy and 0limate
0hange mentioned above senseEchecked its survey Bndings by doing probabilistic modelling
of success and failure rates, see pp. x/–x6 of the study.

Bennet Berger [email protected]

Wacé Stir–aéer [email protected]

Tel: +1.202.955.5050

https://www.brattle.com/

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