Oil prices continue to be depressed and trading conditions for oil and gas companies remain difficult. In such circumstances, commentators are predicting a new wave of disputes in the oil and gas sector, with new types of dispute (for example, claims brought by liquidators following the insolvency of a counterparty) prevailing. However, market conditions vary across the world, and it would be unwise to assume that conditions in a mature market such as Europe are the same, and/or will have the same consequences, in Asia and South East Asia region. In this article, Richard Power considers whether the Asia/South East Asia region stands on the verge of a new wave of energy disputes, or whether the region’s peculiar – perhaps unique – economic circumstances could isolate it from the travails affecting the energy sector elsewhere in the world.
The Economic Drivers
Asia/South East Asia constitutes a huge trading area, encompassing some of the world’s biggest economies. The region is inextricably interlinked with the world economy, so it would be naïve to think that oil & gas/energy companies in the region are immune to the depressed economic circumstances affecting the oil, gas and power sectors worldwide.
The effects of sustained low oil prices are wide-ranging. Projects which were predicated upon an oil price around US$100 per barrel no longer look attractive/viable with the price around US$40p.b. Tight oil and gas, with associated higher extraction costs, are less likely to be brought to market. Companies with assets valued by reference to the oil price have seen huge reductions to their market value, and smaller players may find it difficult to raise finance. New contracts are being put on hold, reconsidered and cancelled.
The low oil price is, to a large degree, caused by reduced demand for oil and hydrocarbon-produced energy. This is partly due to lower levels of economic activity, particularly in China where the economy has slowed drastically (although it is still growing); and partly due to a shift away from CO2- producing hydrocarbons as an energy source. The COP21 UN Conference on Climate Change in Paris late 2015 resulted in an agreement to keep the increase in global temperature to “well below” 2ºC above pre-industrial levels, requiring governments to take action to reduce CO2 emissions. Coupled to this, there is increasingly strong domestic pressure to improve air quality – China, in particular, now sees improving air quality as a political necessity.
Worldwide, this has resulted in a shift away from coal, oil and gas to renewables. In 2015, electricity generated from renewables accounted for around half of the new power generation capacity worldwide[1]. China is set to introduce an emissions trading scheme in 2017, and in 2015 and 2016 India and Indonesia started to phase out their subsidiaries of the fossil fuel industry. China’s command economy has recently changed direction, favouring expansion of the services sector, rather than heavy industry (with both steel and cement production likely to have peaked by 2014), and a general move away from energy intensive industries to low-energy industries. This means that 85% less energy is required to generate each unit of future economic growth for China than was the case in the past 25 years. Given that China is one of the biggest markets for hydrocarbons, the impact on the oil and gas industry is readily apparent.
At the same time, new sources of oil and gas are available: oil from Iran and shale gas from the USA. Downward pressure on demand coupled with an increase in supply inevitably drives down prices, causing economic hardship for those whose business models require a higher oil and gas price.
Asia/South East Asia’s unique circumstances
However, Asia/South East Asia is not Europe and North America. The region’s economies are still expanding to an extent due to low costs bases, and there is a political and economic need to bring power to communities and businesses which currently lack such access. This means that Asia and South East Asia will be the main drivers of growth in the worldwide energy sector to 2040. According to the IEA’s World Energy Outlook 2015, “Energy use worldwide is set to grow by 30% to 2040…driven primarily by India, China, Africa, the Middle East and South East Asia”. ExxonMobil’s The Outlook for Energy: A View to 2040 predicts that “by ….2040, most of the world’s oil and gas exports will likely be headed to the region”.
So while the reduction in demand for fossil fuels from China and other countries in the region is bad news globally, there is still significant demand for energy (and therefore, oil and gas) in the region. For example, China is the world’s largest importer of, and second largest consumer of, oil, and its gas market is bigger than that of the European Union. The China National Petroleum Corporation projects that China’s dependence on foreign oil will hit a new high of 62% in 2016. Similarly, the IEA predicts[2] that by 2040, India will have the largest share of growth (approximately 25%) in global energy demand, and its demand for oil will increase more than any other country in the world – by 2040, India’s oil import dependence will rise above 90%.
The suitability of natural gas as a “bridge” between “dirty” coal and renewables for power generation means that demand for gas is also likely to increase to 2040 (the IEA predicts a 50% global increase in consumption of natural gas, driven by China and the Middle East). This is good news for countries such as Malaysia and Indonesia: Indonesia is ranked 10th in the world for gas production and 14th for reserves, while Malaysia is the world’s second largest exporter of liquefied natural gas (LNG), and Indonesia the 5th largest.
Consequently, it is likely that the impact of the global downturn in oil (and gas) prices will be somewhat ameliorated in the Asia/South East Asia region. However, this does not mean that there will not be an increase in the number of energy disputes, or a change in their nature. On the contrary, the region’s almost unique circumstances are likely to see the emergence of more and different types of energy dispute.
Energy Disputes in Asia/South East Asia: Current Status
It is difficult to form a view of the number and magnitude of energy arbitrations currently underway in the Asia/South East Asia region, because these are largely confidential. However, the International Centre Settlement of Investment Disputes (ICSID) in November 2015 indicated that oil, gas and mining disputes account for 38% of all ICSID cases in Asia/South East Asia/Pacific region; when power generation disputes are added, the figure becomes 42%. So it is safe to conclude that energy disputes account for upwards of one-third of all investor-state arbitrations in the region, whether they be ICSID-administered arbitrations or subject to other rules.
At a commercial dispute level, most non-domestic disputes will also be referred to arbitration, most commonly subject to China International Economic and Trade Arbitration Commission (CIETAC), Singapore International Arbitration Centre (SIAC), International Chamber of Commerce (ICC) or Kuala Lumpur Regional Centre for Arbitration (KLRCA) rules. The Chinese model Production Sharing Contract contains a multi-tiered dispute resolution clause, cumulating with a reference to arbitration subject to CIETAC rules (although anecdotally, it appears that it is common to replace this reference with SIAC or ICC rules).
That being said, it is fair to say that in the Asia/South East Asia region, there is a general cultural residence to formal dispute resolution and a preference for reconciliation via negotiation or mediation. It is likely that this, combined with the comparatively robust nature of the regions’ energy markets, has resulted in less commercial energy disputes to date than one might have predicted given the shocks to the global energy economy. The question is whether this is likely to continue.
Energy Disputes: Trends for the Future
Economic hardship
While the effect of depressed oil & gas prices may be lessened in the Asia/South East Asia region, companies are not immune to it. It is therefore likely that there will be more energy disputes linked to financial hardship than one would have witnessed in the recent past:
• debt claims for unpaid fees;
• breach of contract claims in respect of a joint venturer’s inability/refusal to meet cash calls in JOAs, or a refusal to invest in the drilling of exploration wells in compliance with a concession agreement, etc.;
• breach of contract claims arising out of the postponement or cancellation of uneconomic projects; and
• spurious force majeure claims. These might be attempts to disguise an operational failing due to cost-cutting as an event beyond the party’s control; or claims for relief due to economic hardship due to market conditions beyond the party’s control. The former are nothing unusual in this sector, although one may see more of such claims. The latter, however, raise the question of whether an unexpected economic event can ever be a force majeure event. Under English law, the answer is generally no, but under other legal systems in the region, relief for economic hardship might be recognised. Similarly, some contracts can contain “hardship clauses” allowing a party to suspend performance if it would cause economic hardship to perform. In such contracts, the drastic fall in the oil price might well lead a party to trigger the hardship clause, and give rise to a dispute as to whether they truly face economic hardship such that the clause can be validly relied upon.
Where payment obligations are breached in one contract, there can be a domino effect, so that sub-contractors cannot pay their contractors and so on. Ultimately, this can lead to one or more of the parties in the contact chain becoming insolvent. Although insolvency is a domestic matter, and practices and procedures will differ from country to country, it is worthwhile noting that disputes involving an insolvent party create a different dynamic than normal commercial disputes where there is often a continuing commercial relationship which will provide an incentive for amicable settlement. An insolvency practitioner who steps into the shoes of an insolvent company will have legal obligations to maximise recoveries for creditors, which might mean he pursues a claim which the company would not have. This is particularly the case where the insolvency practitioner is funded by debt holders to pursue a claim which could be the investors’ only realistic prospect of recovering any of their investment in the failed company.
A growth in the number of arbitrations
As indicated above, growth of energy demand is likely to lead to a growth in oil and gas imports in the region, and the construction of new power generation plants and renewable projects. All things being equal, it is reasonable to predict that this will lead to an increase in the number of disputes between parties in the energy sector – quite simply, more business is likely to lead to more disputes. While the cultural resistance to formal dispute resolution is unlikely to change significantly, there are only so many steps one can take to avoid disputes, particularly where the Claimant is from a country with a more aggressive approach to dispute resolution, as is the case with many of the major players in oil & gas/power generation.
Gas price reopeners
There is currently little tradition in the region of gas price reopener arbitrations, at least compared to Europe and the Middle East. However, the face of the region’s gas market is changing, and this is likely to bring about at least some of the same pressures which triggered the last round of gas price reopener arbitrations in Europe.
The price of gas in long term gas supply contracts in the region is commonly linked to the price of oil, as was the case for many decades in Europe. However, in Europe the emergence of gas trading hubs such as TTF and Zeebrugge, and the arrival of US Henry-Hub-priced shale gas, created liquidity and undermined the link between the gas price and the oil price. As the oil price soared to $100 a barrel, so gas buyers triggered the renegotiation clauses in their long term gas supply contracts, claiming that the oil–index mechanism caused undue financial hardship. The result was a wave of arbitrations which, largely, imposed new non-oil-linked pricing mechanisms on the parties, and required the suppliers to repay considerable sums of money to the buyers.
So far, gas trading hubs have not developed in the same manner in Asia/South East Asia as they have in Europe, and given the widely differing geographic and political considerations in the region, this is not surprising. However, two factors are likely to start undermining the link between gas and oil prices: first, the rest of the world has largely moved to spot trading for gas, which if it does not go so far as to establish a global benchmark price for gas, certainly does give a number of gas-only comparator prices for trading. Secondly, the US is now exporting Henry-Hub-priced shale gas via LNG exports into the Asia/South East Asia region. As these factors make an impact on the market for gas in the region, it is likely that economic pressures will make the case for triggering the price renegotiation mechanism commercially more attractive. Again, while cultural resistance to formal dispute resolution procedures might mean that not all of these renegotiations end in arbitration, it is likely that there will be more such arbitrations in the region than has been the case.
The promotion of mediation in the context of arbitration
Cultural resistance to formal dispute resolution has already contributed to the development of regional arbitral rules and laws which incorporate mediation, and a willingness by tribunals to suggest mediation, which those in the West may find unusual. Article 40(2) CIETAC Rules and Article 51 of Chinese Arbitration Law both envisage the arbitrator playing the role of a conciliator in a dispute. The Singapore International Mediation Centre – SIAC protocol envisages parties to an arbitration staying the arbitration in order to explore settlement via mediation.
There is no reason to expect this trend to decrease, and over the next quarter of a century it is possible that the region will develop its own arbitration culture in which mediation is interwoven with arbitration to meet the particular needs of parties in Asia/South East Asia. This development might be assisted by a rise in energy disputes: energy disputes are particularly well suited to mediation, in that there are a limited number of players in the sector and these parties will often have long term, ongoing commercial relationships with one another. The prospect of achieving an amicable reconciliation to a dispute and preserving those commercial relationships is therefore attractive. Gas price review arbitrations are particularly well suited to mediation, given that the arbitration is merely the end of a contractually-specified renegotiation process.
Conclusion
The global energy market is currently suffering from continued low oil prices, causing upheaval which affects oil, gas and energy generation. However, the Asia/South East Asia region is likely to feel this less intensely than some other parts of the world, and while the region is likely to witness its fair share of hardship-related disputes in the sector, the increasing demand for oil and gas and new energy projects is likely to fuel a concomitant rise in the number of energy disputes. Changes to the regional market for natural gas/LNG may give rise to more gas price reopener arbitrations, although these and commercial energy disputes might play a significant role in the development of regional arbitral systems which accommodate mediation in accordance with local cultural perceptions. Overall, the picture is perhaps a happier one than elsewhere in the world.
Richard Power is a partner at global law firm Clyde & Co.
Recommended for you
