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Oil & Gas

Changing the gas long term contracts after a decade of price reviews?

Posted by on 16 March 2017
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Written by Marco Lorefice, Senior Lawyer, Oil & Gas & International Arbitration at Edison. Marco will be speaking at the upcoming Flame conference this May in Amsterdam, on the session "Changing the contracts after a decade of gas price reviews?".

A new era for the gas long term sales and purchase contracts have begun. The system created in the 60’s to trade gas on long term basis with the take or pay contracts is changing. The driving force of such change is constituted by the switch from oil linked contracts sales price to hub prices. Inevitably, as a consequence, the existing format of gas long term sales and purchase contracts is under a deep reconsideration by the industry towards a process to dismantle such contracts.

Are the “old” contracts outdated? This seems to be the most fascinating question arising out of a decade of gas price reviews in continental Europe which put under an enormous pressure on the oil linked price formulas. This period of time has seen not less than three waves of price reviews, many of those been resolved by arbitrations. If in the first waive (2010-2012) it has not been an impossible exercise for the buyers to demonstrate that the then occurring decoupling between oil and market prices and the consequent incapability of the buyers to sell the gas economically, already with the second wave (2012-2015) the parties have begun to consider the resolution of the difficulties originating with the decoupling otherwise. With the final waive of price reviews begun in 2015, it has become obvious that the most efficient way to restore the equilibrium of the contract without requiring periodically the intervention of the tribunals, was that of eliminating the oil linked formulas and to replace them with a system incorporating an automatic adaptation of the contract sales price to the market prices.

The reasons which is justifying the overcome of the oil linked formulas by the hub prices is the liberalization and the increased liquidity of the markets which created several trading hubs in continental Europe. There is no need of referring to the gas to gas competition any more.

However, this is not new for the United States and the United Kingdom, where this system has been in place since long time.

The long term contracts of new generation resemble more and more to the short and spot contracts in terms of contract sales price and flexibility.

Indeed, these “new” long term contracts see a new structure to reflect a change in the risk allocation, whereby the contract sales price are fully indexed to hub prices and along with such changes the flexibility granted in the “old” system tends to disappear with volume clauses referring to 100% of the agreed quantity of gas to be taken and the make-up rights not any longer available to the buyers. The price review clauses becoming meaningless, and with that the relevance of the “market of the buyer” and “economically market the gas” principles.

One could wonder if the next contractual term of the contracts to be affected by the changes contemplated with the switch from oil linked to hub prices formula will be that related to the duration, and with that the need for the industry of such contracts themselves. It is correct to assume that for the construction of the new pipeline the long term contracts may be necessary to assure the return on the investments but, may be, this will be the last change in the industry.

The end result produced by this new trend would be the change in the nature of the gas sales and purchase contracts from a take or pay to a take and pay basis with all consequences arising therefrom.

Learn more about Flame here.

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