Energy & Resources sector: Keeping the gears moving

Unpredictable demand, disrupted supply and macroeconomic fluctuations can lead to:

• counterparty default, where operating partners are falling into financial difficulties and failing to pay invoices or meet cash calls;
• failure in fulfilment of contractual obligations, with parties looking to obtain relief from contractual obligations and/or trigger force majeure clauses;
• termination of licences by host states, on the grounds of economic distress or default on licence agreements;
• price review disputes, where parties seek to force an adjustment to contracted pricing and tariffs; and
• decommissioning disputes, with some parties seeking to bring forward decommissioning dates or dates for posting of security under decommissioning agreements.
  
  

The quantification of losses
Coming to an amicable settlement is often preferable in terms of cost as well as the ongoing and future business relationship. However, despite best efforts, disputes are sometimes unavoidable.

Whether differences are resolved by negotiation or more formal procedures, claims (and defence of claims) need to be supported by the establishment of legal liability, causation and the quantification of losses.

Establishing causation and calculating any losses can be complex:

• How do you separate losses when they relate to more than one isolated issue i.e. to decouple the financial effect of each issue?
• How do you determine the timing between the loss and recovery, given that projections for the business may no longer be appropriate in a time of significant uncertainty?
• How much of the loss has been or may be mitigated i.e. what is the optimal commercially justified measure?
• What future price assumptions do you apply in the calculation, given commodity and resource price volatilities? What is the effect of any changes in state-imposed volumes, pricing or royalties?
• How do you account for pre-emption right clauses and what value is attributable to a licence in the event of a default under a partner or licencing agreement?
• In price review disputes, how do you resolve conflicting interpretations of the contractual formulae?
• In the event of a sudden and unexpected change in commodity prices, how do you determine whether decommissioning costs and dates need to be revised?

The challenges and complexities often lie in the assessment of the most appropriate assumptions to be applied in a loss quantification model.

The key to a good third-party contractual relationship is clarity in the contract. Like a gear in a machine, contracts determine the speed, direction and movement of the relationship. When the gears break and stop functioning as intended, many complex and inter-related questions need to be answered in order to repair the damage or, in this case, to quantify the loss.

When it becomes apparent that there is potential for a contract to buckle and falter, contracting parties are most often best served by pre-emptively addressing the potential areas of contention in order to minimise the impact and disruption. Taking pre-emptive action and seeking advice at the earliest stage possible from in-house teams, legal and/or commercial experts with a deep working knowledge of the industry will help parties plan for and navigate the challenges and set them on a path to obtaining the best possible results for their stakeholders. So maybe now is a good time to shift gear, look at your contracts in more detail, and put a plan in place to negotiate any required changes to them, helping to ensure your relationships continue to remain strong now and in the future.