With West Texas Intermediate (“WTI”) temporarily falling through the negative price floor on Monday, and spot LNG prices in Asia hitting all time lows, issues arising out of storage capacity and counterparty solvency are high on the agenda of most oil and LNG trading entities. In fact, this week Hin Leong Trading seems to have collapsed.
In this article we consider some of the key ‘take away’ messages in dealing with the issues involved.
The potential topping out of storage capacity is causing problems with various sale and purchase agreements. According to the Financial Times, the slide in WTI May forward prices “was exacerbated by traders seeking to offload any obligations to take on physical product ahead of the contract’s expiry today as storage reached capacity at its delivery point in Cushing, Oklahoma”. In other words, the lack of storage made the delivery of WTI crude May a liability rather than an asset.
Although the domestic nature of the WTI market makes it a potentially poor comparator for international Brent crude, refined oil products (including bunkers) and LNG, all of these markets are suffering from issues relating to availability of storage. As such, buyers are considering their options to avoid, or delay, delivery. Hence, the current focus on force majeure clauses.
Although the expression ‘force majeure’ has no clear meaning in English law, it is used to describe a type of clause that excuses or suspends performance of contractual obligations on the occurrence of a specified event. The wording of these clauses is therefore critical.
Although unavailability of storage capacity in the current market, may seem an obvious event that falls within most force majeure clauses, in English contracts, the position is far from straightforward. By way of example only:
- Causation and oil/LNG prices: Most force majeure clauses require some causal link between the event (pandemic) and the hinderance in ability to perform. It may not be entirely clear whether the topping out of tanks is caused by a drop in demand due to COVID-19 or the crash in oil prices, (which it might be argued is partially (but not wholly) caused by increased oil supply due to the Russia/Saudi Arabia supply dispute). If there are parallel causes, the clause might require that they are both capable of being force majeure for the clause to be operative (see page 64, CMS Annual Review in developments in English oil and gas law (2018)).
- Exclusions from FM: Some force majeure clauses in the oil and gas sector are drafted with wide exclusions to market events. For example, the AIPN Master LNG Sale and Purchase Agreement (2012) expressly states that force majeure does not include: “any change in the market or demand for LNG or Natural Gas or events primarily affecting individual downstream customer facilities”. This is said to apply “Notwithstanding” the non-exhaustive list of force majeure events. There is doubtless room for argument over whether a change in demand caused by one of the events listed is excluded.
- Performance: Most force majeure clauses will require an impact on a performance obligation – for example performance is “prevented”, “delayed”. “hindered”, “reduced”, “interfered with” and/or “curtailed” (see, for example, BP Oil International Limited general terms & conditions for sales and purchases of crude oil and petroleum products 2015 edition). In the context of a ‘plain vanilla’ sale and purchase agreement (where there is no prescribed buyer use), it may be that the buyer’s ability (in the strict sense) to perform its purchase is in no way impacted, notwithstanding it can no longer use the hydrocarbons for the purpose that it subjectively intended. Much may depend on the actual delivery terms of the sale and purchase agreement.
- Take-or-pay: Absent contractual wording to the contrary, it is a general principle of English law that a force majeure clause will usually be interpreted as being inapplicable where alternative methods of performance still exist. If the buyer has the option to “pay” rather than “take”, it may raise interesting questions as to whether the buyer may give alternative performance by simply paying the “take-or-pay” sum, and not taking deliver, such there can be no force majeure. That said, express terms of the LNG sale and purchase agreement may provide otherwise. Again, much may turn upon specific drafting.
- Choice between counterparties: If the buyer or seller that has problems with performance has multiple sale and purchase agreements, and is able to perform some (but not all) of them, the issue may arise of whether the force majeure clause is capable of being triggered as – that party – if it chooses – may perform the contract in question.
- Reasonable and Prudent Operator/mitigation: A party seeking to claim force majeure may be under an obligation to act as an RPO, or take steps to mitigate the impact of the force majeure. Depending upon the wording of the agreement, this may (or may not) require it to deal with its existing inventory to manage the minimise the impact on the contract in question.
For further details of force majeure clauses see:
- Force majeure clauses in oil and gas contracts are given further consideration here.
- Force majeure clauses in construction and EPC contracts are given further consideration here.
In an oil or LNG price downturn the solvency of a counterparty becomes key. The last oil downturn saw the demise of OW Bunker, and ensuing years of litigation concerning ownership of bunkers sold to OW Bunker and rights under the Sale of Goods Act 1979 (“SGA”). This week Hin Leong Trading seems to have collapsed and has reportedly told the banks “oil pledged as collateral for loans had been sold to raise cash”, leaving a combined exposure of approximately US$3.3 billion.
The lessons learnt from previous experience in an oil downturn are various, but seem to include:
- Sales of bunkers are not sales of goods for the SGA, in English law, such as sellers are not entitled to rely on section 49 of the SGA to withhold payment in the event that valid title was not passed (see page 44, CMS Annual Review on developments in English oil and gas law (2016) here.
- Section 52 of the SGA provides for specific performance where the goods fall within the definition of “specific” or “ascertained”. However, in many arrangements for the sale of hydrocarbons the goods will be neither “specific” (“…goods identified and agreed on at the time a contract of sale is made and includes an undivided share, specified as a fraction or percentage, of goods identified and agreed on as aforesaid”) or “ascertained” (“probably means identified in accordance with the agreement after the time a contract of sale is made” - Re Wait  1 Ch. 606 at 630). This might result in a seller, in financial difficulty, double selling hydrocarbons and leaving the buyer with only a claim in damages (see Oil & Gas: Hydrocarbon sales - risk of loss of pre-payment and without delivery of goods)
- Ensure that transactions where physical possession, or title, pass prior to payment (or vice versa), are subject to appropriate risk assessment and, where possible, security – such as a letter of credit.
Additional guidance on protecting your position in a falling market may be found at: Oil & Gas: Protecting your position in a falling market.