Articles


Price & COVID-19 Impact on the Oil and Gas industry

By

Kiran Ram (Associate, Oil & Gas Department)


Hakem Arabi & Associates

Volatility has always been a challenging element of the oil and gas industry, but it has rarely been more extreme than it is today. COVID 19-led combined with its dramatic impact on financial markets, have led to rapid price swings. As at April 15, 2020, Brent crude eased at 0.76 per cent to US$31.50 per barrel (US$1=RM4.32) which is about a stunning 50% drop year-to-date. At the same time, Saudi Arabia had discounted its selling price and promised to pump more oil, leading to historic price drops.

Thirteen-nation Organisation of the Petroleum Exporting Countries (OPEC), Russia and other allies met on April 12, 2020 to cl inch a deal to reduce production by 10 million barrels per day, the biggest oil cut ever, to float oil prices. Initial efforts to cut oil production was blocked by Mexico, after the country cast doubts on OPEC’s plan and refused to sign up for its share of cuts.

Prolonged depressed oil prices and revenue environment, as well as declined production would likely to continue to present major challenges for oil and gas companies that will result in the inability of the companies to fulfil contractual obligations. Thus, causing a surge in invoking ‘force majeure’ provision where the operation and efficacy of force majeure provision in oil and gas contracts will be tested.



COVID-19 & Force Majeure on Oil and Gas industry standard contracts



The consequences of the COVID-19 outbreak for the oil and gas industry have been far wide reaching. This has increasingly become a concern for oil and gas companies that it will result in an inability to fulfil their contractual obligations, causing a surge in invoking ‘force majeure’ provision in contracts.

As force majeure is a contractual concept under the English law (though under certain civil regimes), each case must be regarded on its own individual merits. In practice, force majeure clauses may have a variety of forms, but the predominant tenets is that an unparalleled event has occurred which prevents a party from performing its contractual obligations. However, it may be more of an issue where performance is also influenced by the recent crash in the oil price.

In addition, the party relying on force majeure would usually take steps to mitigate the effects of force majeure event – the spread of COVID-19 or the government announcement on movement control order/movement restriction order.

Force majeure is distinguished from the English common law doctrine of frustration, which requires a more rigorous standard of proof to be met, with the requirement that it has become impossible to perform the contract rather than merely more difficult.

There is no hard and fast rule in the drafting and constructions of force majeure clauses, leaving the same to be negotiated between the parties.

However, an effective force majeure clause generally consists of two (2) main components, namely the description of what constitutes a “force majeure event” and the consequences of the occurrence of a force majeure event.

A well drafted force majeure clause may even contain a provision as to the procedures to be complied with by the party relying on such force majeure clause upon the occurrence of a force majeure event.

Most contracts in the oil and gas industry set out an exhaustive list of force majeure events, which includes not limited to “epidemic and quarantine restrictions” and “an action or directive issued by the specific Government of that contracting party”.

Notwithstanding that such events are specified as constituting force majeure; careful consideration should be given to the nature and effect of such events.


The overarching principles of Force Majeure to an Oil & Gas contract



  • an unprecedented event has occurred.
  • the unprecedented event prevents a party from actually performing its contractual obligations (rather than it is more expensive to do); and
  • the unprecedented event is typically the sole cause of the party’s inability to perform.

Parties relying on the force majeure clause would usually have to take steps to mitigate the effects of a force majeure event – spread of COVID-19, or government announcements regarding the risks as these do not in themselves constitute force majeure.


Considerations when relying on a Force Majeure clause in an Oil & Gas contract



There are four (4) considerations when attempting to rely upon a force majeure clause in an oil & gas contract: -


  1. Are there specific references to “epidemic”. “pandemic”, “Act(s) of God” or “acts of government” in the definition of force majeure event?
  2. What are the conditions that must be met in order to invoke the clause?
  3. What would the contractual consequences be if the clause were to be invoked? This could include termination of the contract, suspension of a particular contractual obligation, extensions of time or allocation of losses; and
  4. Is there any interaction with mandatory local law? It is vital to ensure that enforcing any force majeure provisions would not contravene any legislation in the jurisdiction in which the contract is based.

Some examples of Force majeure and COVID-19 in several oil and gas industry standard contracts



Agreement
AIPN JOA (Article 16)
AIPN UUOA (Article 18)

Summary of FM provision
The definition of force majeure in the Association of International Petroleum Negotiators (AIPN) Joint Operating Agreement (JOA) and Unitization & Unit Operating Agreement (UUOA) generally mirrors the associated upstream petroleum contract. The affected party should consider force majeure in line with such agreement.

Application to COVID-19 and analysis
One of the specific events listed in the optional provision of the Association of International Petroleum Negotiators (AIPN) model contract is "lockouts, and other industrial disturbances even if they were not beyond the reasonable control of the Party.” It is arguable on the commonly received meaning of the term that a lockout can only apply in the context of a labour dispute, though an industrial disturbance would likely be of wider application and may be more useful.


Agreement
South Eastern Africa upstream licence

Summary of FM provision
Any failure to comply, or delay in complying, with any non-payment obligation (in whole or partially) set out in the [licence] by either Party will be justified and to the extent that such failure/delay has been caused by force majeure.

Force majeure means any cause or event beyond the reasonable control of the affected Party, which is the cause of the default or delay in compliance. Force majeure events include epidemics, blockages, public order disturbance, labour disturbance, quarantines and government illegal acts.

Application to COVID-19 and analysis
One of the specific events listed in the [licence] force majeure clauses is an "epidemic.” COVID-19 has been classified by the World Health Organisation as a pandemic, a further level of materiality, though depending on the circumstances it may be that its local effects (and, most importantly, its effect on the claiming Party) are less severe. Other events that may be applicable are "quarantines" or "public order disturbance" i.e. the Concessionaire is unable to carry out minimum work obligations due to the lack of manpower caused by a quarantine order issued by the host government.


Agreement
Northern Africa upstream licence

Summary of FM provision
Any event delaying or preventing the performance by a Party of its non-financial obligations under the Production Sharing Agreement (PSA) is considered as force majeure provided that the occurrence of such event or circumstances is irresistible, unforeseeable; and independent of the will of the party invoking force majeure.

In exceptional circumstances an extraordinary or supernatural event, foreseeable but irresistible and independent of the will of the invoking Party, may also constitute force majeure.

Application to COVID-19 and analysis
Whilst the Production Sharing Agreement (PSA) does not contain a list of specified force majeure events, it is drafted very broadly and states that any event causing the delay/preventing the performance of the affected party can be considered as force majeure, provided that such event is irresistible, unforeseeable and independent of the will of the party invoking force majeure.


Agreement
Energy Charter Treaty

Summary of FM provision
Force majeure means "irresistible compulsion or coercion, unforeseeable course of events, fulfilment of contract.”

Application to COVID-19 and analysis
In the absence of the express inclusion of relevant events such as "epidemics,” "acts of government" or "quarantines" as force majeure events, it is challenging to establish that the non-fulfilment of contractual obligations is impossible. It may be worth reviewing other applicable provisions in the Energy Charter Treaty (ECT), such as the stabilisation clause or hardship clause (if applicable). For instance, where a hardship clause is provided, the affected party may be entitled to call for renegotiation of the contract, if the continued performance of the affected party's obligation has become excessively onerous due to the outbreak of COVID-19.

What’s Next?


It is Important to clarify whether force majeure is applicable to the contract. Some contracts may require for certain procedures to be followed upon the triggering of force majeure event which may differ from one contract to another.

Typically, the party relying on such clause would be required to serve a notice notifying the other party of the occurrence of such event.

Parties to the contract shall in good faith perform and fulfil all requirements as set out in the contract to successfully rely on the force majeure.

However, it must be remembered that failure to fulfil pre-requisites and procedures set out in the contract for the purpose of reliance to a force majeure clause may deny a party from successfully invoking such clause.


Be cautioned – “there is no one size fits all”



  • Consider an appropriate legal strategy early - might be better contractual ways to deal with the current disruption to operations.
  • If a new contract is negotiated, or when conducting due diligence, carefully review any proposed force majeure clause and other contractual terms to consider if risks in respect of COVID-19 are appropriately addressed.