As the coronavirus spreads, the LNG market faces some dizzying uncertainties.

The broad strokes are clear: sagging demand mixed with low prices and potential storage issues. But the market faces a myriad of smaller, more ambiguous issues too. Namely, the potential for LNG counterparties to invoke force majeure, citing the pandemic as an event that prevents them from performing their contractual obligations.

Some international counterparties have already claimed force majeure. For example, LNG importers in India declared force majeure late last month, leaving at least five fully-laden LNG tankers idling offshore, according to a report by Reuters citing unnamed sources. However, the extent to which such claims pose a legitimate obstacle to LNG suppliers is not altogether clear. To start, companies must consider the core principle of force majeure, Brian Bradshaw, partner at Sidley Austin LLP, told Hart Energy.

Brian Bradshaw
“Most people trying to solve operational problems don’t approach the issue in terms of contract amendments or legal implications,” said Brian Bradshaw, partner at Sidley Austin LLP.

“Force majeure has at its heart a couple of different defining principles, but the first is a physical impossibility,” Bradshaw said.

To delimit that concept, many contracts list events, including floods, earthquakes, tsunamis or other natural hazards. If a listed event occurs, “it’s easy for the parties, in the context of the dispute, to say ‘we allocated that risk [for this specific event],’” he said, and relief from obligation is granted more readily.

Layers of removal

The coronavirus differs in critical ways from physical events such as earthquakes. The latter can destroy a regasification facility. Meanwhile, the COVID-19 pandemic may involve a government-mandated port closure—a clearer case, in this context—or vaguer instances, such as a recommendation, maybe not a federal order, that workers stay home, preventing cargo offload. These situations include a layer of removal from physical impossibility that complicates force majeure disputes.

“As you get further insulated or removed from the core of a physical problem, [invoking force majeure] becomes more and more challenging,” Bradshaw said.

Pandemics or epidemics have not been standard inclusions in force majeure clauses; some contracts list them, while others have a “catch-all at the bottom of the list that says [in practice] ‘all these listed events, plus any other event,” Bradshaw said. “And courts have interpreted contracts to say, ‘Any other events’ means anything else in the listed categories above.” You might categorize a tidal wave with a tsunami, for instance, but classifying a financial crisis with the two isn’t generally acceptable.

Going forward, pandemics will likely enter the usual force majeure lexicon, along with other events “that don’t rise to the level of a pandemic, but lead to stay at home orders or diminished workforces as a result of sickness,” Bradshaw said.

Greg Hill, partner at Hogan Lovells LLP, agreed, adding that “instead of just adding epidemics to a laundry list of major events … clauses might say specifically what happens [to LNG volumes] during a period of government [public health] shutdown.”

Regardless, given “the significant amount of devils in the details,” Bradshaw said that counterparties must engage in “a very, very detailed fact-dependent analysis to figure out if the facts [of a force majeure claim] apply to the general principles [of physical impossibility or government intervention].”

No ‘price majeure,’ but storage?

Parsing the facts of any claim demands a clear distinction between relevant and nonrelevant facts. Historically, the LNG market has seen disputes over whether long-term market shifts constitute force majeure events, Bradshaw said. 

Still, parties seeking excuse from performance must prove a connection between financial facts to physical impossibility, which is tricky to establish in court. In Bradshaw’s experience, “Parties often say, ‘Listen, there’s no such thing as price majeure.’ In other words, the fact that it’s uneconomic does not impact your ability to [physically] take a cargo.”

The situation grows more complex when market conditions, e.g., low demand, blend into physical constraints, e.g., buyers’ storage capacity.

“It almost comes full circle when [a regasification facility] says, ‘The facility has no ability anymore to receive additional LNG because the tanks are full. There is physically no place to put it’” due to reduced downstream purchase orders, Bradshaw said.

Force majeure and new LNG models

“Often parties work something out, an alternative arrangement within the contract,” such as a temporary volume suspension with later restoration, often at the end of a contract, Hill told Hart Energy.

Greg Hill
“The bigger concern [for LNG as a result of the coronavirus] is the potential recession. Maybe not this year, but next,” said Greg Hill, partner at Hogan Lovells LLP.

However, as the LNG market has evolved, long-term (10-plus years) dedications, the sort with built-in restoration, have begun to expire and be replaced with a “merchant model” of supply contracts (often three to five years) that are less likely to include the same provision, Bradshaw said.

On a 20-year contract, for example, it makes more sense to add a year to the end. In contrast, “as a percentage basis, (adding a year onto a three-year contract) is the equivalent of giving you almost seven years of extension,” he explained.

Instead, the newer contracts emphasize the ability for parties to sell cargo on the market, making the destination terms more flexible and less liable to claims of nonperformance due to buyers’ regional market conditions. 

Add to the mix that many of these contracts operate under free onboard shipping agreements, where the buyer is liable once the LNG is loaded onto a ship, “the ability to claim force majeure in that context is really unlikely,” Bradshaw added.

Storage issues in a rapidly changing environment raise difficult questions. For example, if one country reopens its ports when another bars entry, the former hasn’t suddenly gained more capacity. But the validity of any claim is far from given.

“The bigger concern [for LNG as a result of the coronavirus] is the potential recession,” Hill said. “Maybe not this year, but next.”

Operators: Write it all down

To adapt to current challenges, LNG suppliers are focused on their key operations: where is their cargo going and how will they get it there? But Bradshaw reminds his clients, despite the frenzy of activity right now, they need to make sure their lawyers are involved.

“The advice is: Always get concrete agreement of what [you’re] doing,” he said. Suppliers should note how they have amended a schedule (e.g., when a delayed vessel will arrive by and, critically, who is liable if the cargo is not accepted upon arrival). 

“Most people trying to solve operational problems don’t approach the issue in terms of contract amendments or legal implications,” he said. “So, I very strongly encourage people to write down exactly the new deal that they’re agreeing to.”

“Because again, one cargo can be $25 million, but it doesn’t take long [before an LNG supplier says, after a few cargos] ‘We have a $100 million problem now,’” he continued. “You want to make sure you get that right.”