This article was featured in our 2023 Energy Arbitration Report, which is part of a series of industry-focused arbitration reports edited by Jus Connect and Jus Mundi.
This issue explores the energy industry, encompassing information on electricity & renewables, based on data available on Jus Mundi and Jus Connect as of September 2023. Discover updated insights into energy arbitration and exclusive statistics & rankings, as well as in-depth global and regional perspectives on energy projects, disputes, & arbitration from leading lawyers, arbitrators, experts, arbitral institutions, and in-house counsel.
THE AUTHORS:
Charlotte Murphy, Managing Associate at Stephenson Harwood LLP
Daniel Boon, Associate at Stephenson Harwood LLP
The Ukraine – Russia conflict has renewed focus on the impact of economic and trade sanctions on the global energy industry, particularly the impact of sanctions on the entirety of the oil and gas supply chain. The Oxford Institute for Energy Studies aptly describes the long- reach of sanctions: “Looking forward the market focus should not only be on whether the oil sector will be directly targeted by sanctions, but also the crescendo effect of self-sanctioning along the oil supply chain all the way from marketing to financing to shipping.”
Noticeably, it is not uncommon for the sanctioned State to impose countersanctions. For example, Columbia University’s Center on Global Energy Policy pointed out that, following the USA, UK, and EU’s imposition of sanctions in 2022, Russia introduced countersanctions, including the sanctions on Gazprom’s former European subsidiaries and halting gas exports to Finland.
Unsurprisingly, a number of disputes and issues have arisen as a result of sanctions, particularly in relation to the Russian sanctions targeting the energy sector and their knock-on effects on global energy supply chains. For example, Shell announced in February 2022 that it intends to exit its equity partnerships held with Gazprom and related entities.
We summarise below some key issues that arise in relation to the imposition of sanctions in the energy sector, along with some practical suggestions on managing these issues in an attempt to resolve any disputes efficiently or avoid them arising in the first place.
Back to Back Contracts
Oil and gas contracts are commonly part of a longer chain of supply, e.g., the buyer purchases LNG from the producer (usually from a facility in which the seller has an interest). The buyer then has contracts to supply the purchased LNG to downstream customers, whether for private consumption or public use. In the event that one entity (save for the end user) in the chain is sanctioned, it is likely that the end user will face some disruptions and bring a claim against its supplier. Such claims could then be “passed up the chain” causing severe disruptions to all involved and, subject to the terms of the respective contract, leaving some parties out of pocket if their downstream damages cannot be fully recovered.
It is, therefore, helpful to have sufficient protection built into the contract to cover any loss arising from the downstream contract and, to the extent possible, ensure that the terms are “back-to-back”. This is particularly important with regard to arbitration clauses to ensure that any disputes in the chain can possibly be resolved in consolidated or concurrent arbitrations.
Force Majeure
A key area of dispute in relation to sanctions and their impact on the supply chain is whether a party affected by sanctions is permitted to rely on force majeure to suspend its obligations under the contract. This depends on the provision of the force majeure clause. However, it is common for the clause to provide that “acts, rules or regulations of a governmental authority” amount to an act of force majeure.
Often the force majeure clause requires the party relying on it to take further action. For instance, the clause may require the party affected by the force majeure event to take “reasonable endeavours” to overcome the event. The English Commercial Court in MUR Shipping BV v RTI Ltd [2022] EWHC 467 (Comm) clarified that this obligation only requires the party relying on the clause to take action envisaged by the contract. However, this was later overturned on appeal, and it was held that an event could be “overcome” if its adverse consequences were completely avoided and the underlying purpose of the parties’ contractual obligations was achieved, even if the contract was not performed strictly in accordance with its terms (here, by making payment in Euros instead of US dollars). However, this position may change further as permission to appeal to the Supreme Court has been granted.
This highlights the need to carefully consider the wording when drafting force majeure clauses and make clear if they are intended to include sanctions. Ensuring that any other requirements in the force majeure clause are properly satisfied should also be taken into account before seeking to rely on it.
Representations and Warranties
These are also useful tools to protect against the potential negative impact of sanctions. Strong and wide-reaching representations and warranties to prevent sanctions breaches will also assist in flushing out any potential issues in the negotiation phase. For example, if there is a concern regarding the identities of any other parties in the chain, or the ultimate destination/source of cargo.
Limitation of Liability
In a commercial dispute, two aspects of loss need to be considered. The first is the loss suffered by the counterparty if a sanctioned party fails to comply with its contractual obligations due to the impact of sanctions, and a replacement cargo needs to be sourced. In the example cited above, Finland claimed that there would be no disruptions to Finnish consumers despite Russia’s suspension of gas supplies. If Finland achieved this by purchasing gas from alternative suppliers through last-minute contracts, the costs of doing so may be significant. Ordinarily, subject to the usual principles of causation and mitigation being satisfied, Finland could seek to recover this cost from Russia. However, if the contract stipulates (as is common in LNG supply contracts) that amounts recoverable due to the failure to supply are capped at a percentage of the cargo value, established by reference to the contract price, it is not inconceivable that this amount is insufficient to make whole the loss suffered, especially if market prices are high due to the global circumstance. One option is for parties to be aware of the commercial realities of the agreed cap on the recoverable amounts when the contract is negotiated.
Second, as established above, if a party in the supply chain is unable to comply with its contractual provisions due to the impact of sanctions, it is likely that various claims will be brought in the supply chain. The key question is the extent to which any loss suffered by the innocent party due to claims by its customers, resulting from the sanctioned party’s failure to comply with its contractual obligations, can be passed on to the sanctioned party. Ultimately, this depends on whether the contract excludes the sanctioned party’s liability for such loss and warrants a close reading of the relevant contractual terms.
Sanction Checks on All the Parties In the Supply Chain
Prior to entering into the contract, a sanction check against the known parties and their significant shareholders should be taken to flag any potential issues so that appropriate protection can be included in the contract. Such a check can usually be done for a relatively low cost. As part of this due diligence, it is important to consider the potential jurisdictions involved and the origin and destination of the cargoes (and included in the representations and warranties discussed above).
Future Proofing
While the development of the global sanctions regime can be hard to predict and may change rapidly, it is useful for companies operating in the energy sector to carry out period horizon scanning to try to mitigate the effects of future potential sanctions. It is not uncommon for sanctions regimes to target the energy sector (including oil & gas and renewable energy) due its global importance, and it is therefore sensible for advance contractual and operational preparations to be taken where possible. For example, a “sanctions playbook” can be put in place for important transactions, which could include a protocol for operational strategies (such as identifying alternative supply sources) and communication procedures in the event that new sanctions are imposed.
This is particularly relevant for companies that are focused on the renewable energy push, as the raw materials and technology required for the energy transition are often sourced from higher-risk jurisdictions. In particular, if the tensions between the USA and China continue to escalate, it would not be inconceivable that the countries impose sanctions prohibiting the importation of materials (as they did in 2021 when the USA banned the importation of polysilicon from China due to human rights concerns) or the exportation of technologies (as China proposed to do in February 2023 when it considered introducing export sanctions on a large number of technologies related to the renewable energy transition, including those which are crucial for the manufacture of photo voltaic cells for solar panels). In general, it is advisable to build flexibility into contracts at an early stage, to try to provide protection against future events.
ABOUT THE AUTHORS
Charlotte Murphy is a Managing Associate at Stephenson Harwood LLP in London. She works in the International Arbitration team and specialises in disputes involving energy and international trade.
Daniel Boon is an associate at Stephenson Harwood LLP in London. He specialises in international commercial arbitration, and his practice often involves multi-sectoral disputes in Asia, the Middle East, and Africa, including sanctions-related disputes, with a particular interest in investor-state dispute resolution.
Find more data-backed insights in our 2023 Energy Arbitration Report
