Risks of importing Russian LNG during Ukraine war (Part I)

By Wang Jihong and Liang Danni, Zhong Lun Law Firm
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Amid the escalating conflict between Russia and Ukraine, the US, EU and other Western countries and regions have successively issued economic sanctions against Russia, exerting a resounding impact on the international natural gas trade.

Among these measures, the US president banned Russian oil, natural gas and other energy imports on 8 March 2022, calling on other World Trade Organisation members to also suspend trade co-operation with Russia.

Since Chinese enterprises also import liquefied natural gas (LNG) from Russia, sanctions will inevitably affect those with long-term LNG purchase and sales contracts. This article explores, in two parts, how Chinese enterprises can respond to the trigger of a price review mechanism, changes of upstream LNG supply sources, and compliance obligations concerning sanctions and export controls under the new situation.

TRIGGER OF PRICE REVIEW

Due to the outbreak of the Russia-Ukraine war, the German government suspended Russia’s proposed new Nord Stream 2 natural gas pipeline to Europe on 22 February, as the US president banned Russian energy imports and the US and other Western countries repeatedly issued sanctions against Russia’s natural gas projects.

Wang Jihong, Zhong Lun Law Firm
Wang Jihong
Partner
Zhong Lun Law Firm

Subsequently, natural gas prices in Europe and the US rose accordingly and may remain close to historic high levels in the coming months. In view of this, the price formula that Chinese enterprises originally locked into contracts, now favouring buyers, may trigger the seller to invoke the price review clause because it no longer matches the current market price.

This exposes enterprises to risks, such as a substantial increase in costs, weakened competitiveness of the downstream market, and increasing uncertainty of business planning.

In long-term LNG purchase and sale contracts, besides basic clauses on annual contract quantity and LNG specification, there are usually clauses that can greatly impact upon the contract value and risks, not the least of which is the price review mechanism.

With increasing global LNG trading volume, the upstream suppliers’ sales mode has changed, from “point-to-point” to “resource pool”, which continues to affect price expectations in long-term LNG contracts.

The traditional LNG trade period usually ranges from 10 to 25 years. This characteristic of long-term trade adds uncertainty to the price lock. To protect contract parties from risk that an agreed price upon signing may not reflect the future LNG market situation, parties often include price review clauses in the contract.

This stipulates that when contract price no longer matches market price, and contract performance reaches a certain period, parties should adjust the contract price through consultation and other means, lest either refuses to perform the contract.

COUNTERMEASURES

To counter this risk and determine standards and methods to be adopted when meeting requirements of price review and possible eventualities, Chinese enterprises are advised to review contract terms in advance, from aspects of trigger factors such as: periodicity and market changes; negotiation procedure and time; dispute resolution mechanism; and application of new contract price, such as whether retroactive to the contract term previously performed.

Danni Liang, Zhong Lun Law Firm
Liang Danni
Associate
Zhong Lun Law Firm

For contracts already executed, enterprises should confirm whether the contract stipulated applicable validity and conditions of the original contract price before price renegotiations with the seller. For example, if the buyer and seller can’t agree on the contract price after renegotiation, the original contract price will continue to apply.

Moreover, during consultation, the buyer and seller should negotiate in good faith, and consider market conditions and comparable contracts at the time of renegotiation. If the seller insists on modifying the original price formula, enterprises may propose to change a certain co-efficient of the price formula on the original basis to avoid any drastic change to the contract price and gain more initiative.

If the final consultation fails, enterprises may consider arbitration to settle the dispute which, of course, requires a wide scope of application of the arbitration clause under the contract, under which any dispute arising from or in connection with the contract may be settled through arbitration, thus making it a feasible choice.

For contracts still in startup or negotiation stage, to protect their interests as much as possible, enterprises should be precise and flexible when drafting and revising the price review clauses.

They should also pay close attention to arbitration clauses. In addition to standard provisions on arbitration rules, place and arbitrators, other specific requirements may be added to enhance the efficiency of arbitration.

For example, for disputes arising from price review, agreements may be made to adopt bifurcation for the tribunal to first review legal liability (namely, the trigger factor of the price review) and then the amount (actual adjustment of the contract price) to avoid unnecessary time and cost in submitting irrelevant evidence.

However, enterprises should note that prudent deliberation is required in drafting and modifying unusual arbitration clauses to avoid complicating the arbitration procedure and causing other disputes.

In general, considering risks faced by Chinese enterprises in importing LNG during the Russia-Ukraine war amid the current international political situation, it is suggested that professional consultants are engaged to study sanction policies and trading precedents so that more prudent business decisions can be made by combining both professional legal and financial advice – while fully considering potential changes to an unpredictable international situation and project requirements.

In part two of this article, to follow, the authors will continue to discuss how Chinese enterprises can respond to changes of upstream LNG source of supply, and compliance obligations concerning sanctions and export control.

Read more: Risks of importing Russian LNG during war in Ukraine (Part 2)

Wang Jihong is a partner and Liang Danni is an associate at Zhong Lun Law Firm

Zhong Lun Law Firm

22-31/F, South Tower of CP Center

20 Jin He East Avenue

Beijing 100020, China

Tel: +86 10 5957 2288

Fax: +86 10 6568 1022

E-mail:

wangjihong@zhonglun.com

liangdanni@zhonglun.com

www.zhonglun.com

Law.asia subscripton ad red 2022