Investments in Energy: The Case for Oil and Gas [In a Nutshell]

Joining William Powell and Joseph Murphy of Natural Gas World, Lewis McDonald discusses what the future now looks like in terms of investments in energy, namely oil and gas. Given the burgeoning global population, rising standards of living and climate goals, there has been a serious increase in awareness and concern in global climate change around the world.

The environmental, social and governance (ESG) agenda is now at the top of many companies’ priorities though currently appearing to mainly affect companies in Europe and less so in Asia. Prior to the outbreak of the Covid-19 pandemic, ESG was the major issue being discussed in board rooms. With about 1200 financial institutions, together controlling around $14 trillion, divesting or wanting to divest from fossil fuels, primarily based on consumer demand and consumer sentiment and where the laws and regulation are heading, we have seen rather a chilling effect on investment in the oil and gas sector – and the big question is … where does it all go from here…

 

Lewis McDonald
Lewis McDonald
Partner, Global Head of Energy, London
+44 20 7466 2257

 

 

Future Cities Series: Emissions down in lock-down ⁠– how can we lock-in the climate gains?

We are well into the pandemic and lockdown in many regions, so it is natural to ask the question, “when will this end and when will we return to normal”… The problem is, “normal” was not sustainable, in so many ways. Those of us in the energy industry particularly know that to be true.

This article is part of our Future Cities series where our sector experts examine the most pressing issues facing our cities in the post-Covid era and provide their views and advice on how to prepare for, and adapt to, the long-term legacy of the crisis.

 

The “business as usual” scenario put out by the International Energy Agency in its 2019 World Energy Outlook does not make for happy reading. It had us on a crash course towards over three degrees of temperature increase due to carbon dioxide emissions from fossil fuel consumption. The IEA also has a “sustainable development scenario” which keeps us within the Paris limits of 1.5 degrees. The only problem is that, according to the OECD, we would need to spend €6.3 trillion per year globally in each of the next 10 years for us to get there. To give you a feeling for how much money that is, the total size of the global economy is estimated at around $86 trillion. And so the challenge seems virtually impossible.

But here’s the point. The estimates from the IEA and OECD were based on projected rates of energy demand, which were based on projected behaviours of the world’s population (commuting, urban development, consuming etc). Those projections were made a few months before Covid-19 hit, and saw us increasing our energy demand by 25% between 2019 and 2040.

As my daughters would say, “Dad, those predictions are, like, so ten weeks ago”.

Since Covid-19 forced the “Great lock-down”, our behaviours have changed. For example, we’re now “zooming” to work and business meetings instead of travelling there physically. Online shopping, telemedicine, home delivered food are up… the list goes on. As a result of the accumulated changes in our behaviour, energy demand has plummeted (oil demand sank as low as a 30% reduction globally and daily power demand has been down by at least 15% in France, India, Italy, Spain, the United Kingdom and the US northwest), and taken our emissions down with them. On top of that, the share of renewables in the overall energy mix has risen.

The latest prediction is that global CO2 emissions will drop by 8% this year. In the UK alone, the change in electricity demand patterns has led to an average of 60% of our power now being carbon free (39% renewables and 21% nuclear), and the CO2 intensity of the UK power system has halved to around 100gCO2/kWh. Pollution levels have dropped by around 50% in London, leading to dramatically improved air quality. Similarly, cities from Delhi to Bangkok to Beijing have all seen an unprecedented decline in pollution levels.

Don’t get me wrong, there are many challenges that arise from the changes we are experiencing, and many stakeholders in the energy value chain are suffering. We can’t stay locked down forever, and no one would advocate for that.

But let’s be honest, there are many positive aspects of this lock-down. Many of us have been able to redirect the time spent commuting and travelling from one meeting into another into greater productivity, more personal time, more time with family, a greater community spirit etc. If this trend continues post-lockdown, this will undoubtedly lead to more custom for local businesses, leading to a decentralisation of wealth and more vibrancy in regional cities. The continued presence of Covid-19 in the years ahead may also cause many to re-think their desire to live in mega cities (which have been hit especially hard by the pandemic) and lead to a renaissance of the suburbs. This will have an impact on energy demand distribution, travelling profiles and a new way of looking at energy supply and demand across the country. It will certainly have an impact on the design of cities and other urban centres.

So, instead of spending all of those trillions each year on decarbonising our ever-expanding energy system, perhaps we’d be better-off redirecting some of this money towards the infrastructure and technologies which support the continuation of the behaviours which lower energy demand (from superfast fibre optic broadband, VR meeting technology, dedicated bicycle lanes, drone deliveries etc. etc. to innovations that have not even been considered yet). Given all of the potential benefits that we have witnessed during this pandemic, this now seems like an inevitable direction of travel and one which may help to redress some of the existing imbalance in our society.

Key Contacts

If you have any questions, or would like to know how this might affect your business, phone, or email these key contacts.

Lewis McDonald
Lewis McDonald
Partner, Global Head of Energy
+44 207 466 2257

 

A revised MER UK Strategy: Implications for UK Oil & Gas Participants

Last month, the Oil and Gas Authority (the “OGA”) released a consultation paper (the “OGA Consultation”) setting out its proposals to revise the Maximising Economic Recovery Strategy for the UK (the “MER UK Strategy”).[1]  The OGA’s proposed revisions are potentially far-reaching and are aimed at positioning the UK’s oil and gas industry as a solution, rather than an impediment, to achieving the Government’s carbon neutrality targets.

In this briefing we review five key changes proposed in the OGA’s consultation document, and consider their impact on participants in the oil and gas industry.

Introduction

The MER UK Strategy will be familiar to all participants in the industry.  Since March 2016, the MER UK Strategy has had as its core obligation a requirement to “take the steps necessary to secure that the maximum value of economically recoverable petroleum is recovered from the strata beneath relevant UK waters”.

The OGA Consultation, released on 6 May 2020, has been issued in the wake of the UK government’s introduction of legislation in June 2019 to achieve carbon neutrality by 2050 (the “Net Zero Target”). The wide-ranging changes proposed in the OGA Consultation – considered in detail below – reflect this, with new obligations put forward including the proposed introduction of new low carbon obligations requiring industry participants to reduce flaring and emissions, explore and implement carbon reduction measures such as platform electrification and imposing new good faith obligations in respect of carbon capture and storage (“CCS”), amongst others.

Change to the Central Obligation

The OGA MER’s Central Obligation is to “secure that the maximum value of economically recoverable petroleum is recovered from the strata beneath relevant UK waters“. This core principal objective of “maximising the economic recovery of UK petroleum” is enshrined in Section 9A(1) of the Petroleum Act 1998.

The OGA Consultation envisages adding a second branch to this Central Obligation, by requiring participants to “take appropriate steps to assist the Secretary of State in meeting the net zero target, including by reducing as far as reasonable in the circumstances greenhouse gas emissions from sources such as flaring and venting and power generation, and supporting carbon capture and storage projects”.

Relevant persons, in this Consultation, are understood to be those persons listed in section 9A(1)(b) of the Petroleum Act 1998 – namely holders of and operators under petroleum licences, owners of upstream petroleum infrastructure, persons planning and carrying out the commissioning of upstream petroleum infrastructure and owners of relevant offshore installations.

The effect of this proposed change is to directly integrate the government’s Net Zero Target into the Central Obligation. Indeed, changes to the introduction of the MER UK Strategy and its supporting obligations indicate the clear intention of the OGA to support and empower industry participants to identify and take steps to reduce their greenhouse gas emissions (“GGEs”) and, in maximising economic recovery, to consider their social licence to operate and develop and maintain good environmental, social and governance practices in their plans and daily operations.

New Carbon Capture and Storage Obligations

At the crux of the MER UK Strategy was the requirement that relevant persons plan, commission and construct infrastructure in a way that enables the maximisation of the value of economically recoverable petroleum from the area where the infrastructure is located. The OGA Consultation proposes the introduction of a new requirement that relevant persons also take into account whether, and how, the relevant infrastructure can also be used to (i) help meet the Net Zero Target, including by reducing GGEs, and (ii) provide for or support the development and use of facilities for any CCS projects.

The OGA Consultation also proposes the introduction of an obligation requiring relevant persons to have regard to CCS projects when complying with the strategy, including whether there are possibilities for collaboration with persons planning or carrying out CCS project, negotiating access to infrastructure for CCS projects “in timely fashion and in good faith”, and permitting access to the relevant infrastructure to be used for CCS project “on fair, reasonable and non-discriminatory terms”. As further set out below, the lack of clarity as to the scope of this new obligation, and how it will be applied in practice, inevitably carries with it a risk of disputes. However, for companies with offshore CCS credentials, this new obligation will help ensure greater access to infrastructure for them. Should the OGA’s proposed amendments be implemented, we expect to see a flow of investment towards these companies to follow suit.

Introduction of New Governance Obligations

The OGA Consultation also envisages the introduction of new governance obligations requiring licensees to “apply good and proper governance at all time”, including complying with principles and practices which the OGA may direct. No clear governance standards are referred to in this document, so it is unclear at this stage against which principles compliance will be benchmarked. The OGA Consultation has however already indicated its intention to “bring a company’s track record and appetite for actively pursuing energy transition matters into discussions under the licence”. It is unclear at this stage whether this new requirement would apply to existing licences or would be limited to licences to be granted.

Third Party Access and Collaboration Obligations

The OGA Consultation envisages the replacement of the previous collaboration obligation which required participants in the market, amongst other things, to consider whether collaboration or cooperation with other persons could reduce the costs or increase the recovery of economically recoverable petroleum amongst other things. The new obligation proposed would instead require the collaboration and cooperation of participants not just with other relevant persons but also with other participants throughout the supply chain – including persons seeking to acquire an interest or invest in offshore licences or infrastructure in the region, and persons providing goods or services relating to relevant activities in order to support the delivery of such activities on time and on budget. This new obligation would bring with it a change in the way procurement happens in the UK oil and gas exploration market – operators will be looking not only to the actions they can take to help achieve the Net Zero Target, but also what measures suppliers down the chain have in place to also meet this target.

Similarly, where relevant persons are not able or decide not to ensure the recovery of the maximum value of economically recoverable petroleum from their licenses or infrastructure, the OGA Consultation proposes that they be subject to a new obligation to “provide access to all relevant data and other information, including to allow bona fide persons to establish technical and financial competence”.

Other obligations

Other obligations are proposed in the OGA Consultation, including the introduction of:

  1. New asset stewardship obligations on owners and operators to “reduce as part as reasonable in the circumstances greenhouse gas emissions resulting from sources such as flaring and venting and power generation”, and to achieve optimum potential for the re-use or re-purpose of infrastructure. The obligations also refer to owners and operators undertaking “relevant and measurable metering and measurement activities” to ensure these are met;
  2. A new decommissioning requirement that, prior to the planning of or partial decommissioning of any infrastructure, relevant persons ensure and be able to demonstrate that options for that infrastructure’s continued use, including the re-use of re-purposing for CCS projects, has been suitably explored. Such a change would now require participants to integrate these considerations into their decommissioning plans; and
  3. New requirements regarding the reductions of GGEs. While the focus of the new strategy is on CCS projects as a means of reducing GGEs, the OGA Consultation also envisages the introduction of new obligations concerning the adoption and deployment of emerging and existing technologies for the reduction of GGEs resulting from flaring, venting and power generation, and to enable projects relating to hydrogen supply to be planned for and developed. This is unsurprising, with the replacement of conventional hydrogen in industrial applications with low-carbon hydrogen, and the increasing demand for clean or zero-carbon hydrogen as a source of energy.

These additional obligations complement the overarching shift of the MER UK Strategy to reducing GGEs.

Commentary

The changes to the MER UK Strategy reflect the current mood in the oil and gas industry, including the perception that it needs to address the questions it is facing about its ‘social licence to operate’, and to remain attractive as a source of investment in the longer term. The OGA Consultation envisions addressing these concerns by positioning the UK oil and gas industry as the solution to achieving Net Zero, rather than the impediment it is more commonly perceived to be.

The changes also reflect the UK Government’s focus on implementing far-reaching changes to meet its Net Zero Target, as also demonstrated by the recent proposals for the implementation of UK Emissions Trading Systems after the UK’s EU Exit,[2] and the upcoming consultation paper on the implementation of a carbon emissions tax as an alternative.

With climate change and reducing global GGEs now a priority item on the UK Government’s agenda, it is not surprising to see that the strategic changes proposed focus on the reduction of GGEs and on the adoption and implementation of good environmental, social and governance (“ESG”) principles. CCS technology, in particular, plays a central role in the new proposed strategy.  This is perhaps unsurprising given that the OGA is the carbon dioxide storage licensing authority, which approves and issues storage permits, and the recent findings made in the Committee on Climate Change’s May 2019 Net Zero Report that “plans for early deployment of CCS must be delivered with urgency – CCS is a necessity not an option for reaching net-zero GHG emissions”.[3]

However, while the proposed amendments to the MER UK Strategy will undoubtedly be perceived by many as a welcome and much needed shift, the lack of detail or supporting explanation for how these new obligations will be implemented, monitored and sanctioned nonetheless leaves scope for confusion and, as a result, a risk of disputes arising,  including between the OGA and relevant persons, but also between relevant persons themselves, for example between operators who see these new obligations imposed on themselves and their joint venture partners, or between operators and companies down the supply chain.

As reminded in the introduction to the OGA Consultation, a failure to act in accordance with the current Strategy is sanctionable, with penalties including revocation of a licence or operatorship. We expect players in UK oil and gas market to seek further clarity on the scope of these new obligations.

From an ESG perspective, the OGA Consultation raises a number of questions:

  • What governance standards should relevant persons be applying, and do the standards the OGA assesses relevant persons against go beyond the traditional financial and technical capabilities assessment conducted by the OGA when determining whether to grant licences?
  • Similarly, what criteria will the OGA be taking into consideration in evaluating companies’ energy transition track record when determining whether to grant licenses? Will this disproportionately work against smaller oil and gas companies who have commonly been slower to announce carbon reduction targets? Will these obligations apply to the grant of new licences only or will they also apply to existing licences?

In parallel however, the proposed changes introduced by the OGA Consultation also highlight the very significant growth potential in the CCS market, with some of the changes looking to remove existing hurdles to market access for companies specialising in CCS projects. Many IOCs will have already turned their minds to the integration of CCS capabilities as part of their portfolio – the OGA Consultation will only serve to reinforce that trend. At the same time, we also expect to see some push back in this area. It remains to be seen how a new obligation requiring relevant persons to negotiate access to infrastructure for CCS projects “in timely fashion and in good faith”, and to permit access “on fair, reasonable and non-discriminatory terms” will be implemented, and whether decisions not to grant third parties access for CCS projects will lead to a fresh wave of disputes. For those interested in our analysis of the proposed changes to the Third Party Access Regime, and the implications for the upstream oil and gas industry, we will consider these issues in a separate post to follow.

[1] The OGA Consultation and the proposed changes to the OGA Strategy Review in track are available here.

[2] See UK Government and Devolved Administrations’ Response on The future of UK carbon pricing, June 2020, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/889037/Government_Response_to_Consultation_on_Future_of_UK_Carbon_Pricing.pdf  

[3] Committee on Climate Change, ‘Net Zero: The UK’s contribution to stopping global warming’, Chapter 6: Delivering a net-zero emissions target for the UK, May 2019 https://www.theccc.org.uk/wp-content/uploads/2019/05/Net-Zero-The-UKs-contribution-to-stopping-global-warming.pdf

Maguelonne de Brugiere
Maguelonne de Brugiere
Senior Associate, London
+44 20 7466 7488
James Robson
James Robson
Senior Associate, London
+44 20 7466 2641

Going through energy transition – fewer constraints and more private investments are needed

If we look at the last few months, the energy markets have been hit by two crises. The first one, the most obvious, due to a slump in demand as a result of the lock-down and the halt in transportation (think, for example, of civil aviation being essentially stopped). This crisis was compounded with the war on crude oil prices that unleashed between Saudi Arabia and Russia earlier in the year.

Collapse in prices

The combination of these events led to a collapse in prices at unprecedented levels and speed. Investors’ disaffection with the oil sector also went hand-in-hand with the collapse in prices. This brings to mind the letter Larry D. Fink, Blackrock’s CEO, wrote to investors right on the heels of a similar position statement from the EIB indicating a progressive phase-out of investment and financing in the fossil fuel sector.

This not only because the sector’s profitability has considerably decreased, but also because oil & gas have proven like never before that they are subject to strong politically-minded influence and disturbance. 60% of the world’s oil production originates from countries where exports of oil products constitute 50% of overall exports.

Energy transition

Not only that, but energy transition also casts a shadow on fossil fuels. We’re experiencing what could be defined as ‘oil Darwinism’: the weakest companies with the highest production costs risk disappearing—it is calculated that if the current distress landscape persists, 70% of businesses producing non-conventional gas in the USA could go out of business—whereas Oil Majors will survive but at the price of lower profitability.

Even by virtue of such an unfavourable current juncture, energy transition marked by decarbonisation, decentralisation, digitalisation, is finding a renewed boost and new sponsors.

The downturn is accelerating energy transition mainly for three reasons. First of all, there’s a political motivation. At present there is strong political support for decarbonisation. The need for a Green Deal has been the flagship of the European Commission President von der Leyen, also reiterated over the course of the last few weeks as one of the pillars on which the relaunch of our European economy will rest.

Capital flow

The second reason is economic in nature: on most of the globe’s surface energy production from renewable sources has by now turned out to be cheaper and, as we know, money, like water, goes the easy way. At this time, if we think of the success of initiatives such as green bonds, financing associated with sustainability indexes or, conversely, discontinued financing for fossil fuels, it appears evident that a great flow of capital will be reserved for renewables, which can now compete on a level playing field with fossil fuels (the so-called market parity).

A further push towards energy transition has sociological roots, considering the eurhythmy of renewables with prevailing paradigms at this point in time. We’ve moved on from a world of efficiency towards a world of resilience, and renewables are extremely resilient because, for instance, they do not depend from the political or oligopolistic decisions of whoever owns them. A second paradigm lies in the transition from globalisation to self-sufficiency and renewables enable us to have a – so to speak – ‘home-grown’ production.

The third paradigm is widespread risk aversion and desire for security that are intrinsic qualities of renewable energy production. One last reason pushing towards sustainability: the health-care emergency has widened social, cultural, and political differences by creating new rifts. In a world of great divisions, decarbonisation is one of the few categories that finds (almost) everyone in agreement.

Resources of the future

From an economic standpoint, photovoltaic solar energy can certainly be a resource for the future of Italy. The construction of “utility scale” plants in the most irradiated areas, maybe not short-term, but rather over the medium term, might give investors great satisfaction. Limits to development by now only lie at a regulatory level: unfortunately to date the construction of large PV plants aimed at reaching the goals of the European Green Deal is opposed by some local authorities and especially by the Cultural Heritage Departments.

Hopefully, at a juncture where the Italian economy specifically needs private investments, this difficulty can finally be overcome.

Even energy efficiency and the tax concessions associated with it may constitute an interesting opportunity for operators and investors. In terms of energy efficiency, today Italy is already one of the most advanced countries in the world. However, the road ahead is still long: suffice to think of the need to radically improve the energy performance of public buildings. In this case, too, well-established international practices could be applied (think for example of ‘energy performance contracts’) which allow for energy efficiency works to be entirely financed by private investors.

Lorenzo Parola
Lorenzo Parola
Partner, Milan
+39 02 0068 1370

A SPECIAL, GLOBAL, EDITION OF THE EUROPEAN ENERGY HANDBOOK

We are delighted to present an update to our European Energy Handbook.

The European Energy Handbook usually reports on regulatory, legal and market developments in the European energy sector. However, these are not usual times as the COVID-19 pandemic is creating significant health, social and economic challenges worldwide, forcing governments and businesses to critically assess the impact on their people, operations and governance.

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ENGLISH COURT UPHOLDS SCC AWARD DESPITE RESPONDENT’S ARGUMENT THAT ARBITRATION AGREEMENT WAS SIGNED BY DEFUNCT PREDECESSOR

 

In Carpatsky Petroleum Corp v PJSC Ukrnafta [2020] EWHC 769 (Comm), the Commercial Court has upheld the enforcement of a US$147 million Stockholm Chamber of Commerce (the “SCC”) award issued in 2010 in favour of Carpatsky Petroleum Corporation, incorporated in Delaware (“Carpatsky”), against PJSC Ukrnafta (“Ukrnafta”), Ukraine’s oil and gas producer (the “Award”). Enforcement was allowed despite an argument from Ukrnafta that the arbitration agreement was signed by Carpatsky’s predecessor, which had ceased to exist in 1996. Given that the parties had already fought this issue on the enforcement front in a number of jurisdictions, including Ukraine and Sweden (the seat of arbitration), the Court had to consider whether an issue estoppel arose as a result of the foreign courts’ findings, noting that there was a public interest in sustaining the finality of supervisory courts’ decisions on properly referred procedural issues arising from the arbitration.

Background

The parties and the Agreements

In 1995, Carpatsky Texas (“CT”) and Ukrnafta’s subsidiary SE Poltavanaftogaz (“PNG”) entered into a joint activity agreement to develop and exploit a gas field in Ukraine (the “JAA”). In June 1996, CT was merged into Carpatsky: CT ceased to exist, Carpatsky assuming CT’s rights and obligations. In October 1996, PNG and “Carpatsky Petroleum Corporation, registered in Texas” entered into a restated JAA, which contained an arbitration clause. In 1998, the parties executed an addendum to the restated JAA (the “JAA Addendum”, and together with the JAA and the restated JAA, the “Agreements”).The JAA Addendum (i) replaced PNG with Ukrnafta; and (ii) amended the arbitration clause such that it referred disputes to SCC arbitration. All the Agreements were signed by the President of “Carpatsky Petroleum Corporation” and stamped with CT’s seal.

Arbitration proceedings

In 2007, Carpatsky filed a request for arbitration with the SCC. Ukrnafta submitted an answer without a reservation as to jurisdiction. Following two rounds of submissions by each party, Ukrnafta served objections to the tribunal’s jurisdiction alleging that there was no valid arbitration agreement under Swedish law because the Agreements were made with CT, which had ceased to exist. The tribunal determined that it had jurisdiction, at the very least because the parties had entered into an arbitration agreement by engaging in the arbitration without raising an objection to jurisdiction. The arbitration proceeded on the merits, and the tribunal issued the Award in favour of Carpatsky.

Ukrainian proceedings

In early 2009, upon the application of the Ukrainian Deputy Public Prosecutor, the Kyiv Commercial Court held that the Agreements had not been executed as they were signed by CT, which had ceased to exist as at the date of the Agreements (the “Kyiv Court Decision”).

After the tribunal issued the Award, Carpatsky commenced enforcement proceedings in Ukraine. In 2013, the application was dismissed with reference to the Kyiv Court Decision on the ground that there was no written arbitration agreement (the “Kyiv Enforcement Decision”, and together with the Kyiv Court Decision, the “Kyiv Decisions”).

Swedish proceedings

In 2009, Ukrnafta brought proceedings before the Stockholm District Court arguing, with reference to Swedish law, that the tribunal lacked jurisdiction. The proceedings were stayed pending the arbitration. In 2011, the District Court rejected Ukrnafta’s argument, confirming that the tribunal had jurisdiction.

In addition, Ukrnafta sought to set aside the Award on the basis that the tribunal had exceeded its mandate and had made errors which affected the outcome of the arbitration (the “Swedish Challenge Proceedings”). In 2015, the Svea Court of Appeal rejected all Ukrnafta’s challenges to the Award (the “Swedish Challenge Proceedings Decision”).

US proceedings

In February 2009, Ukrnafta sued Carpatsky in the 190th District Court of Harris County, Texas asserting a number of causes of action, including negligent misrepresentation, fraud and misappropriation of trade secrets, and contending that all amendments to the JAA after the date of the merger were void ab initio. The case was removed to federal court, and the US District Court for the Southern District of Texas (“SDT”) stayed the litigation pending the arbitration proceedings. The stay was lifted following the termination of the Swedish Challenge Proceedings. In October 2017, the SDT granted Carpatsky’s motion to confirm the Award. Ukrnafta appealed.

In April 2020, several days after the Commercial Court in London upheld enforcement of the Award, the US Court of Appeals for the Fifth Circuit (the “Fifth Circuit”) dismissed Ukrnafta’s challenges to the District Court’s order confirming the award. In its ruling, the Fifth Circuit found that under Delaware law, the President of “Carpatsky Petroleum Corporation” had authority to enter into the JAA Addendum on behalf of Carpatsky and the use of CT’s seal was irrelevant. The Fifth Circuit also noted that Ukrnafta waived its right to challenge the tribunal’s jurisdiction by submitting to arbitration proceedings, and, in any event, an arbitration agreement was created during the arbitration. The Fifth Circuit dismissed the due process violations pleaded by Ukrnafta, noting, in particular, that the merits hearing looked “like a full-blown federal trial”. Finally, the Fifth Circuit held that allowing the Kyiv Decisions to prevent enforcement would “gut international arbitration and interfere with the global commerce it promotes.”

English proceedings

Carpatsky successfully applied to the English court to enforce the Award. Ukrnafta sought to set aside the order granting permission to enforce before the Commercial Court. Ukrnafta argued that under Ukrainian law there was no valid arbitration agreement given that the JAA Addendum was executed on behalf of CT. Ukrnafta also contended there was a serious procedural irregularity in that the tribunal (i) dealt with an issue concerning a limitation of liability clause on a basis which had not been pleaded; and (ii) took a procedurally irregular approach to the agreed methodology for assessing damages, which resulted in a serious mathematical error.

Overview of the Commercial Court decision

There was a valid arbitration agreement

The Court held that Ukraine was estopped by conduct from arguing that Ukrainian law governed the arbitration agreement given that it had argued that Swedish law was applicable in the arbitration and Swedish proceedings. It concluded that under Swedish law there was a valid arbitration agreement in the JAA Addendum between Ukrnafta and Carpatsky, noting, in particular, that the parties intended both objectively and subjectively, to enter into the JAA Addendum with each other. It further noted that both (i) the conduct of the parties’ representatives in the arbitration under the SCC Rules and (ii) the parties’ participation in the arbitration and exchange of pleadings gave rise to an arbitration agreement even if there had not been one before.

No issue estoppel on the validity of the arbitration agreement

The Court reminded the parties that an issue estoppel can arise from foreign court decisions in relation to enforcement, referring to Diag Human SE v Czech Republic (discussed in one of our previous blog posts). However, given that the Ukrainian courts did not address the existence of an arbitration agreement as a matter of Swedish law, an issue estoppel did not arise. The Court noted that to the extent its determinations related to the validity of the JAA Addendum under Ukrainian law it would be unjust to recognise an issue estoppel as precluding Carpatsky from successfully contending that the JAA Addendum was valid.

Issue estoppel on limitation of liability and on damages methodology

The Court held that there was a public interest in sustaining the finality of decisions of the supervisory courts (the Swedish courts in this instance) on properly referred procedural issues arising from the arbitration. It also noted that, in assessing whether there was an issue estoppel arising from a decision of the supervisory courts in respect of an arbitration-related procedural issue, English courts should not adopt an overly-narrow approach to whether the same issue has been decided by the supervisory court. The Court considered the arguments raised by Ukrnafta in the Swedish proceedings, concluding that Ukrnafta’s procedural irregularity complaints were either substantially the same (in the case of the limitation of liability point) or the same (in the case of the damages methodology) to those pursued before the Court. These arguments had been considered (and rejected) in the Swedish Challenge Proceedings Decision, which gave rise to an issue estoppel.

Comment

The Commercial Court’s decision in this case is another clear example of the English courts’ pro-enforcement stance. The judgment is also an important reminder to commercial parties that their participation in the arbitration proceedings may in itself be capable of constituting an agreement to arbitrate, even if the arbitration agreement in the relevant contract is in some way defective. In addition, the decision reiterates that the principle of issue estoppel may affect the parties’ ability either to enforce an award or resist enforcement in the English courts where there have already been attempts to enforce or challenge the award in foreign courts, especially before the courts of the seat of arbitration.

For more information, please contact Brenda Horrigan, Partner, Chiara Cilento, Associate, Olga Dementyeva, Associate, or your usual Herbert Smith Freehills contact.

Brenda Horrigan
Brenda Horrigan
Partner
+61 2 9225 5536
Chiara Cilento
Chiara Cilento
Associate
+1 917 542 7842
Olga Dementyeva
Olga Dementyeva
Associate
+44 20 7466 7644

 

Joint Operating Agreement arguably a “relational contract” but Commercial Court declines to imply duty of good faith or Braganza duty

 

In a recent decision, the Commercial Court found that an express and (on its face) unqualified right to discharge the operator in a Joint Operating Agreement (JOA) was not subject to any implied term of good faith, or that the right would not be exercised capriciously, arbitrarily or unreasonably: TAQA Bratani Limited and Others v RockRose UKCS8 LLC [2020] EWHC 58 (Comm).

The decision confirms that unqualified termination or discharge rights in JOAs are unlikely to be subject to implied terms of good faith, and therefore provides comfort for those who might exercise such rights.

The decision is also of interest in that, despite the court being prepared to treat the JOAs as arguably falling into the category of “relational” contracts (as considered here, for example), it nonetheless declined to imply an obligation of good faith in relation to the discharge right.  It is therefore a helpful reminder that the question of whether a contract is “relational” is just part of the analysis. The onus will still be on the party seeking to establish a duty of good faith to show that such a duty should be implied. As this decision makes clear, where that duty would qualify an otherwise unqualified contractual right, this may prove to be difficult.

James Robson, a senior associate in our disputes team, considers the decision further below.

Background

The defendant, RockRose, was the operator of the Brae Fields in the North Sea. There were four Joint Operating Agreements and a Unitisation and Unit Operating Agreement (together, the “JOAs”) between the defendant as Operator and the claimants as non-operating Participants (TAQA, JX Nippon and Spirit Energy).

The JOAs each contained the following clause governing the discharge of the Operator (or a clause not materially different to this):

19.1 Operator may be discharged;

(a) at the end of any calendar month by the Operating Committee giving not less than ninety (90) days notice to it, provided that in respect of any vote of the Operating Committee on any such discharge under this Article 19.1(a) the voting interest of the Participant which is the Operator and the voting interest of any Participant which is an Affiliate of the Operator shall be ignored and the required percentage figure shall be one hundred per cent (100%) of the total votes available to the remaining Parties;

The claimants voted unanimously to terminate the appointment of the defendant as Operator under each of the JOAs, and notices were served giving the defendant 365 days’ notice of its termination as Operator.

The claimants sought declarations from the court that the notices were valid. They argued that they had an unqualified right to discharge the defendant as Operator, which they had validly exercised.

The defendant argued that the express terms on which the claimants relied were impliedly qualified, such that the claimants could not exercise their right to discharge the Operator capriciously or arbitrarily, and could only do so in good faith.

Decision

The Commercial Court (His Honour Judge Pelling QC sitting as a High Court Judge) held that, on their true construction, the express terms of the JOAs conferred an absolute right to discharge the defendant as Operator, which was not subject to any implied constraint as alleged by the defendant.

Express terms

The judge held that the express terms of the JOAs were clear. Clause 19.1 unambiguously conferred an unqualified right on the claimants. The decision to discharge the Operator was a binary one with no room for evaluation or adjudication. If the parties had intended to qualify the discharge right, they could and would have done so expressly.

Looking at the contract as a whole, the judge also noted that the inclusion of such an unqualified right was consistent with the common understanding of the parties as to the nature of their relationship. The JOAs did not establish a partnership, and if the parties’ interests were no longer aligned, they were free to act in their respective individual best interests.

The judge added that there was nothing within the factual or commercial matrix which suggested that the court should reach a different view on the appropriate construction of the contract.

Implied terms

The judge went on to consider whether the express provision was qualified by an implied term. The judge referred to the principles applicable to the implication of terms, as set out in the Supreme Court’s decision in M&S v BNP [2015] UKSC 72 (considered here). These include the principle that, where there is a detailed commercial agreement, terms are to be implied only if to do so is necessary in order to give the contract business efficacy or was so obvious that it goes without saying. He then went on to consider the alternative bases on which the defendant sought to establish that terms should be implied.

First, the defendant relied on the Supreme Court’s decision in Braganza v BP Shipping Ltd [2015] UKSC 17 to argue that an implied term qualified the manner in which the discharge right may be exercised, such that it was limited by concepts of “good faith, and genuineness and the absence of arbitrariness, capriciousness, perversity and irrationality”.

The court held that no such qualification fell to be implied. It was not necessary to imply any of the terms for which the defendant contended either to give business efficacy to the JOAs or to give effect to what was so obvious that it went without saying. Further, while accepting that this is an incrementally developing area of law, the judge considered it clear that, on the current state of the authorities, the Braganza doctrine has no application to unqualified termination provisions sitting within complex agreements between sophisticated commercial parties. Extending a Braganza duty to absolute rights in professionally drafted, or standard form, contracts would be an “unwarranted interference in the freedom of parties to contract on the terms they choose, at any rate where there is no fiduciary relationship created by the agreement”.

Second, the defendant argued that the JOAs were ”relational” contracts and, as such, a duty of good faith should be implied into the relevant clause, relying on Yam Seng Pte v International Trade Corp [2013] EWHC 111 (QB) (considered here).

The judge was prepared to treat the JOAs as being at least arguably ”relational” contracts (presumably because, as is typical for such agreements, they were long-term and involved a high degree of co-operation and collaboration between the parties). However, he did not accept that a duty of good faith fell to be implied as a result. This was principally because the parties had legislated for the discharge of an operator in clear, express terms, and an implied duty of good faith would impermissibly qualify that right. As the judge put it, “it is not necessary, indeed it would be wrong, to imply such a term … because it is not necessary in order to make the contract the parties have chosen work as it is to be presumed they intended it to work, or, to the extent there is any difference, to give effect to their presumed common intention”.

In the context of their implied term arguments, the defendant placed significant weight on the Oil and Gas Authority’s “Maximising Economic Recovery Strategy for the UK” (“MER UK”). The defendant argued that this strategy emphasised collaboration, cooperation and straightforward dealing between licence holders, and those features “chimed” with the implied terms the defendant was seeking. The judge rejected this argument. MER UK was published in 2016, and so could not inform an implied term in an agreement signed many years earlier.

The defendant also introduced expert evidence to try to establish that there was an industry practice which qualifies an unqualified discharge right, and that this context is relevant either to construing the express terms, or implying a term. The judge rejected this too. Indeed, the judge concluded that the expert evidence demonstrated that there is no such industry practice.

James Robson
James Robson
Senior Associate
+44 20 7466 2641

 

EUROPEAN ENERGY HANDBOOK 2019 – 2020

WELCOME TO THE 2019-2020 EDITION OF THE EUROPEAN ENERGY HANDBOOK!

Now in its eleventh edition, the European Energy Handbook 2019 – 2020 provides an in-depth survey of current issues in the energy sector in 42 European jurisdictions.

In addition to contributions for the European Union, Belgium, France, Germany, Ireland, Italy, Russia, Spain, and the United Kingdom from our own offices, this year we have contributions from Schoenherr (Austria, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Hungary, Moldova, Montenegro, Romania, Serbia, the Slovak Republic and Slovenia), Loloçi & Associates (Albania), Kromann Reumert (Denmark), Ellex Raidla (Estonia), Roschier (Finland and Sweden), Kyriakides Georgopoulos (Greece), BBA//Fjeldco (Iceland), Meitar Liquornik Geva Leshem Tal Law Offices (Israel), Kinstellar (Kazakhstan), Cobalt (Latvia and Lithuania), Arendt & Medernach (Luxembourg), Zammit Pace Advocates (Malta), Houthoff (the Netherlands), Karanovic & Partners (North Macedonia), Arntzen de Besche Advokatfirma AS (Norway), WKB Wierciński, Kwieciński, Baehr (Poland), Campos Ferreira, Sá Carneiro & Associados (Portugal), Homburger (Switzerland), Kolcuoğlu Demirkan Koçaklı (Turkey), and Avellum (Ukraine).

This year’s edition focuses on recent legal and commercial developments in each jurisdiction, and covers issues such as the Energy Union, the adoption of the latest package of EU energy legislation, and the ‘Clean Energy for All Europeans’ bundle of directives and regulations updating the EU’s energy policy framework to facilitate the decarbonisation of the sector and the transition towards cleaner energy.

Climate change, the energy transition and associated challenges are strong themes in nearly all of the contributions of this edition – as each jurisdiction aims to meet its EU renewable energy obligations by 2020 and beyond. Other topics in this edition include the increasingly important role of electricity storage, new nuclear projects, the progress of privatisations, new gas and electricity interconnectors, the emergence of subsidy-free renewable energy projects in a number of jurisdictions as well as the growing role of electric vehicles, the need for charging infrastructure, and their impact on electricity grids.  At the time of writing, the exact shape of Brexit is as yet unclear. Wider political implications for the UK and the EU aside, Brexit will also have an impact on the energy sector, as it puts into question the continued coupling of the British (and, indirectly, the Irish) electricity markets to the EU energy markets, and the current electricity and gas trading arrangements between Great Britain and the EU.

If you would like to obtain a full copy of the guide or a specific chapter, please fill out the form.

EEH 2019-2020 DOWNLOAD FORM

Silke Goldberg
Silke Goldberg
Partner, London
+44 20 7466 2612