Frédéric Gilles Sourgens, James McCulloch Chair in Energy Law & Faculty Director, Tulane Energy Law & Policy Center
In yesterday’s post, James Douglass provided an excellent introduction to the changing landscape of global liquified natural gas (LNG) markets due to the policy interventions by the Trump administration. These interventions have ripple effects not just in LNG markets but across global value chains. These policy interventions begin with tariffs and the remaking of the relationship of the U.S. to its trading partners under international economic law. Still, that is not where it ends, as the Trump administration has used tools like the declaration of an energy emergency to provide positive support for certain kinds of energy projects. This means that the commercial energy landscape is changing systemically due to the effects of Trump administration policies. Quite some of these effects are intended and reflect the administration’s policy goals. Yet, as is the case in any large-scale policy shift, it is unavoidable that there will also be unintended consequences.
When we think of international energy value chains, it is natural to think of the large extractives projects that start these chains off. This includes oil and gas projects for the currently dominant hydrocarbons energy paradigm. It also includes hard rock mining for many of the materials needed for hydrocarbon-based energy generation and deployment (e.g., nuclear electricity generation or electric vehicle batteries). In many instances, these projects will have a public partner. Most global oil and gas and hard rock mineral reserves are owned by states. Even in the U.S., there is significant public ownership of minerals. Many of the ripple effects of the administration’s policies will undoubtedly reach these projects in due time. The Center’s Investor-State Dispute Prevention and Mitigation program will be of help in evaluating how we can efficiently and effectively work through these changes.
Yet, the rhythm of global energy value chains is not dictated only (or even predominantly) by investor-state relationships. Rather, the many crisscrossing global commercial deals between international trading partners that buy and sell materials, refine them, resell them, and transform them into inputs useable by end consumers are the beating heart of the global energy system. When we consider the ripple effects of the Trump administration’s energy policies, we cannot ignore this dimension of the global energy system. The Trump administration has toppled many of the basic assumptions underlying the risk assignments between commercial actors in the global energy system. It has very much meant to do so to entice a greater share of these value chains to take root in the U.S. The resulting turmoil therefore is not a bug of the current policy environment. It is a feature to be addressed.
Consequently, both domestic and global commercial energy disputes are preprogrammed. The risks and rewards of many energy transactions simply look different today than they did when the transactions were concluded. To the extent that commercial partners engage in short term transactions, they can address this change promptly in their next round of negotiations. They will come to an agreement who should bear what risk in return for what return – or simply not transact with each other. In such a setting, the disruptive effect of current U.S. policy will mostly be felt commercially. There would be little reason for such transactions to lead to significant disputes. Of course, the last transaction prior to the change in policy could still lead to a dispute. Yet, particularly between repeat transaction partners, one can expect that they will have many reasons to work out their differences as part of the next commercial negotiations. Some disputes will remain. But they will be ‘normal’ disputes that have comparatively little bearing on the system as a whole. Systemic adjustments will simply happen in the next round of contracting and not because of arbitration.
Arbitration will be critical for the energy system as a whole because the energy system also relies on many longer-term commercial transactions that are impacted by policy changes. The purchase and sale of many raw materials can both be transacted on a spot market and on a long-term offtake basis. Longer term arrangements will be impacted differently than spot market transactions. The same is true with regard to other critical agreements like those undergirding refining relationships, manufacturing supply chains etc. Existing policy does (and means to) make many of these transactions lopsided to industry-force production to the U.S. Dealing with these transactions – retooling or unravelling them as the case may be – is very much of systemic importance for the domestic U.S. as well as the global energy system.
We are likely to see critical disputes arising out of such transactions in the not-so-distant future. Given the popularity of arbitration clauses, these disputes are likely to end up in arbitration, whether formally domestic or international. These arbitrations will be of critical importance in two sets of cases at least. First, many of the transactions themselves are critical for the energy system as a whole: certain parts of energy value chains are highly ‘concentrated’ meaning that a set of players has a disproportionate share of the total volume of a particular type of transaction. Any dispute involving such central players will itself have ripple effects for the future of the system as a whole. It will create a new benchmark for the future function of a key part of the energy system.
In addition, many transactions, including long-term transactions, use contractual terms and structures that are reasonably similar to each other. In some cases, they simply adopt model contracts. Even in cases that they do not, many law firms have access to sophisticated deal precedent libraries and will simply borrow the best terms deal to deal. This means that even in the absence of model contracts, a certain amount of standardization of terms is to be expected in the industry. When a key term or deal structure is subject to arbitration, lawyers will likely use the result of an arbitration in follow on proceedings and may share news of an arbitration award with each other (if only to make stakeholders aware that they are appropriate counsel to handle similar disputes). Of course, there is no formal rules of precedent in arbitration. Awards are not binding on third parties. Still, arbitral awards themselves can have an outsized influence on how the industry perceives risks and on what terms it might work out similar disputes once the first round of award has been placed in the public domain.
This means that there is now a particular set of demands on dispute resolution that can no longer be ignored: the need for speed. There is a significant interest in resolving matters fast so as to set the curve for what follows. Or put differently, if one does not want to live with the outcome of someone else’s arbitration, one better get to a result before news of a sister proceeding breaks. How should we deal with this critical scenario?
Re-negotiation and Mediation
The incentive structure certainly looks to favor coming to terms commercially with one’s counterparty. Coming to terms by way of negotiation or mediation has the benefit of finding solutions that are commercially viable for all parties. It opens a window through which to address an unassigned or mutually undervalued risk by going back and assigning the risk and the changing related rewards now that the risk has become more salient.
In the international context, principles like the Trans-Lex principles codify that in certain types of transaction at least, attempting to come to such a commercial workout is in fact part and parcel of the implied covenant of good faith and fair dealing. For example, Trans-Lex Principle IV.6.7 provides that “[e]ach party has a good faith obligation to renegotiate the contract if there is a need to adapt the contract to changed circumstances and the continuation of performance can reasonably be expected from the parties.” This Principle will not be directly applicable to most transactions – most transactions are governed by a specific national law as opposed to the principles. Still, any applicable law that incorporates an implied covenant of good faith and fair dealing may well look to provisions like the Trans-Lex Principles as guidance for how parties in international commerce might assign the risk in question. Depending on the strength of the covenant in the applicable law, this duty will be better grounded or more easily ignored. (In transactions subject to Texas or English law, one can more easily dispense with this line of reasoning given the general absence of such an implied duty. In transactions subject to Dutch law, the duty would have greater importance. And French law would find itself somewhere in the middle.)
Similarly, arbitration rules strengthen the idea of resort to mediation. This is true in all major arbitral rules. Rule R-10 of the AAA Commercial Rules imposes a presumption of mediation – be it one that any party can unilaterally overcome. (The same also applies for Article 6 of the AAA international rules). The case management techniques of the International Chamber of Commerce Rules similarly suggest “encouraging the parties to consider settlement of all or part of the dispute either by negotiation or through any form of amicable dispute resolution methods such as, for example, mediation under the ICC Mediation Rules.” The Singapore International Arbitration Centre Arbitration Rules also encourages the tribunal to inquire about the potential to settle disputes in mediation (Art. 32.4(b)). The London Court of International Arbitration Rules dominant set of rules that are perhaps less inclined to weigh in institutionally in favor.
There may therefore be good commercial and legal reasons to resort to negotiation or mediation to avoid a dispute reaching a full-blown arbitration proceeding. This route is likely also amongst the fastest to resolve a dispute. The parties therefore would have an additional reason – the need for speed – to make their own risk assignment and avoid the rigors of arbitration.
The Arbitration Trilemma
A rather significant number of disputes will not be amenable to resolution by renegotiation or mediation. For instance, a party may have used sufficiently similar contract language in a large number of transactions. A negotiated outcome in one dispute implies the likelihood that other contracting parties will also want a similar workout. This may well be unaffordable. At some point, the language or structure is so central to a party’s business model that it must be defended. There is no commercial sense in reaching a settlement because any settlement – if applied across a company’s transaction portfolio – would be ruinous.
Similarly, a party may well feel that it truly should not shoulder the risk in question. Its own fundamental business decision to enter into the transaction may have been rested on the notion that the class of risk in fact was assigned – even if the particular manner in which the risk actually materialized obviously was not. Giving in in this scenario would be catastrophic precisely because it would undercut the very commercial assumptions that had the deal make sense in the first place. Here, too, the deal must be defended at all costs.
Finally, there may be no commercially viable settlement. Settlements are commercially viable if there is some chance of future business or the cost of arbitration exceeds the settlement value of the claim. The current landscape places the likelihood of some the very types of transactions at issue in the dispute in doubt. This means that the chance of future business – and thus the opportunity for value – is significantly lower in the current context. The arbitration value is all there is. There is no more business to which to restructure in the short term.
In these cases, the need for speed is pronounced. I need to get out from the avalanche of cases coming behind me. If I am to award quicker than others, I will not have to live with the award terms litigated by others. I also will be out from under the relationship more quickly. This means that I will free up whatever remaining value in the transaction as quickly as possible and thus can use it to pivot to other endeavors.
The problem is this: speed is hardly the only concern parties have in arbitration. Arbitration creates a client trilemma. Clients want arbitrations to be fast, cheap, and reach an informed result that applies the assignment of risk as agreed to by the parties. The problem is that we hardly ever get things fast, cheap, and well done. Fast and well done means expensive. Fast and cheap means questionably done. Cheap and well done typically means that things will take time. How are we to proceed when there is a decided need for speed?
Balancing the Energy Arbitration Trilemma
Energy stakeholders should not let the need for speed dictate their actions willy-nilly. The need for speed is critical. It is also just one component of the overall strategic landscape energy stakeholders face. In this overall strategic landscape, stakeholders will do well to examine their own commercial goals in the underlying dispute: are they trying to vindicate a provision in a contract that is of particular importance to their business? If so, how common is the provision in the contracts of third parties? How much time and money can they spend defending or prosecuting a case? What is the downside of a negative award? What is the upside of a positive award and how likely is it that this upside will actually be realized (either by enforcing the award or using the award to realize outcomes in other transactions)? The list goes on.
Each dispute will be fundamentally different. It will thus suggest that the parties make different strategic choices at the beginning of the arbitration process. There is no right way to satisfy the need for speed. There is only good, context-driven decision-making.
With that said, there are ways in which stakeholders can increase speed without increasing cost or sacrificing quality. The first and most important step is obvious but still bears mentioning: the choice of counsel will be critical as subject-matter expertise is at a comparable premium in the disputes in question. The same goes for the choice of arbitrator.
Just as importantly, parties need to have a very clear understanding of their case early and ideally before they commence the arbitration process. The key determinant of speed, cost, and quality of an arbitration is the first procedural conference with the arbitral tribunal. This conference sets the time table and the tools that will be available in the arbitration. Knowing what tools are needed to achieve one’s preferred outcome (and avoid a worst-case scenario) and what tools are extraneous to that goal is critical to tailor the optimal procedure for the case. This does not mean that one should forego all procedural elements in a case that could entail delay (i.e., document exchanges and other forms of fact finding). Without knowing what documents one needs (if any) one just cannot make an informed use of a largely bespoke process. Early preparation therefore is critical to balance the arbitral trilemma and will pay dividends later.
This means that energy stakeholders should audit their exposure to the current policy environment immediately and with the help of counsel. The earlier one understands an exposure, the more likely it is one that can shape the terrain in which a dispute will proceed as opposed to react on the terrain chosen by one’s counterparty. This early understanding will help one have a cleareyed view what disputes could be resolved through a workout and what disputes cannot. This early understanding is unbiased by the inevitable pressures of defending one’s point of view once a case is filed. Resolving the trilemma rests on making as much uncertainty knowable as early as possible. This does not mean that one can gain certainty. It just means that one has a better appreciation of risk. It is this improved understanding of risk that is the only key for any party to balance the arbitration in any given dispute. This is particularly so when disputes are as systemic as the next wave of energy arbitrations promise to be.
