A Useful Template for Answering "Hard" Law School Exam Questions

Here is an example of a first-class answer to a relatively difficult law exam question that was written by a postgraduate law student from a top UK university.

GAS SUPPLY TRANSACTIONS AND DISPUTES

Please explain the different elements in the formula and how they apply to determine the price

This is an oil indexation formula.

1. P=Price
2. Po= defined base price in eurocent per kWh (Euros/kWh)
3. Go= price of gas oil in €/tonne net of all taxes & duties (current gas price at the time of negotiation)
4. GoO= an agreed historic price of gas oil
5. HsFO= price of high sulphur fuel oil with sulphur content of 1% or less in €/tonne net of all taxes & duties (current price of high sulphur fuel oil)
6. HsFOo=an agreed historic price of high sulphur fuel oil
7. In order to determine the price (P), the base price (Po) is multiplied by the product of fluctuations in the values of the nominated indices. Here, the numerator, Go-current price of gas oil is divided by the denominator, Go- historic price of gas oil and the resultant figure is then multiplied by the percentage weighting (in this case 50%) which is assigned to that index.

The same process is applied to the other index, high sulphur fuel and the resultant figures are added and then multiplied by the Po component to give the applicable contract price.

The defined base price, Po, will be agreed between the parties. 0.5 is the percentage weighting of the change which in this example is 50%. The historic gas price will be fixed by the parties and it will not change. It is what the parties had agreed in the original contract or in the price revision. It will be specified in a number in the contract. For the gas price, you can refer to Bloomberg and look at the current quotations for the current gas price. Note: gas price is very volatile and can fluctuate on a daily basis. You stabilise the situation by taking the monthly average price or monthly quotations of nine preceding months for e.g. P=Po+0.6x0.9x0.007753x(Go-Goo). Here, the pass through factor is the reference to 0.6 & 0.9.

One can look at oil as a comparative alternative fuel because gas is not traded. You can now look at the hub price of gas because gas has now been traded for about 30 years. So can say P=PHub, which is the hub price in the UK or Germany or wherever the parties wish. Due to the contracts being long term, one cannot fix the price because the gas prices fluctuate so parties do not want to be restricted to a fixed price. The formula allows you to make changes. The contract does not need to be reviewed every month because it will fluctuate. Recalculation of the price will be done automatically and in accordance with what the parties have agreed in the contract.

 8.The price revision clause allows one or both parties to instigate a review of the contractual price formula in response to unforeseen changes in the market for example the increasing divergence between gas and crude oil prices in recent years. Price revision clauses are more general in nature than say hardship clauses and respond to changes in the market rather than dealing with a specific issue. The price review provision will provide that the price will be subject to review either at the request of a party which can demonstrate that the resultant price is no longer appropriate in light of prevailing market conditions or by periodic application, wherein the price (by reference to the base price, the choice of indices or the percentage weightings assigned to particular indices) could be revised to something which is agreed (or which is determined) to be more appropriate to the prevailing market conditions.

A price review provision depends for its application either upon proof that the pricing mechanism is in some way out of step with prevailing market conditions (which might not necessarily result in hardship) or upon the application period having arisen. It is usually three years before a price review clause can be triggered. The joker is an exceptional right to invoke a price review before three years and a party still needs to satisfy the need for a trigger. The change must be so dramatic or sudden that one cannot wait three years. This is an exceptional remedy and is rarely used by the parties as it is usually preserved for the occurrence of extreme or very dramatic circumstances. It is not to be used lightly by either party to the contract.

Elements of Price Review Clauses (PRCs)

• A “trigger” event (or events) allows for the invocation of the price review mechanism and enables one party to reopen the price formula. The parties will want some flexibility to allow for changes in circumstances but not too much since (a) given their cost and time commitment, attempts at price renegotiation should not occur too frequently, & (b) when they do occur, the parties will want to have a reasonably clear idea as to whether the trigger conditions have been met or not;
• A procedure to be followed in carrying out the price review including what happens if no agreement is reached. This is a period of negotiation often limited in time, during which the parties seek to find a solution. Many clauses will provide details of the matters the parties may consider (or not consider) in their discussions; &
• Methodology of the review including the parameters for the amendment of the price formula & when any amendments take effect.
• Price review must follow a two stage process:
• (1) A party must establish that a price review has been “triggered” in accordance with the provisions of the clause, then
• (2) The parties will determine whether and how a price review is to be effected and through what channels.

1. The two triggers in Atlantic LNG v Gas Natural were:

• (1) A substantial change in the economic circumstances in Spain; &
• (2) The Contract Price resulting from application of the formula set forth in Article 8.1 does not reflect the value of Natural Gas in the Buyer’s end user market.
• Therefore:
• (a) have to prove that the change is substantial;
• (b) that the change is beyond the control of the parties;
• (c) that the change in the economic circumstances is not what was reasonable expected;
• (d) the contract price does not reflect the value of Natura Gas in the buyer’s end user market, &
• (e) the parties have exercised due diligence.

Once the price review clause is triggered, that parties must negotiate for a short period of time and if no solution can be agreed, then they must go to  arbitration or expert determination. One party can claim damages or loss of  profits. The tribunal or the expert will ask how you want the price to be revised (the adjustment phase). One has to make sure that the requested price is fair and equitable.

• 10. In Atlantic, gas prices in Spain dropped in the early 2000s. As US Gas prices were starting to rise Gas Natural decided to enter in a 6 year deal with GDF Suez to sell its full Atlantic LNG off-take into the American market. In 2005, LNG triggered the price revision clause under the SPA, in order to procure a significant increase in the price payable for LNG by the buyer, Gas Natural. The parties were unable to agree on a possible revision of the pricing provisions in the SPA and so the seller initiated arbitration, in order to settle the matter. The buyer counter-claimed for a significant decrease in the price. The award, which was eventually made by the arbitral panel introduced a new two part pricing mechanism in the SPA, which was applied with retrospective effect to the time when the seller had first triggered the price revision clause. The pricing scheme firstly, preserved the Spanish pricing formula contained in the contract but revised its base price component. Secondly, it added a “New England Market Adjustment” for quarters in which more than a percentage identified in its decision of the LNG is resold for delivery to New England. This formula resulted in Atlantic having to pay Gas Natural over $70 million USD for a period from 21/04/05 to 31/12/07.

The seller then appealed to the US District Court against the award claiming that the arbitral tribunal had exceeded its authority by imposing the new pricing mechanism and so rewriting the SPA between the parties. The Court however upheld the decision of the arbitral tribunal on the grounds that the price review clause in the SPA did not prescribe any particular limits on how the price revision should be structured and that the arbitral tribunal had not in fact sought to exercise a power which it did not have. The reopener clause only required that a “fair and equitable” revision of the price be set. The key lesson to be learnt here is that a price review clause should be drafted as explicitly as possible, with clear parameters to guide any expert or arbitrator in making any revisions and to point towards the implementation of a pendulum arbitration decision.