The 2017 hurricane season has already had a significant impact, with Hurricanes Harvey and Irma causing billions of dollars of damage in Texas and Florida. And more hurricanes are likely on the way. In the past, damage from hurricanes has caused oil and natural gas prices to fluctuate. The consumers hardest hit by those price fluctuations have been large industrial consumers, such as textile and manufacturing factories and gas-fueled electric power plants. This is true not only because of the large volume of natural gas they consume, but also because these consumers tend to purchase natural gas directly from producers pursuant to supply contracts that use a short-term (either weekly or daily) index price or spot pricing. In an already volatile market, daily prices can skyrocket when a hurricane hits.
Both suppliers and consumers of natural gas should have a firm understanding of how their supply contracts may be affected when hurricanes make the delivery or taking of natural gas impossible, difficult, and/or more expensive. This alert discusses the protection that may or may not be afforded by a force majeure clause in a supply contract and what suppliers and consumers should look for when reviewing existing supply contracts and negotiating new ones.
Every supplier and consumer of natural gas should review its natural gas supply agreements to see if they contain a force majeure clause. Because force majeure clauses vary even within an industry, suppliers and consumers should ensure that if they have multiple supply contracts—both vertical (upstream and downstream contracts) and horizontal (contracts with multiple customers)—the force majeure clauses therein are aligned so that the effect of a hurricane or other weather event is treated consistently in all transactions. Finally, suppliers and consumers should understand the scope of force majeure clauses, the requirements of providing notice of a force majeure event and invoking the clause, the effect of invoking the clause, and how to challenge a claim of force majeure.
Most commercial contracts contain a “force majeure” clause. The term “force majeure” is a term of art used in contracts to mean some “act of God” or other event outside of the parties’ control that excuses one party from performing under the contract. Force majeure clauses often list trigger events under the clause (most commonly “acts of God,” flood, fire, war, civil disturbance, embargoes, labor strikes, governmental actions, and terrorist acts) and specify the notice required to invoke the force majeure clause. The effect of invoking the force majeure clause is typically to excuse performance under the contract during the invocation of the clause. Although force majeure clauses in supply contracts are typically invoked by the supplier, they may be invoked by the consumer as well. Hurricanes can affect not only natural gas supply, but natural gas demand as well. Due to electricity outages, evacuations, and flooding, many industrial gas customers may be inoperative or unable to operate as usual, and thus have no need for the supply elected under their contracts. Few consumers have the ability to store unused gas they may be obligated to buy under the contract, so they may invoke their force majeure clauses when, due to weather-related shutdowns, they are unable to operate.
While a force majeure clause likely lists weather-related conditions among the covered force majeure events, the mere existence of a weather-related event, such as a hurricane, is likely insufficient to invoke the force majeure clause’s protections. More commonly, the clause requires that performance be impossible due to the weather event. In many situations, hurricanes and their resulting damage do make performance impossible, and the force majeure clause may be properly invoked. The more difficult cases arise when one party to the contract claims performance is impossible, while the other maintains that performance is possible, but just at a greater expense to the other party.
Force majeure clauses typically exclude market fluctuations and changes in economic conditions. At some point, one party may claim that the changes in economic conditions are so extreme that it is impossible to perform the contract. Or, where pricing is based on an index, a party may claim that the index should not apply because it was unreliable or did not reflect historical trends during the time of a storm. Moreover, force majeure clauses often apply to “unforeseen” circumstances only. With forecasters able to predict hurricanes several days in advance, the position that a hurricane in the region is an unforeseen circumstance may be challenged.
Force majeure clauses play an important role in commercial contracts, but parties need to have a firm understanding of when they apply, how to invoke them, and how to challenge an improper invocation by a contracting party. In drafting or reviewing a force majeure clause, a party should ask itself the following questions:
- Is this a generic force majeure clause or is it tailored to the appropriate industry and/or area of the country?
- Does the force majeure clause specifically cover hurricanes?
- Does the force majeure clause cover disruptions in transportation?
- Does the force majeure clause apply to disruptions in a pricing index?
- What does the force majeure clause say about market fluctuations and changes in economic conditions?
- If there is a dispute regarding a claim of force majeure, which law applies?
Parties also need to understand the notice provisions of force majeure contracts, regardless of whether they are the party invoking the clause or the party receiving a notice of force majeure. Typically, notice clauses provide some requirements of how, when, and to whom notice of a force majeure event is to be given. Notice should be sufficient to allow the other party to assess the validity of the claim. If challenged, the party asserting the force majeure clause bears the burden of proving that the claimed event excused performance under the force majeure clause. When providing notice of a force majeure event, or when receiving notice of one, a party should consider the following questions:
- Is the notice addressed to the correct person or office?
- Does the notice provide sufficient details regarding the force majeure event to allow the other party to assess the validity of the claim?
- Is the notice timely?
- Does the notice specify the duration of the force majeure event?
- Does the notice clause require confirmation of receipt from the other party?
With the hurricane season under way, all natural gas suppliers in the Gulf Coast region and consumers purchasing natural gas based on a spot price or indexed contract should familiarize themselves with their supply contracts and, in particular, with the force majeure provisions contained therein. Parties should understand the requirements under the notice provision, as well as what type of evidence or support is required when a claim of force majeure is asserted or challenged.
The terms and provisions of supply contracts and other contracts will obviously vary in each different situation and will be subject to differing interpretations, applications, and requirements depending upon specific contract language and applicable state law.