In a recent interview with Asian Legal Business, Reed Smith Energy and Natural Resources partner Nick Moon shared his thoughts on the latest trends in energy and commodities disputes in South East Asia. Topics discussed included the impact of trade disruption and price volatility in the commodities markets, how the clean energy transition is changing the nature of disputes, South East Asia’s role in the critical minerals supply chain, and the risk of increased environmental, social and governance (ESG) regulation giving rise to disputes under long-term supply contracts. A summary of the interview is set out below.
The impact of trade disruption and price volatility
The last few years have been a period of significant challenges and price volatility for market participants in the energy, transport and commodities sectors. The COVID-19 pandemic and resulting lockdowns caused energy and commodities prices to plummet. Then, as lockdowns began to ease, increased demand, combined with Western sanctions on certain Russian energy companies and Russian origin goods, caused substantial price rises on commodities ranging from natural gas and coal to metals and wheat.
The disruption caused by the combination of the pandemic, Russian sanctions and price volatility resulted in some market participants having difficulty in performing their contractual obligations. Consequently, we have seen a sharp increase in the number of disputes arising between parties in these sectors. According to the Singapore International Arbitration Centre’s (SIAC) annual reports, in 2018, 27% of new claims filed at SIAC were in the “trade” sector, rising to 47% in 2023.
The value of the disputes in the energy, transport and commodities sectors has also increased significantly. In large part, this reflects the volatility in commodity prices seen during this period. Under English law and other common law systems, the starting point is that damages for non-delivery of goods are calculated as the difference between the contract price and the market price at the time and place of scheduled delivery. Therefore, the greater the difference between the price of a commodity when the contract was agreed and when it was due to be delivered, the higher the value of the claim.
The clean energy transition and its impact on disputes
The clean energy transition, both in South East Asia and globally, has led to a shift in the types of projects that market participants are investing in, and the types of products that they are selling and purchasing. This, in turn, has led to a shift in the nature of disputes that are arising in the energy, transport and commodities sectors.
A notable example is liquefied natural gas (LNG), which is regarded as an important transition fuel in many South East Asian countries, including the Philippines, Thailand and Vietnam. Until the late 2010s, disputes concerning the sale and purchase of LNG cargoes were relatively rare, as fewer cargoes were produced, and the majority were sold by the seller directly to the end buyer. Since then, a surge in the price of LNG and an increase in the volume of cargoes traded in the third-party market, combined with the use of long-form agreements that often were not intended for trading arrangements, has led to an increase in performance-related disputes under LNG sale and purchase agreements arising from, for example, failures to deliver or take cargoes and force majeure issues.
The clean energy transition in South East Asia has also seen market participants make significant investments in the construction and repurposing of facilities used in the production of renewables, including biomass, sustainable aviation fuel and circular pyrolysis oil. These projects often include a prepayment by an offtaker in return for the right to purchase the product produced at the facility over a five to 10-year term. Many of these projects are still early in the construction phase, but as they commence production it is likely that disputes involving these types of renewable products will become increasingly common in the energy, transport and commodities sectors.
South East Asia’s role in critical minerals supply chain
At present, geopolitical tensions have not precipitated widespread disputes among market participants in the critical minerals supply chain in South East Asia. However, the general sentiment is cautious, with many participants showing a keen interest in the requirements for electric vehicles to qualify for tax credits under the U.S. Inflation Reduction Act.
Many are actively organising their businesses and choice of business partners to optimise their prospects of benefiting from the tax credits and, in particular, looking at favourable jurisdictions with tax treaties with the U.S. Indonesia is an example of a key jurisdiction and major nickel producer working towards a trade deal with the U.S. to allow nickel and other critical minerals used in electric vehicle production to be shipped to the U.S.
ESG regulations and the burden of compliance
Over the last two years or so there has been a proliferation of ESG regulations, both in South East Asia and globally, as countries take steps to meet their climate change commitments. Examples include the Association for Southeast Asian Nations’ (ASEAN) Taxonomy for Sustainable Finance and the EU’s Deforestation Regulation, Forced Labour Regulation and Methane Regulation, all of which have or are due to come into force this year.
A common theme of these regulations is that they require market participants to which the regulations apply to obtain additional information on how and where the commodities that they are trading, financing and importing are being produced. As such, the regulations are likely to have a global impact, as producers and intermediate parties within the supply chain that may not be subject to the regulations themselves will be expected to provide information to enable other market participants to comply.
Whilst it is too early to know whether these regulatory changes will give rise to disputes between parties, generally it is not uncommon for disputes under long-term supply contracts to arise as a result of such changes. These can occur when the contract does not state clearly, or does not state at all, which party is responsible for regulatory compliance. If ensuring compliance involves a significant financial outlay or, as is usually the case, the penalties for non-compliance are substantial, a party may seek to get out of a contract rather than incur the financial cost of compliance or risk penalties.
To avoid this scenario, producers, traders and end users will want to ensure that their contracts clearly specify which party is responsible for ensuring compliance with any applicable regulatory requirements as and when they come into force.
The outlook for disputes in the energy, transport and commodities sectors
The clean energy transition will continue the shift away from fossil fuels towards transition fuels and renewables. The pace at which this shift will take place remains uncertain however. The proliferation of ESG regulations is set to continue and will impose additional requirements on market participants. In the meantime, the risk of further disruption to trade caused by sanctions, geopolitical tensions and trade wars remains in the short to medium term. Against this background, market participants in the energy, transport and commodities sectors will need to consider how best to future-proof their contracts, to minimise the risk of disputes arising.
Client Alert 2024-216