Contract Renegotiation in the Wake of Falling Oil Prices

In the wake of a spiraling downward trend in the price of crude oil, which now stands around US$60 per barrel, Exploration and Production Companies (E&Ps) are pushing to cut down on their costs and postponing some projects. On the international scene, we see some oil majors such as Royal Dutch Shell and ConocoPhillips announcing spending cuts whilst British Petroleum (BP) and Chevron have announced job slashes and in the case of Chevron, the postponement of its drilling budget. Across board, there appears to be a general move towards budget cut by E&Ps in their 2015 capital investment outlook and postponement of deepwater oil and gas exploration and drilling activities.

There is an interesting move by E&Ps to get their suppliers and service companies to reduce costs. Many E&Ps including Mexico’s State Oil Company, Pemex and Saudi Arabia’s State Oil Company, Saudi Aramco recently announced their intention to renegotiate a few of their service contracts due to falling oil prices. These companies are asking oil field service companies for pricing discounts not only for new contracts but on existing contracts.

Traditionally, the concept of sanctity of contract (pacta sunt servanda) is well entrenched in law. The general consensus by the courts is that once parties have freely entered into a contract, they should be required to honour their obligations no matter how onerous, save for very rare exceptions such as frustration. The concept of contract renegotiation is based on the doctrine of (rebus sic stantibus) that things remain as they are for a contract to remain binding. It tries to create a balance and suggests that some unexpected changes in circumstances may warrant revisiting a contract. A contract may be renegotiated where there are provisions in that contract which permits it in certain instances. However, there are increasing instances where parties have had to come to the negotiation table where one of the parties alleges circumstances so onerous that despite the absence of specific renegotiation clauses in the contract, they seek to have certain terms in the contract revisited in order to maintain the economic equilibrium.

Renegotiation clauses are commonly used in international oil and gas investment contracts, which are usually long term and sometimes unpredictable in nature to restore the economic equilibrium between contracting parties upon the occurrence of certain predicted but sometimes unforeseen events. Such events would usually have an adverse economic effect on one of the contracting parties thus justifying the need for renegotiation. In today’s changing oil and gas climate where there are many uncertainties, parties ranging from oil company executives, host governments and more recently, service companies are increasingly having to go back to the drawing board to renegotiate certain aspects of an existing contract despite parties’ best intentions to maintain the integrity of their contracts.

Of course, where the contract in question already contains a renegotiation clause, the problem is half solved. This however, does not in itself guaranty a seamless process as only the first huddle is crossed. Parties may still find it difficult to agree that a trigger event for renegotiation has actually occurred. Even where there is a general consensus as to its occurrence, the question still remains as to whether parties will agree at the negotiation table and if an agreement is not reached, has the other party’s duty to renegotiate been discharged by the fact that an attempt at negotiation has been made or is there a further duty imposed on the other party to try to negotiate in good faith with the adversely affected party bearing in mind the need to compromise in order to reach a consensus. These are questions which have been raised and dealt with by arbitration tribunals.

The issue is more complicated where there is no provision for renegotiation in the contract. Overtures for the revisiting of a contract for the purpose of altering already agreed terms which would result in reduced advantage to the other party would usually be resisted. As in the situation above, where E&Ps are seeking to reduce pricing in existing and ongoing contracts, service companies would not be pleased to provide same. Where the law applicable to the contract does not support renegotiation in the absence of a contractual provision, the other party can insist on strict compliance with the terms of the contract. Thrown into this mix is the issue of the extent of each party’s bargaining power. Where the party seeking renegotiation is doing so from a position of strength, it becomes more difficult to resist renegotiation. There is also the need to maintain the existing business relationships between parties so as to push back competition, and even the possibility of repudiation of the contract where one party alleges that it is no longer able to fulfill its obligations under the contract due to extenuating circumstances. Where this process is not properly managed, it could lead to prolonged and drawn out battle in court or arbitration as the case may be. It will be interesting to see how this development plays out in Nigeria.

Nigerian law does not specifically recognize the concept of a duty to renegotiate outside of the contract provisions. However, service companies rely on E&Ps for their continued operations and with the current falling oil prices and resultant budget cuts leading to postponing of major projects by E&Ps, they may be left with a lot of idle rigs and major job cuts. It is in their interest to concede to price cuts. Large service companies would ride out the storm through job cuts, slashes in pay rates and even salary freezes. Smaller companies, especially those with a high debt portfolio would be hardest hit.