With the energy sector primed for a perfect storm of disputes, largely due to the looming energy transition, gas price volatility and supply chain issues resulting from the war in Ukraine, it is not surprising that even a cursory review of the Paris Arbitration Week 2023 agenda shows that energy-related disputes are a clear concern and focus.
To help manage the high risk and costs associated with meritorious energy-related claims, companies in the energy sector and the outside law firms that work with them can look to legal finance.
Disputes arising from the energy transition
The energy transition is a key consideration for many companies: According to a recent survey by White & Case, almost half (42%) of corporates identify energy transition investment as a high priority, compared with just 14% two years ago.
The energy transition will inevitably lead to increased investment in infrastructure and the construction of renewable alternatives. Where there are large scale construction projects, there will inevitably be an increase in related disputes given the uncertain and complex nature of these transactions. Construction projects are easily affected by external pressures like cost inflation, supply chain bottlenecks, labour shortages and extreme weather events, and typically involve many parties other than the main parties to the contract, making disputes convoluted and expensive to resolve.
It is likely we will also see an increase in energy-related investor state disputes. According to the latest International Centre for Settlement of Investment Disputes (ICSID) report, almost half (46%) of the ICSID cases in 2022 were in the energy and mining sectors. Claims are likely to be especially prolific in Latin America, where some governments put green energy policies on hold to profit from the spike in global fossil fuel prices following the conflict between Russia and Ukraine.
Unpredictable markets will lead to price review disputes
Over the last few years there has been significant market volatility around gas and liquefied natural gas (LNG) prices, with decreased demand at the peak of Covid-19 followed by global shortages in the wake of Russia’s invasion of Ukraine. The current price volatility will inevitably result in an increase in price review arbitrations in the long term as negotiations on price adjustments break down. According to recent research by Queen Mary University of London (QMUL), 28% of in-house lawyers and arbitration experts see price volatility as being the most likely cause of energy disputes over the next five years.
Gas price review clauses are typically incorporated into long-term gas contracts — the purpose of which is to allow the parties to adjust the contract price to match the market value for gas. However, this creates an obvious conflict of commercial considerations between parties: High gas prices mean that suppliers will be seeking upward price reviews, while continued economic uncertainty means buyers will want to keep costs low and be incentivized to resist any price rises.
Market price volatility changes the commercial assumptions on which energy projects are based and often results in arbitration. Simultaneously, we will likely see an increase in contractual disputes as suppliers look to break or renegotiate contracts to profit from inflated market prices.
Companies can navigate the legal costs of disputes through legal finance
When a company has been harmed, pursuing an arbitration claim may be the only path to recovery — but it is an expensive and risky one. Legal costs can diminish balance sheets, claims can take many years to resolve and they present a binary risk of loss. So, as the volume of disputes in the energy industry increases and key issues in the sector become more contentious, legal finance will become a natural consideration for parties. Indeed, 84% of respondents to the recent QMUL survey on energy disputes indicated that they believed there would be an increase in third-party funding of energy-related disputes.
As one respondent in the recent QMUL survey explained: “Clients are becoming more risk adverse and feel that arbitrations are less of a ‘sure thing’ to recover their claims. [Third-party funding] will help them offset the risk of the cost of experts and counsel.” This is already evidenced in increased uptake of financing for arbitration claims. Illustrating the widespread acceptance of the category, ranked law firms reported 197 funded cases in 2022, and the top firms accounted for a considerable portion of these (49%).
In the simplest legal finance arrangements, capital is provided upfront to pay legal fees and expenses for a matter to proceed in exchange for a portion of the future proceeds of the claim. Generally, capital is non-recourse, not debt, meaning the claimant has no obligation to repay its legal finance partner if its case loses.
Another application of legal finance that is increasing in popularity amongst corporations is monetization, in which working capital is advanced against the future value of pending claims. Companies in the energy sector are increasingly using legal finance in this way — not only because it can de-risk a portion of a pending claim (because accelerated legal finance capital is kept regardless of the outcome) but also because it allows them to reallocate valuable resources to core business priorities, something that may be increasingly important in an uncertain economy.
Companies in the energy sector should seek arbitration finance partners with deep expertise in financing high-risk disputes. While control of strategy and settlement decisions remain with the client unless otherwise agreed, working with an experienced arbitration finance partner delivers a host of other benefits, including insights on case strategy, arbitrator selection, damages methodology and judgment enforceability.
This article was originally published in CDR Magazine here.