On Monday, June 16, 2014, Gazprom and Naftogaz each announced that they were commencing arbitration proceedings under the SCC Rules (seated in Stockholm, Sweden).

The arbitration arises under Contract No. KP dated January 19, 2009 (the “Contract”), a 10 year, long-term gas sales agreement between Gazprom and Naftogaz for volumes ranging from 40 to 52 billion cubic meters of gas per year. On the basis of the statements released by the parties, it appears that Gazprom will be alleging a debt claim. Naftogaz appears likely to invoke the price review provisions and seek a decrease in price. The value in dispute is in excess of US$4.5 billion.

To resolve the dispute, the tribunal will likely need to consider the price review provisions in the Contract. Pricing terms and price review provisions are confidential and rarely disclosed. However, Ukrainskaya Pravda — a Ukrainian news outlet — purported to publish the terms of the Contract when it was agreed. Assuming that the Contract published by Ukrainskaya Pravda contains the price review provisions that are relevant to the current arbitration between Naftogaz and Gazprom, the tribunal will be required to interpret some unusual terms.

For instance, the Contract published by Ukrainskaya Pravda does not appear to provide a set period of time during which the parties may initiate price reviews. The parties appear to be allowed to initiate a price review at any time during the Contract’s term. There do not appear to be any limits on the number of times that the parties can commence price reviews. While providing flexibility, this type of price review clause also creates the possibility that the parties are frequently reviewing the price; which would be very disruptive. For example, if either party is unhappy with the result of the arbitration, then it can immediately seek to commence a new price review. The tribunal will be aware of this possibility and it may color the decision it reaches.

The price review provisions in the Contract published by Ukrainskaya Pravda require the tribunal to determine whether there has been a material change in the market for fuel and energy products. But the Contract does not appear to define “market” explicitly. The tribunal will need to determine what market data they should evaluate in order to determine whether there has been a material change. The definition of “market” may be contentious. While Gazprom supplies almost the entirety of the country’s imported gas, Ukraine has begun to diversify its energy supply. Some European energy companies have recently begun providing “reverse flow” gas to Ukraine through Poland and Hungary. Data from markets outside Ukraine may be relevant. The tribunal will need to determine whether it is allowed to consider this data from markets outside Ukraine under the terms of the price review provision.

The terms of the Contract published by Ukrainskaya Pravda also require the tribunal to determine whether or not the price produced by the price formula reflects the “market price”. The Contract does not specify any approach for determining the market price. Moreover, while the price formula is indexed to gasoil and mazut (a low quality fuel oil), and each is weighted equally, there is no explicit wording about why these variables were chosen and whether or not their weighting relates to any specific market segmentation.

In short, the price review provisions of the Contract published by Ukrainskaya Pravda provide the tribunal with little guidance and a tremendous degree of discretion. This makes the proceedings more complex and is likely to increase the uncertainty about the result. Parties entering into long-term gas supply contracts should give careful attention to the lessons that can be learned from this example.

There are an array of options available when negotiating price review provisions and the drafting choices made by the parties can have an impact on the magnitude and complexity of future pricing disputes. Proper consideration of price review provisions is key and can help limit the uncertainty in price review arbitrations. For more information on drafting options and other pricing and dispute resolution considerations in modern long-term gas supply agreements, see our initial post providing a primer on modern long-term gas supply contracts.