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Check your contracts before hurricane season: the 2005 hurricane season had the most significant impact on the Gulf Coast oil and natural gas industries in history. Physical damage to Gulf Coast facilities was extensive, and the impact on supply was unprecedented, with 100% of Gulf oil production and 94% of natural gas production down during Hurricane Katrina.

Gas supply contracts should have words that clearly deal with the results of a natural disaster.

The 2005 hurricane season had the most significant impact on the Gulf Coast oil and natural gas industries in history. Physical damage to Gulf Coast facilities was extensive, and the impact on supply was unprecedented, with 100% of Gulf oil production and 94% of natural gas production down during Hurricane Katrina. With this decrease in production, natural gas prices skyrocketed.

The consumers hardest hit by price fluctuations such as those seen in the wake of hurricanes are 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 the fact that 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.

The National Oceanic and Atmospheric Administration (NOAA) predicts three or four major hurricanes this hurricane season. With this in mind, suppliers and consumers of natural gas should have a firm understanding as to how their supply contracts may be affected when hurricanes make the delivery or taking of natural gas impossible, difficult, and/or more expensive.

This article discusses the protection that may or may not be afforded by the inclusion of a force majeure clause in a supply contract and what suppliers and consumers should look for in 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.

Force Majeure

Most commercial contracts contain a "force majeure" clause. "Force majeure" is a term of art used in contracts to mean some "act of God" or action outside of the parties' control that excuses one party from performing under the contract. When force majeure clauses are negotiated by the parties, they normally define the trigger events under the clause (most commonly "acts of God," flood, fire, war, civil disturbance, embargoes, labor strikes, governmental actions, and terrorist acts) and the notice required to invoke the force majeure clause.

The effect of invoking the force majeure clause is typically an excuse from performing under the contract during the invocation of the clause, rather than performance under alternate terms.

Although force majeure clauses in supply contracts are more typically invoked by the supplier, they may be invoked by the consumer as well. Hurricanes Katrina and Rita not only affected natural gas supply but demand as well. Due to electricity outages, evacuations, and flooding, many industrial gas customers were inoperative or unable to operate as usual. Therefore they did not require 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 shut-downs, they are unable to run.

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 to be insufficient to invoke the force majeure clause's protections. More commonly, the clause requires that performance be rendered 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 hurricane activity in the Gulf Coast at higher than historical levels in 10 of the past 12 years, and 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.

When To Invoke

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 applied?

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. Typical notice clauses provide some requirements of how, when, and to whom notice of a force majeure event is to be given.

Legally, it is important to understand whether the contract is drafted so that compliance with the notice provision is a "condition precedent" of invoking the force majeure clause or is simply a duty under the force majeure clause. In the former case, a claim of force majeure may not be upheld if the requirements of the notice provision are not met. In the latter, a party objecting to some aspect of the notice must show that it was prejudiced by the other party's failure to provide appropriate notice.

Notice should always 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 or agreement from the other party?

Before the winds start howling again, 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 sort of evidence or support is required when a claim of force majeure is asserted or challenged.

James Orr is a partner in the Atlanta office of Sutherland Asbill & Brennan. He focuses his practice on energy litigation cases. He has over 20 years of experience in this field, representing energy clients in a wide variety of judicial and regulatory proceedings, at both the state and federal level. He can be reached at 404-853-8578 or james. orr@sablaw.com.

Jennifer Ide is an associate in the Atlanta office of Sutherland Asbill & Brennan. Her practice encompasses a broad range of civil litigation, with a particular focus on energy litigation, tax controversies, and complex commercial matters. She can be reached at 404-853-8397 or jennifer.ide@sablaw.com.
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Title Annotation:Natural Disaster Clause
Comment:Check your contracts before hurricane season: the 2005 hurricane season had the most significant impact on the Gulf Coast oil and natural gas industries in history.
Author:Orr, James A.; Ide, Jennifer N.
Publication:Pipeline & Gas Journal
Geographic Code:1USA
Date:Apr 1, 2007
Words:1419
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