On 20 April 2020, the WTI benchmark price for crude oil in the US temporarily fell to negative $37.63, the first time in history it has fallen below zero.
This unprecedented situation was caused by a collapse in demand coinciding with a surge in supply. In March 2020, a number of countries flooded the market with oil, causing a glut in supply. At the same time, the outbreak of COVID-19 led many countries across the world to impose lockdowns and travel restrictions, causing a precipitous decline in demand. Requirements for storage rose exponentially, and many businesses faced (and continue to face) the invidious choice of selling cargoes at a loss or (if they can) paying above the odds to store it.
Although the oil price has since recovered slightly, these events have resulted in many contracts becoming uneconomical and the performance of parties' legal obligations becoming more difficult. They have caused many businesses – both crude purchasers and other market participants – to consider their options to vary, delay or terminate their contracts.
One question many clients are posing in this context is whether a collapse in oil prices might excuse performance of a contract on force majeure grounds.
As we explain, whilst the collapse of the oil price had and continues to have a negative knock-on effect for contracts throughout the supply chain, that impact is likely to be predominantly economic in nature. Force majeure is unlikely to apply to that situation unless specifically provided for in the contract, and parties would be well advised to consider the other options available to them in this difficult period.
Force majeure clauses
There is no definition of force majeure under English law and a party will only be able to rely on a force majeure clause if one is included in the relevant contract. Whether an event constitutes a force majeure event will depend on the specific wording of the clause and will vary between contracts. A typical clause will be engaged where there is a supervening event beyond the control of the parties, which prevents or delays the performance of contractual obligations.
For more information, please see our detailed article on force majeure and COVID-19 here.
Is the collapse in oil price a force majeure event?
The collapse of the oil price is highly unlikely to constitute a force majeure event in itself. However, each case is fact specific and should be considered on an individual basis.
Contracts will usually list the different types of event which may constitute a force majeure event. Whilst it is not uncommon to find “pandemic/epidemic” or “changes in law” listed, it would be unusual to see “a change in market condition” or “decline in commodity prices”. Many force majeure clauses also contain a catch-all provision such as “or any other event beyond the control of the parties”, but it is likely to be difficult to argue that the collapse in oil prices or the economic consequences are force majeure events within the scope of that provision, particularly if it does not list any similar events .
Further, most force majeure clauses require the supervening event to have prevented a party from complying with its contractual obligations. This means that performing these obligations must have become physically or legally impossible. An increase in the cost, or difficulty in performing, will not be enough to satisfy this requirement. Even where a force majeure clause provides that the event need only have “hindered” or “delayed” performance, the fact that it has become more expensive is unlikely to trigger force majeure, unless there is clear wording to that effect in the contract.
In a standard sale and purchase agreement, where there is no prescribed buyer use, it may be that the only significant obligation the buyer has is to purchase the oil. Although this obligation may have become severely uneconomical as a result of the oil price collapse, and even if alternative options (such as storage) are impossible or prohibitively expensive, complying with the obligation to purchase will in the majority of cases still be physically possible, such that the force majeure provisions of the agreement are unlikely to be triggered.
The effect of negative pricing
Further, the low price of oil might result in the contract price becoming negative, requiring the seller to pay the buyer for taking its oil. Again, whilst patently uneconomic, this is unlikely to trigger the force majeure provisions of the contract unless specifically provided for within it.
To address this issue, parties should review their contracts to determine whether they contain a “zero” floor price, preventing the contract price from falling below zero. The courts may imply such a provision where they determine that the parties did not contemplate negative pricing, i.e. whether the contract envisaged two-way payments.
Given the above difficulties, and the potential consequences of wrongly calling force majeure (which, under English law, may give a counterparty the right to terminate the contract and claim damages), parties should explore every possible commercial and legal avenue before considering whether to invoke it. This should include a holistic review of their contracts to determine whether or not:
- They have the right to suspend or vary performance, including by suspending cargoes to a later date or agreeing to purchase additional quantities or later contract periods;
- They can attain a reduction in the purchase price, including by invoking any price revision clauses in the contract, or benefit from any price floor provisions in order to avoid negative pricing;
- There are any “material adverse change” clauses in the contract, which may apply where a party’s business or financial condition has materially diminished as a result of the collapse in the oil price; and/or
- They are able to terminate the contract for convenience without penalty (if that is an option being considered).
Above all, looking beyond the immediate crisis, contracting parties should consider engaging with their counterparties at an early stage to try to reach a commercial solution. If appropriate, this may include sending a carefully-worded preliminary notice outlining the difficulties they are facing, highlighting any relevant supportive provisions of the contract, and seeking discussions in order to resolve the issue in a way that preserves the parties' commercial relationship for the future.