The Growing Need for Arbitration in Energy Disputes

The Southeast Asian market is one of the fastest growing and promising solar energy markets due to increasing demand for energy and governmental policies towards reducing carbon emissions and increasing renewables. Asia is also home to the world’s three most prominent importers of Liquefied Natural Gas (‘LNG’): Japan, China, and South Korea.¹ The Asia-Pacific area, which is home to a sizeable proportion of the world’s economies, is expanding at the quickest rates. India is one of the world’s fastest growing economies, and with increasing urbanisation, the nation will account for around 25% of global energy consumption by 2040.² As per recent reports, in 2023, the renewable energy sector in India will attract $25 billion in investment.³ Further, it aims to be a leading producer and supplier of green hydrogen in the world.⁴ This may seem fascinating, but flipside of these huge investments is that these investments/projects lead to disputes of different shapes and sizes. These disputes may arise due to various reasons like energy crisis, supply chain disruptions, geopolitical instability, sanctions, pricing volatility, etc.

As per the recent reports issued by some of the leading arbitral institutions in the world, the energy sector generates a significant number of disputes, and it continues to dominate the caseload of such institutions⁵. Energy projects are typically lengthy, intricate, and money intensive. Political shifts, environmental legislation, and geological phenomena also heavily impact the industry. They increase in size and complexity, are capital extensive, span over the years, involve several actors, and have a complicated contractual structure and project financing. Energy disputes can take many different forms. They can happen between two States, two private parties, or a private party and a State. When it comes to resolving disputes, arbitration has become the standard practice, especially on an international level, in the energy industry.

Factors Influencing Disputes in the Energy Sector

The following factors influence disputes in the energy sector:

Firstly, a specific price cannot be quoted in the contract due to the energy contracts spanning over decades. Hence, the price review provision permits the parties to periodically realign the contract price to gas market circumstances. The contracts relating to energy contain clauses for a price review, including indexation or references embedded in contracts to market prices, with corresponding clauses to renegotiate contracts. Considering the very substantial volumes provided over the course of a long-term gas contract, even a little change in price per unit of gas can result in a massive shift in revenue, perhaps in the hundreds of millions of dollars.⁶

Secondly, energy contracts run for more extended periods of time. Due to the spanning decades, policy changes by the Government are common. When such change takes place, new obligations for the parties come into play which affects the terms of the agreement, making energy contracts a breeding ground for disputes.

Thirdly, global politics affect the re-energised market overall. For example, the current Russian-Ukrainian war influenced world pricing. Russia is wealthy in natural resources, particularly gas and oil.⁷ Consequently, disputes of this nature not only affect the local market but also have the potential to influence the international market, serving as a trigger for more energy conflicts.

Fourthly, energy contracts include laying pipelines, establishing grids, etc., which may run thousands of kilometers and encompass multiple geographical terrains. These terrains offer their own hardships, hence offering a suitable ground for dispute germination.

Lastly, there are external factors that affect the market, such as global politics and increase in electricity prices, lead to the reopening of contracts, disputes, and arbitration.

Arbitration: A Preferred Method of Dispute Resolution in Energy Disputes

1. One-stop shop for multiple agreements: The number of substantive players in the sector is relatively limited. Therefore, parties will invariably be involved in several long-term contracts, partnerships, and joint ventures simultaneously. Every party has a stake in the contract’s clarity, and parties to many contracts should make sure that the chosen solution in one agreement has equivalent analogues in all other project agreements.
2. Confidentiality: Disputes involving trade secrets, intellectual property issues, high-technology information, and other competitive practices are sensitive and vital, so parties may want to protect them to prevent their competitors from taking undue advantage. Arbitration proceedings and awards are confidential and serve to protect the integrity of the contract and parties to the contract.
3. Neutrality: Even though parties are the ones that select the arbitrator, such an arbitrator continues to be a neutral and impartial body, since both parties are given an equal opportunity to decide on the arbitrator. Thus, ensuring that the chances of dissatisfaction with the award are low.
4. Expert as an arbitrator: Due to the complex nature of energy contracts involving technical terms, it is challenging to decide the dispute without an expert. In arbitration proceedings, an expert can be appointed as an arbitrator, allowing the dispute to be resolved in light of technicality and legality at once.
5. Enforcement: The nature of arbitration allows the award to be enforced internationally, ruling out the possibility of domestic courts’ intervention. Often, domestic courts are lenient in passing orders against the State. In matters of lawful expropriation and related concerns, domestic courts may tend to be unusually benevolent to State entities. Arbitration, being a party-neutral form of dispute resolution, minimises the interference of domestic courts, thereby maintaining the transparency of the proceedings. Awards rendered under international investment arbitrations, such as the ones under the ICSID, are more easily enforceable and free from State intervention.

6. Party autonomy and flexibility: The parties are free to choose the seat of arbitration, the arbitrators, the language, and the applicable rules and laws to the proceedings. These features inspire confidence in the parties, making arbitration a preferable form of dispute resolution in energy disputes.

Challenges to Arbitration in the Energy Sector

1. Consolidation of parallel proceedings: Parallel or multiple proceedings can arise in all industries, but they are more common in the energy industry due to the frequency of multi-party and multi-contract transactions, especially in complex construction projects and joint venture agreements, and the potential for overlapping claims under State contracts and investment treaties. A party may not consent to arbitration for all disputes arising from similar contracts. In the UK, parallel procedures cannot be consolidated without the parties’ approval.⁸ Hence parallel arbitrations may continue.
2. Arbitrability: The laws of the seat of arbitration or the place of enforcement might not allow the arbitration of certain issues like deadlocks in joint ventures, specific performance of the contract, etc. In such energy disputes, it becomes challenging to arbitrate on matters concerned since it poses a threat of setting aside the award.
3. Lack of expert arbitrators: Not every arbitral institution is equipped with a pool of arbitrators that are experts in the energy sector, and even otherwise, there is a dearth of expertise in this field.
4. Interference of national courts: A party may challenge a particular policy or a notification of the Government that affects the pricing. These challenges usually occur through writ petitions in High Courts, which remain pending for a long time. As a result, arbitration proceedings suffer as the outcome of the writ petition will have a bearing on the decision of the Arbitral Tribunal. Courts, in some cases, also issue anti-arbitration injunctions, putting the arbitration on hold.

5. Public policy: In recognition and enforcement proceedings, some jurisdictions construe the public policy widely and thus, it becomes difficult to enforce the awards.

The Way Forward

When dealing with multiple contracts between same parties, one must consider incorporating same dispute resolution clauses in all such contracts so that there is no multiplicity of proceedings in different forums. This is necessary to consolidate future conflicts and to save time and energy by avoiding multiple arbitration proceedings. Further, each contract’s arbitration clause must allow for the consolidation of disputes from related contracts and the scope of the dispute resolution clause must be wide. As a best practice, the parties must consent to consolidation and agree on the consolidation methods. As far as the intervention of domestic courts is concerned, there is a feeling that courts are wary of enforcing verdicts against the Government. Limiting the scope of judicial interference and ensuring the finality of arbitral awards is necessary. Also, Med-Arb clauses may be considered while entering such contracts. Mediation and arbitration can work hand in hand to resolve complex disputes and maintain harmony between parties for future contracts. Formulating contracts for shorter periods, say three years instead of five, may eliminate or at least bring down the need for price reviews, thereby refuting a significant dispute ground altogether. While choosing the arbitration seat, the parties must be careful with the approach of the courts of the seat. Lastly, arbitral institutions having a panel of experts in the field should be preferred and arbitrators should familiarise themselves with the dispute and its technical aspects before the proceedings begin.