Covid-19 has depressed demand for energy and commodities in recent months. With many economies now in or heading towards recession, demand is clearly going to be depressed for the foreseeable future. Such weakened demand emphasises the value and importance of energy and commodity storage.
This article is intended as a brief and high level overview for energy and commodity owners and suppliers looking to negotiate storage contracts and sets out some key practical and legal points to think about.
Initial Practical Considerations
Here are some important guiding principles that you should think about at the start of any negotiation. These are based on my experience of negotiating storage agreements over a number of years:-
- Plan ahead: before starting to negotiate, you should come up with a clear and focussed strategy as to what issues matter to you most. If possible, you should look to form an early view about whether the storage owner will be receptive to suggested changes.
- Be realistic: it is unlikely that you will obtain all the changes you ask for. Storage owners have good reason for wanting certain clauses and they are unlikely to concede ground easily.
- Prepare to compromise: all negotiations involve an element of give and take. Have a clear idea as to what are your “must haves” versus “nice to haves”. From my experience, it is rare for storage owners to refuse changes, particularly where they are reasonable. After all, they are in the business of attracting and keeping long term customers and will look to accommodate requests, particularly ones they think are reasonable, where they can.
Key Legal Areas to Consider
1. Storage Fees: you should clearly understand what fees will be payable and in what circumstances. Many contracts contain tank rental fees which are payable irrespective of the amount of product stored. In addition, minimum storage or throughput based fees are common. You should be clear as to what the financial impact will be if the amount of product being stored or throughput is less than the minimum contractual requirement. Bear in mind that whilst take or pay levels may be set at a low level, many of the additional services operators offer (eg: fees for entry/exit, blending, heating or pump over services ) often attract high fees. These can sometimes be overlooked particularly as they are often embedded in a schedule of fees at the back of the contract.
Also, many contracts allow a storage operator to amend their rates. Customers will usually have the right to approve changes but beware contracts which provide that the increased rate will apply should you, as the customer, not object within a given time period. You should also understand what the consequences of non-acceptance will be. Typically, a customer will need to accept the revised rate or else terminate the contract.
Lastly, some storage contracts trigger a right to renegotiate if economic circumstances change to such extent that the fundamentals of the originally agreed deal have changed. This obviously gives the operator justification for reopening the contract and seeking to increase its rates.
2. Force Majeure: very much the hot topic! Although force majeure will depend on the contract in question, under English law at least, adverse economic conditions and falls in market demand, are not typically force majeure events. To amount to force majeure, the event generally has to be something which prevents a party from performing its contractual obligations. So in the context of a storage arrangement, this means a physical impediment preventing import or export of the product into or from the particular tank or facility.
Despite these evidential difficulties, the highly unusual nature and impact of Covid-19 has compelled market participants to construct FM related arguments that point to operational constraints whereas in reality the impediment is likely to be wholly or exclusively a fall in market demand. This step is often taken with a view to paving the way for a contract renegotiation and, in the current environment, some would argue that it would be a brave counterparty who would flatly reject an FM notice without also entertaining some form of “without prejudice” commercial renegotiation of the contract.
FM clauses in storage contracts sometimes provide that they will terminate after a certain period of time. Clauses with lengthy periods (e.g. 3 or 6 months) are not uncommon. This will mean that you may have to wait a considerable period of time before being able to terminate or knowing for certain whether or not your storage is going to be terminated or not.
3. Tank Maintenance: many storage contracts have provisions dealing with planned or unplanned maintenance. Often, particularly for planned maintenance, storage operators are obliged to offer up replacement storage. For those events and, certainly for unplanned events, it is important to know what legal rights you have particularly with regards to continued payment of rental fees and the possibility of terminating or claiming compensation if the outage is prolonged.
4.Operational Losses: product losses due to normal operations at a storage terminal are common. Storage contracts often have a tolerance limit up to which such losses can be incurred without the storage owner being liable. These operational loss ranges can vary considerably and need to be assessed carefully. Furthermore, as mentioned below (clause 7), often losses above the tolerance limit will only be reimbursed if caused by gross negligence or wilful misconduct. This tends to be a high evidential burden to overcome and, from my experience, often difficult to prove in practice.
5. Title, Risk, and Inspection: there should be clear provisions in your contract specifying exactly if and when title and risk transfers in the product. From a practical standpoint, you would also be well advised to have inspection rights to allow you to have agents attend the facility in order to check that the products are being stored in an appropriate and secure manner.
6. Insurance: the storage operator should be required to have sufficient insurance cover to guard against products being lost or contaminated. However, it is common for a request for the cover to be increased or widened to be refused on the basis that it is against the operator’s policy and/or that the cover provided is in line with the risk/reward basis underpinning the contract. In practice, it can be difficult to persuade an operator to increase its cover without having a knock on effect to other commercial provisions (eg: pricing) in the contract.
7. Liabilities: you should be clear what your rights are if product losses, contamination, or delay in retrieval of product occur. Typically, a storage owner will be keen to limit its liability to acts or omissions amounting to gross negligence or wilful misconduct and/or cap their liabilities to direct losses and/or impose a financial cap. This might mean that you face an uphill struggle to bring a successful claim against a storage operator. As an aside, it is worth noting that English law has no established concept of gross negligence although increasingly the courts will seek to interpret and give effect to it when it appears in contracts.
Time bars within which a customer must bring a claim are also common. It is important to ensure these are not unduly restrictive.
As for customer liabilities, storage owners often look to hold the customer responsible not only for physical damage (e.g. to tanks) but also for losses arising due to contamination of third party product as well as other knock on losses experienced by the storage owner. You should ensure that your insurance coverage is robust enough to cover these eventualities. When faced with such wide rights, you should be comfortable as to the level of risk being taken on and, where necessary, seek to limit your risk by eg: negotiating monetary caps in line with your insurance limits.
8. Insolvency: you should be comfortable as to your rights and the procedures involved in recovering your product if the storage owner, or another trader storing commingled product at the terminal in the same tank or alongside your product, ceases trading or becomes insolvent. For storage contracts, this will often depend on the jurisdiction in which the storage contract is located and may require specific contractual provisions, or the issuance of certain title transfer documents, to ensure successful retrieval of product. From my experience, this element of due diligence is often and unfortunately overlooked.
9. Granting security over products: you may wish to finance your products in storage. Before doing so, you should conduct a legal analysis of the storage facility’s jurisdiction to understand whether effective security can be granted over the products. In addition, the consent to any security being taken will usually need to be given by the storage provider. A key issue to here is the common insistence that the operator be granted a lien over the product as security for unpaid fees. Care should be taken to ensure that such a lien does not adversely affect or inhibit your ability to offer up the product as security for any financing.
10. Sub-leasing: finally, you may wish to have the option to sub-lease your storage to third parties. Understandably, storage owners are not keen to allow this unless they either have immediate rights of recourse against the sub-lessee or else the original customer remains liable for the sub-lessee’s payment of fees and liabilities. You should therefore be comfortable as to the risks you face before you agree to sub-lease. As you can appreciate, storage owners with excess storage capacity are often reluctant to agree to any sub-leasing at all for fear of ending up in a situation where they are competing with their existing customers to sell their storage capacity.
Conclusion
The above is meant as a brief summary of some key practical considerations and legal issues to bear in mind when you are considering and looking to negotiate a storage contract. As this article shows, a number of different issues need to be considered. Also, standards vary quite considerably between storage terms and therefore care should be taken when reviewing them. On the plus side, when tackled in the right way with a strategic and focussed approach, my experience suggests that an operator can usually be persuaded to give ground on any reasonable “must have” requests. After all, they are in the business of attracting and keeping long term customers and will look to accommodate requests where they can.
Provenance Legal | Oliver Mellman | Law Firm 