Navigating global supply shock events in the Middle East oil and gas industry

Tariffs, shipping crises and global inter-state conflicts, however, have created substantial challenges for suppliers of major oil and gas services. At the same time, post-pandemic EPC contracts continue to suffer from the unique drafting of provisions which often seek to limit contractors’ relief for delay and cost originating from these unforeseen supply chain shock type events, while also imposing rigid procurement constraints through nominated or preferred subcontractor regimes.

Understanding the potential avenues available to manage these risks under the contract or as a matter of law remains crucial to successful execution of major oil and gas projects in the Middle East.

The first step for energy services companies looking to manage a globally unforeseen event is to identify the forms of relief available within the contract. In some cases, contracts may expressly permit contractors to claim additional time and cost, sometimes within the scope of the variation clause or perhaps the change in law or force majeure clauses.

For example, entitlement might exist if one of the qualifying bases within the variation clause includes: “the occurrence of any event which would have the effect of modifying the Work and/or the critical path” or words of a similar effect. Often, however, Middle East oil and gas EPC contracts do not contain such wording.

An example of a force majeure clause found in sub-clause 18.1 [Exceptional Events] of the FIDIC Silver Book Second Edition (2017) provides that qualifying events are those that are beyond the parties’ control, could not have been reasonably foreseeable before entering in the contract or are avoidable once the event had arisen, and which may include events such as wars and hostilities, whether war is declared or not, natural catastrophes, terrorism, or acts of public enemies.

Commonly, EPC contracts in the Middle East oil and gas business are FIDIC-derived and carefully crafted to limit the employer’s financial exposure, such that relief can be found for time but not compensation.

It is also common for oil and gas developers to restrict the geographical scope of qualifying force majeure events to either the country of the project, or perhaps the region, potentially preventing contractors seeking to claim relief for cost increases or delays originating from suppliers based in other jurisdictions.

Given the apparently recurring cycle of force majeure events happening which repeatedly have a negative time and cost impact on these projects, it is incumbent on contractors to carefully review the wording of their force majeure clause and consider whether the variation clause can be used in unforeseen circumstances to give rise to entitlement to relief. This should not be left until after the occurrence of a supply shock event, when the focus of the commercial team’s attention should be on reacting and mitigating the impact of it, rather than negotiating the interpretation of the contract.

If there is doubt surrounding the scope of contractual relief available, it may be open to parties whose contracts are governed by Middle Eastern civil codes to rely upon the civil law doctrine of exceptional circumstances or hardship.

The specifics differ slightly between jurisdictions and are different, for example in Saudi Arabia and Qatar, but the common theme is that if unforeseeable events considerably alter the agreement, a party may seek judicial or arbitral intervention with a view to having the loss rebalanced.

While civil code doctrines may be helpful because they might permit a party to recover costs, where such relief is not strictly apparent under the contract, unless the parties agree amicably, invoking these doctrines requires a formal decision maker, such as a judge or arbitrator, to determine whether the event was unforeseeable and whether the losses are sufficiently exorbitant. These matters which are not defined by the law and reliance upon civil code articles is, ideally, supplementary to contractual arguments if they are available.

An interesting dilemma arises when EPC contracts mandate procurement exclusively from employer-approved or nominated suppliers and pre-approved vendor lists. Initially intended to maintain quality and consistency, recent accounts indicate that strictly enforcing this requirement can greatly exacerbate delay and cost overruns in the wake of global supply shock events.

For example, during the Covid-19 pandemic, certain Italian steel parts were impacted. If the pre-approved vendors were all in Italy, the contractors may have sought permission to go elsewhere to mitigate the resulting delaying impact. In many instances, this was substantially delayed or rejected completely, resulting in corresponding delays to the project.

In these scenarios, what is required is an analysis of firstly the need to mitigate, which is often contractually and legally required, secondly the requirement to follow the contract, thirdly the implied term that an employer is required not to prevent the contractor from performing its works, and is required to act cooperatively  and finally, in the Middle East, the requirement for parties to perform their obligations in good faith, which is often introduced by contractors in this context.

Geopolitical events which are unpredictable and disruptive by nature, appear to be cyclical and remain a significant risk for Middle Eastern oil and gas projects. Contractors and employers alike benefit from clear, and collaborative communication, which recognises the balance required between strict adherence to the contract and recognition of the principles of the civil codes.

If carefully managed at the tender stage, contracts can be drafted to reduce ambiguities in these situations and avoid mismanagement impacting optimal project outcomes. Embracing a balanced, and practical approach, reflecting a ‘shared pain’ mentality and mutual responsibility is key to successfully managing any uncertainty.