How contractors should approach Middle East oil and gas contract negotiations

In my experience main contractors are hard-pressed to successfully negotiate changes to the contracts proposed by the procuring entities; particularly around issues like risk allocation, where the provisions will have been deployed in hundreds of previous projects. It is a particular challenge with the state-owned oil and gas companies in the region.

However, where there are risks that contractors do not want to take and are certain that they will not be able to pass down through the supply chain in the context of a specific project, contractors can and should push for changes – and may have some joy in doing so.

Below, I explore some of the commonly seen provisions that we have seen cause significant issues for contractors – from those dealing with local content obligations, to supply chain requirements, force majeure, and unforeseen site conditions – and examine the scope contractors might have to negotiate amendments or the other measures to reduce the risks they face arising from the contract provisions.

I will do this by exploring specific drafting from recent contracts in the regions, and for this purpose have chosen to look at the standard first tier construction and service contracts issued by the national oil companies in three of the most prolific of the regional oil and gas markets: the Kingdom of Saudi Arabia (KSA), Qatar and Abu Dhabi.

Local content obligations

Local content obligations typically take three main forms in the context of Middle East oil and gas projects: requirements around employment and training of local nationals; requirements relating to use of local suppliers and service providers; and overarching requirements concerning how much contractors must spend in the local economy.

These obligations are common both in local laws across the Middle East and within the contractual requirements that state-owned procuring entities like Aramco, QatarEnergy and ADNOC seek to impose – and there are different degrees to which those requirements can be negotiated down from contract to contract and different consequences for failing to comply with the contractual obligations.

It is crucial for contractors to understand the specifics of the local content obligations and ensure that the costs and resources needed to comply are fully factored into the bids to be submitted.

In respect of Aramco contracts, local content obligations are typically formed of two metrics.

The first is referred to as an in-Kingdom total value add (IKTVA) – a score that contractors are obliged to hit in terms of their total spend under the first-tier contract on, for example, locally sourced materials or research and development in the KSA.

In our experience, IKTVA requirements have been ratcheting up in recent years. For example, in one contract we were involved in negotiations with in 2016, the IKTVA score requirement was set at 35%; in a recent contract negotiation, the IKTVA score was set at 66% in year one, rising to 70% by year five. It depends on the particular works being procured but the general trend is up, and it is becoming increasingly difficult to comply.

Under Aramco contracts failing to meet IKTVA obligations constitutes a substantial breach of contract. Where contractors are responsible for such a breach, Aramco has a right to suspend performance of works or even to terminate the contract for default.

The second set of local content obligations common in Aramco contracts are often referred to as ‘Saudisation’ clauses. These set out requirements around the number of locals that need to be employed and trained. These provisions are typically quite detailed.

It is common that contractors will be required to employ a certain number of locals – sometimes in the hundreds – into a certain number of roles, right up to middle-management positions. For example, I have seen a contract where the contractor was required to train a certain number of Saudi engineers and then actively involve them in the project design process. In another case, a contractor was required to put a certain number of Saudi nationals through apprenticeship courses at Saudi training institutions.

Contractors cannot treat Saudisation provisions as if they are a ‘best endeavours’ obligation. The conditions are strictly applied, and the contract will usually include provision for the levying of financial penalties where they are not met.

The picture in Qatar has its own nuances. Under some QatarEnergy contracts, contractors may find they are subject to so-called ‘in-country value’ (ICV) requirements relating to their expenditure. These are similar to local content obligations like those linked to local procurement of goods or services, training a local workforce, developing local suppliers, and investing in local fixed assets.

In our experience, ICV elements are not a feature of all QatarEnergy contracts but where they do apply, there are often financial consequences for a failure to meet the ICV score specified. For example, I have seen contracts where some of the money otherwise owed to contractors for performance of works under the contract is withheld by QatarEnergy and only returned in full where the ICV score requirement under the contract is achieved. In other cases, failure to achieve ICV requirements under one contract can mean contractors’ ICV scores revert to zero for the purposes of bidding for future contracts, hampering their ability to be successful on future bids.

In relation to ADNOC contracts, the concept of ICV also applies but is broader. It captures things like Emiratisation, meaning the employment and training of locals as well as support for them once contracts are over, as well as goods manufactured or procured in the UAE. It also – somewhat unusually – considers the number of ex-pats who work on projects too, the more the better. Other factors such as use of advanced technology, sustainability measures and revenue generated from outside the UAE will also count towards contractors’ ICV score, unlike in Aramco and QatarEnergy mechanisms.

The ICV under ADNOC contracts is not only something that is taken into account when contractors are bidding for the contract, but also something they need to improve as part of performing the contract. Contractors, when bidding for ADNOC contracts, are expected to propose how they intend to improve their ICV score over the life of the contract.

Supply chain requirements

Procuring entities in the Middle East usually operate approved vendor lists from which contractors that win oil and gas construction contracts will be expected to select suppliers or service providers, often coupled with a preference for local companies.

In the KSA, Aramco typically operates approved local manufacturers lists, where contractors are subject to a mandatory requirement to ask those relevant local manufacturers to bid where the value of the tender is above a certain threshold. In one recent example, the threshold was set at $10,000, which is very low.

In that contract the mechanism provided that where three or more local bidders meet the technical requirements of the tender, contractors are obliged to select one of them to perform the works under the contract, even if they are more expensive to use than a non-local supplier. In circumstances where there are fewer than three compliant bids but Aramco still insists on the use of a local supplier that is more expensive, there is an opportunity for contractors to claim against Aramco for the price difference.

In Qatar, the concept of ‘national products’ – products that are of Qatari origin – originates in statute and often makes its way into first-tier contracts. National products must be used even if they are up to 10% more expensive compared to non-Qatari products.

Similarly, the separate concept of ‘products of national origin’ – products from Gulf Cooperation Council states – is a legal requirement that is also often built into the contracts. Contractors are obliged to use products of national origin provided they are no more than 10% more expensive than non-GCC products.

Under Qatari law, companies that fail to meet the requirements around national products or products of national origin can face a fine of up to 20% of the value of the purchase. This is provided under Qatar law and will apply regardless of whether such a penalty mechanism is included in the contract.

In our experience with QatarEnergy contracts, it is also common to see requirements around use of local subcontractors, as opposed to suppliers – again, even when they're up to more than 10% more expensive compared to non-local subcontractors. However, contractors do have some wriggle room to select non-local subcontractors if the other terms and conditions those companies offer beyond price are not matched by the local subcontractors.

ADNOC contracts tend to be less prescriptive, but contractors should expect to have to justify using non-UAE manufacturers.

The combined effect of the local content and supply chain requirements seen in regional oil and gas contracts undoubtedly makes it more difficult for new entrants to these markets, as they will face significant up-front costs in engaging the local workforce and building relationships with the local supply chains. Those investments are unlikely to be recouped on the first contract and would need to be viewed as a long-term strategy.

Force majeure and changed circumstances

Force majeure clauses are contractual clauses which alter parties' obligations and/or liabilities under a contract when an extraordinary event or circumstance beyond their control prevents one or all of them from fulfilling those obligations.

These clauses exist in most contract forms in the region, however amidst a turbulent geopolitical landscape, with war, terrorism, and the imposition of sanctions and tariffs, it is becoming harder for contractors to claim that events are extraordinary, making it more challenging for them to be able to rely on a force majeure clause in a contract.

While local laws in the Middle East recognise force majeure, it is common that the contracts for Middle East oil and gas projects contain very limited protections in respect of force majeure and it is usually difficult to negotiate an expansion, meaning contractors may need to rely on the relevant local laws in force to find a solution to events which are not clearly covered by the contractual clauses.

Where a force majeure event can be argued to have taken place under the contract, contractors are usually limited to claiming additional time to perform works rather than having any entitlements to costs. However, contractors seeking to negotiate such cost entitlements may be able to make a project-specific case for it where they can point to specific risks in the region and able to further evidence that the measures they might take themselves to insulate themselves against those risks – such as by taking out insurances – do not provide adequate protections and render the risks too high to take on in the context of the project.

Change in law clauses can also provide relief to contractors for changes in applicable laws taking place after contracts are signed and may be the most relevant contractual clauses for addressing the effects of ongoing tariff wars. However, the standards of protection for contractors provided for under change in law clauses in the Middle East varies.

Aramco contracts don't tend to contain any such protections, in contrast to other first tier contracting and service contracts in the KSA that concern non-oil and gas projects. QatarEnergy contracts sometimes contain clauses which provide time and cost relief for contractors for changes in law, subject to various restrictions and with a wide variety of drafting approaches. ADNOC contractors contain quite broad change in law clauses and could, for example, apply to changes in the local tax regime, while many QatarEnergy change in law clauses would not.

Adverse weather is another example of how circumstances can change and impact on projects after contracts have been signed. However, in the Middle East, the risk of adverse weather is typically only addressed in a very narrow and extreme way under force majeure clauses to encompass a natural disaster.

While the Middle East may not be as prone to extreme weather events as some other regions of the world are, with the changing global climate the region may not remain unaffected and contractors need to be aware of the limited protections they will have against the risks posed by adverse weather under Aramco, QatarEnergy or ADNOC contracts.

Unforeseen site conditions

Contractors that take on major offshore oil and gas projects can be exposed to significant delays and costs where adverse site conditions, unforeseen before contracts were signed, materialise. The contracts operated by Aramco, QatarEnergy and ADNOC all address this risk in a similar way, albeit with some differences.

Broadly, the initial onus is on the employer to undertake some form of survey to assess subsurface or site conditions and provide contractors with that data to help inform their bids for the contract.

The degree to which the information is accurate can become an area of dispute, and the contracts typically provide for the concept of ‘rely upon’ information to incorporate the site survey. However, contractors will often still be required to review and verify the survey data – but the mechanism by which this is to be done is often not made clear in the contracts.

This is an area that contractors might want to seek clarifications on during contract negotiations, so that it is clearer what expectation is on them to satisfy themselves that survey data is accurate and what reliefs they may be entitled to if the site conditions they find differ from those identified in the employer survey.

Further difficulties can arise for contractors if it is unclear how the data the employer shares should be interpreted.

For example, it is possible to imagine a scenario where subsurface data is shared for only certain points along a cable route, showing obstructions and rocks. It may be unclear to contractors whether they should interpret the data as showing obstructions and rocks along the whole route, as opposed to only at the points where relevant data was collected.

In that scenario, if employers assumed that contractors would have priced the risks in for the whole route but the contractor has not done so, a dispute may arise as to whether the contractor can claim compensation for encountering rocks or obstructions in locations for which data was not collected.

Sometimes employers will share their own site data interpretation reports with contractors, which may qualify as ‘rely upon’ information under the contract, but the position can become complicated if the contractor faces separate obligations under other parts of the contract to interpret the data itself – i.e. can the contractor rely on the interpretative reports or not?

Issues around sufficiency of data can also arise. Generally, contractors will be expected to take on the risk that the site condition data is sufficient to enable them to appropriately price risks. However, the question of whether a particular unforeseen site condition was due to the site data being insufficient or inaccurate can become an area of dispute, as it is typically employers that will carry the risk around data accuracy, at least for part of the data.

Under Aramco contracts, contractors may have some scope to negotiate what site data constitutes ‘rely upon’ data under the contract. Even for site data that qualifies as ‘rely upon’ data, contractors, as part of the tender process, should seek to clarify the extent of their obligations to review and interrogate that data.

In my experience, some QatarEnergy contracts do not contain any operative clauses dealing with site data and site conditions risk. However, the scope of work provisions often contain references to ‘rely upon’ information, leading to a lack of clarity over the scope of relief available for the contractor. This is something contractors should seek to clarify.

With ADNOC contracts, again it is common to see some subsurface data qualify as ‘rely upon’ data with accompanying time and cost relief for errors in that data. However, contractors should be aware that only where subsurface conditions they encounter were different to the ‘rely upon’ information in a way that was unforeseeable will they have entitlements to claim time and cost relief. This should be factored into the way contractors review the data shared with them.