In the fallout from Winter Storm Uri, Courts continue to clarify the meaning of key provisions in NAESB natural gas contracts. For decades, the check-the-box NAESB terms such as cover standards, payment methods, and force majeure provisions faced little scrutiny. But then Uri froze the Southwest, broke the energy supply chain, and sent gas prices into uncharted territories. The resulting high-dollar claims enticed industry participants to litigate the meaning of often overlooked terms.
The Eleventh Division of the Texas Business Court issued a trilogy of opinions in response to Marathon Oil’s force majeure declaration under a NAESB base contract with Mercuria Energy America. Similar to other NAESB cases: the parties entered a deal that was subject to a NAESB and the added “Special Provisions.” When Uri disrupted Marathon’s gas production, it declared force majeure. Mercuria rejected the declaration, and the suit ensued.
Round One: Battle of the Forms
The first opinion presented a “battle of the forms” issue that arose when the parties entered an ICE deal but exchanged differing Transaction Confirmations. Gas traders often submit bids and negotiate deals on Intercontinental Exchange or “ICE.” Following an agreement, the deals are usually “booked” and either one or both parties circulate a Transaction Confirmation memorializing the deal’s terms.
Marathon and Mercuria’s Transaction Confirmations contained the same price, quantity, delivery point, and duration terms that were agreed to over ICE. But Mercuria’s Transaction Confirmation, which it sent first, denoted that the transaction was “firm,” or uninterruptible without cause. Subsequently, Marathon sent a Transaction Confirmation that added a “pipeline term:” Enable Gathering and Processing. This, it argued, designated the pipeline that would transfer its supply of gas to the trading hub.
Mercuria signed and returned Marathon’s confirmation with checkmarks added to every term except the pipeline term. Mercuria argued that the pipeline term did not become a part of the deal because (1) the ICE agreement did not include the pipeline term, and the ICE agreement controls; (2) the confirmation materially differs from the NAESB; and (3) Mercuria rejected the term when it did not provide a check mark.
This issue was important, as Marathon likely had gas available on alternative pipelines. The pipeline term effectively limited the gas supply analysis to one source. Ordinarily, several pipelines transport gas to a pool or hub. Shippers may have gas transportation contracts with only some or several different pipelines. The inclusion of the pipeline term could prevent Mercuria from arguing that Marathon had gas available on alternative pipelines.
The Court rejected Mercuria’s arguments. First, the parties elected for an oral transaction procedure under the NAESB. An ICE exchange qualifies as an oral transaction, but the NAESB required the “Confirming Party,” here Marathon, to send Mercuria a Transaction Confirmation within three business days. Mercuria may also send its own, which it did. The NAESB further provides that Transaction Confirmations are binding unless the other party provided written notice of disagreement or the terms materially changed the terms of the NAESB or the oral agreement.
Here, neither party objected to the circulated Transaction Confirmations at the time they were circulated. The Court therefore held neither party provided the requisite written notice of disagreement. The Court further held the absence of check marks failed to provide notice of disagreement. And the Court did not agree that Marathon’s confirmations materially differed from either the NAESB or the oral agreement.
In its analysis, the Court referenced NAESB Section 1.2, which distinguishes between commercial terms (i.e. price, quantity, performance obligation, delivery point, period of delivery and/or transportation conditions) versus terms that modify the NAESB (e.g., arbitration provisions or additional representations and warranties). The parties must expressly agree to the latter, whereas the parties must expressly reject the former. Therefore, the Court held that both Transaction Confirmations could be read together with the NAESB as one contract; the pipeline term became a part of the agreement, likely foreclosing Mercuria’s ability to probe Marathon’s alternative supply sources. Sellers that utilize several pipelines at the same hub or pool should consider specifying the pipeline in their Transaction Confirmations moving forward.
Round Two: A Special Provision that “Knocks Out” the Replacement Gas Conundrum
Judge Andrews’s second opinion may solve a frequently litigated issue. That is: must a party purchase gas on the spot market to (1) meet its delivery obligations or (2) to satisfy 11.2’s “reasonable efforts” condition? The Court, relying on several recent cases such as Mieco LLC v. Pioneer Natural Resources, USA, held that a party was not required to purchase gas on the spot market to satisfy its delivery obligations or to demonstrate its reasonable efforts to avoid the adverse impacts of URI.
These cases provide several key takeaways. First, the force majeure event need not render performance literally impossible, “because a buyer could always point to some gas available to the seller to buy, and the buyback method is never precluded due to a weather event.” Second, a party’s prior spot purchases and buybacks do not mean that such practice is a reasonable effort during a force majeure event. As the Mieco court held, in past instances where a party replaced its lack of supply through a buyout or spot purchase, the “party did not have the option to not perform because a shortage of gas without a [force majeure event] is not a force majeure occurrence.” The Mieco court was especially persuaded by the fact that, in other contracts, Mieco included special provisions specifically precluding a declaration of force majeure when replacement gas was available to purchase.
In Marathon, the Court also examined the parties’ Special Provisions. Relevantly, that “to the extent such failure was caused by Force Majeure [then] the party claiming excuse shall have no obligation to seek alternative Gas supplies in order to satisfy any obligation hereunder.” The Court construed this provision as relieving Marathon of the obligation to purchase spot gas or buyback its position to satisfy the 11.2 “reasonable efforts to remedy the event or condition” provision. While other courts may reach the same conclusion in the absence of this provision, its addition may prevent future disputes.
Round Three: A Draw – Neither Party Conclusively Proved Actual Damage
In its last published opinion, the Court considered whether Mercuria’s damages were an unlawful penalty, and whether Marathon’s cost-basis theory was an appropriate measure of actual damage. This issue was raised via summary judgment where Marathon alleged Mercuria replaced its loss of supply through storage gas that was purchased before the storm. The storage gas was purchased for ~$2.00 per unit, whereas gas prices reached over $250 at the West Transfer Delivery Point during the event.
The parties’ NAESB provided for Spot Damages, meaning Mercuria was entitled to the difference between the contract price and the market price of gas at the delivery location, or the closest geographic location with a posted price. The contract price under the Transaction Confirmation was $2.61, so Marathon argued that Mercuria saved money when it replaced Marathon’s shortfall with cheaper storage gas. Marathon argued that awarding Mercuria twenty-plus-million when Mercuria’s actual damage was zero constituted an unlawful penalty.
The Court was unpersuaded. The Court held neither party had conclusively proven Mercuria’s actual damage. Both parties submitted damage models that relied upon differing geographic price postings or used weighted averages. Due to the competing models, the Court held neither party conclusively established damages, which is quintessential to any penalty defense. Additionally, the Court rejected Marathon’s argument that utilizing previously purchased storage gas was tantamount to Mercuria purchasing “cover gas.” “Mercuria did not ‘cover’ – i.e., it did not ‘purchase’ substitute goods ‘after a breach.’ Instead, Mercuria used gas it already owned and purchased well before the breach.”
In sum, the Court determined that Marathon’s “cost-basis” damage model, which relied upon the direct cost of storage gas purchased before the breach, was the improper measure of damages for a penalty analysis. These issues were before the Court on summary judgment, and Marathon ultimately won on liability at trial. Hence, the issue of penalty remains uncertain and may be raised again.
Round Four – The Final Knockout
The first trial in Texas’s new Business Courts, delivered a final knockout blow to Mercuria. Following a four-day bench trial, the Court issued final judgment declaring that the extreme weather caused by Winter Storm Uri constituted a Force Majeure. The Court further held that Marathon made reasonable efforts to avoid the adverse impacts of Force Majeure. Therefore, Marathon’s failure to deliver gas was excused.