Many energy companies and commodity producers, shippers and traders have made pledges to reduce carbon emissions and operate more sustainably. However, in our experience and with some limited exceptions touched on below, we have not yet seen this filter down into the contracts by which commodities are routinely bought, sold, processed and transported.
In this article we consider why that is necessary and, more practically, some of the contractual tools that may be used to assist companies in meeting their carbon emissions reduction and sustainability targets.
The energy transition will of course take time and fossil fuels will not be eliminated overnight. Fuels, such as LNG, are growing in the interim as more renewable sources of energy and emissions reduction technologies are developed. Demand for various metals and minerals will grow significantly to meet the demands of electrification and renewable energy. Soft commodities markets are being impacted by climate change and the need to source our food sustainably. Trading of more “sustainable commodities” (for example biofuels, carbon emissions and sustainably produced metals) is increasing.
Emissions reduction and sustainability need to be addressed not only in the production and end use of commodities, but also in their trading, processing and transport. The method of performance of a contract for supply of any commodity, including the emissions from shipping and reduction or capture of emissions from the use of fuel, can be addressed. Jeremy Weir, CEO of Trafigura, one of the world’s largest oil and metals traders, has commented that “Just as the shift from hydrocarbons to electrification and renewable energy is changing the fundamentals of the commodities we will need, how those commodities are produced, processed and transported along supply chains needs to change too.”
In the LNG market, for example, carbon emissions in respect of some cargoes of delivered LNG are already being assessed and regularly reviewed, based on agreed methodologies, and the emissions can therefore be managed and reduced. Related contractual obligations include obligations to reduce emissions over the term of the contract and potential levies if a specified quantity of emissions in performance of the contract is exceeded. Sales of LNG cargoes may also be bundled with carbon credits.
Similarly, many biofuels have to be certified as sustainable and carbon emissions from the production, processing and transportation of such biofuels are routinely assessed.
Companies in the sector also need to be wary of charges of “greenwashing”, meaning overstating their sustainability credentials in order to attract and retain customers and investors. There has been a rise in complaints, legal proceedings and regulatory enforcement related to greenwashing and it is important that environmental and sustainability claims are accurate and based on objective evidence. Embedding and enforcing contractual obligations related to emissions reduction and sustainability into relevant contracts can likely only assist.
Whilst individual companies may make pledges and adopt initiatives to reduce emissions, in order for them to be effective it seems essential that these issues become an embedded requirement throughout the entire commodity value chain so that all parties involved are playing a meaningful role to operate sustainably and reduce emissions. As explained further below, to achieve this and ensure change does happen will likely require the imposition of relevant contractual obligations on each party involved in commodity supply chains.
What are the relevant types of emissions and how are they measured?
The first step is to consider what type of emissions are relevant and how they can be measured and verified. Only when such emissions can be measured can market participants then set about reducing them.
The relevant elements to carbon emissions reduction along commodity supply chains include the following:
- Carbon emissions directly from production of the relevant commodity;
- Carbon emissions from transport and processing of the commodity; and
- Carbon emissions from the end use of the commodity.
It is also important to keep in mind sustainability issues in respect of the production of the relevant commodity, including issues such as land use change and deforestation, use of resources such as water, working conditions and fair treatment of workers.
Whilst there is not yet one standardised methodology for the measurement, reporting and verification of carbon emissions, there are recognised methodologies available. Many companies have already adopted methodologies to routinely report their emissions. A relevant commodity-specific example, again in the LNG market, is the SGE Methodology for measurement reporting and verification of carbon emissions for delivered LNG cargoes. This Methodology has been developed in partnership by Chevron, Qatar Energy and Pavilion Energy and is intended for adoption by the market, thereby enabling the transparency and credibility of reporting of greenhouse gas emissions for LNG cargoes. Another example is the International Sustainability and Certification (ISCC) scheme which is commonly used in the biofuels market.
Creative methods to incentivise other parties involved in the supply chain may be required. For example, there might be cheaper finance available for sustainable products, meaning lower prices can be offered. However, we see little reason why methodologies for the assessment and reduction of emissions and sustainable practices throughout commodity supply chains cannot be developed and implemented by co-operation and agreement of the parties involved.
Why are the contracts relevant?
At each stage in any commodity supply chain sit the contracts under which commodities are produced, purchased, sold, financed, processed and transported. Whilst some companies may have made commitments to reduce emissions or improve sustainability, in order to meet these commitments, decarbonisation and sustainability obligations will need to be embedded into the entire value chain. For example, a commodity may be processed, shipped, and bought and sold between traders multiple times before it reaches the end user. Decarbonisation and sustainability can only likely be achieved if each of the contracts involved in that chain include relevant obligations such as requirements to supply commodities produced sustainably, a framework for calculation of the carbon emissions from performance of the contract and an obligation to perform the contract in a manner which emits as little carbon as possible.
Whilst this is likely necessary in all contracts, it will be particularly important in longer term contracts. As new technologies and initiatives are developed during the term of the contract enabling further reduction of emissions, the parties involved should be obliged to adopt them and continue to reduce emissions throughout the term of the agreement and perform the contract in the most sustainable manner possible.
An important part of this shift will therefore mean ensuring that these contracts, regardless of the commodity, properly address commitments to reduce carbon emissions, ensure sustainability of supplies and performance of the contract in a sustainable manner. As such, we believe that lawyers have a key role in drafting emissions reduction and sustainability assessment provisions and frameworks for commodities contracts.
Adopting Sustainable Commodities Contracts
We have identified several examples of ways in which contracts can be amended to assist companies in reducing emissions and ensuring sustainable performance of contracts. A number of these examples have been proposed by The Chancery Law Project which is a network of legal professionals focused on ensuring contracts enable solutions to climate change.
Non-Disclosure Agreements (NDAs) and Heads of Terms
Climate change issues and the alignment of commercial objectives with emissions reduction policies are rarely discussed at the outset of a new commercial relationship or identified at that early stage as a key focus for the parties. As a result, they can be relegated to secondary issues or brought up towards the end of a negotiation, if at all. Consider insertion of relevant provisions in precedent NDAs and Heads of Terms to ensure climate change, environmental and sustainability issues are discussed at the outset of a new commercial relationship.
Commodity Sale and purchase contracts:
- Include undertakings and methodology to calculate the carbon footprint of the contract – including from production, processing, transport and, if possible, end use of the relevant commodity – and obligations to develop and implement a plan of ongoing assessment with the object of reducing the carbon footprint. This may include, for example:
- Defining the term “carbon footprint”;
- Agreement to a methodology for assessment of the carbon footprint;
- Regular (say, on an annual basis) assessment of the carbon footprint and sharing of results;
- Development and implementation of a plan for ongoing improvement;
- Potentially, levies/liquidated damages for poor performance/higher emissions.
- Consider inclusion of carbon as a quality specification of the commodity itself and methodology for assessment.
- Consider inclusion of undertakings concerning sustainable sourcing and production of the commodities.
By way of example, in relation to metals and minerals, the OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas expressly recommends that a supply chain policy (and the same guidance includes a sample policy) should be incorporated into contracts with suppliers. Whilst companies may have these policies in place and may conduct due diligence, their value may be questionable unless they are incorporated into contracts with suppliers so that they can enforce compliance or, if necessary, terminate a relationship for failure to comply.
Green Termination Provisions
For example, parties may be locked into supply contracts where the buyer has identified that an alternative supplier offers more environmentally friendly goods or services. Consider inclusion of a standard clause to allow the buyer to exit the agreement without incurring liability unless the existing supplier is able to at least match the green improvements represented by the alternative offer.
Green governing law and litigation and arbitration protocols
Contracting parties can ensure that, whatever governing law is chosen to resolve disputes rising from the contract, that law will be construed in a manner consistent with the goals of the United Nations Framework Convention on Climate Change (UNFCC) and the Paris Agreement and the manner of dispute resolution shall also be Paris aligned. There are also protocols that can be adopted in arbitrations to ensure that the arbitration is conducted in a carbon efficient manner.
Other issues to consider addressing in commodities contracts
- End use requirements;
- Risk sharing of climate events and pandemics;
- Travel policies.
- A contractual duty in charterparties for both parties (charterers and owners) to take all reasonable steps to maximise energy efficiency and payment of liquidated damages for failure to comply;
- A clause encouraging the parties to consider opportunities and cooperate to maximise the laden ratio of the vessel and minimise repositioning voyages in ballast during the charter period, thereby promoting more efficient (and therefore more cost effective) use of a vessel, facilitating cooperative dialogue between owners and charterers, and potentially opening up additional employment opportunities for the vessel;
- Obligations concerning use of “green” fuels and related reporting and disclosure, combined with an obligation to pay a levy for using fuels with a higher carbon content;
- An optional mechanism for time charterparties, to share the cost (between owners and charterers) of the shipowner’s investment in fuel-saving technologies or operational improvements which improve the fuel efficiency of time-chartered vessels, benefitting the charterer with long term savings on fuel costs and the shipowner by making such improvements affordable where they would otherwise be commercially unattractive;
- Rights to terminate a long-term contract for the transportation of goods for a greener carrier or shipper. It encourages green competition between incumbent and competitor carriers or shippers, while incentivising appointed carriers or shippers to continuously improve their green performance.
Without express contractual obligations related to emissions assessment and reduction and sustainability issues similar to those outlined above, we find it difficult to see how companies can properly meet their emissions reduction and sustainability targets and ensure decarbonisation throughout commodity supply chains.
With that in mind, we believe that companies in the energy and commodities sectors should be conducting reviews of their contract templates and precedents and/or standard terms and conditions to address these issues and ensure that they are included in all future contracts.
Whilst words in the contract may not be the ultimate answer, significant change is unlikely to happen until these types of obligations can be contractually enforced throughout supply chains and we consider it is an essential starting point to drive change in the way businesses operate.
At Mercatis Law we are very excited to partner with our clients in the energy and commodities sectors to help develop ways to drive forward the transition to a low carbon economy.
About the Author
Simon advises on disputes, transactional and advisory matters in relation to the trading, transporting and financing of a wide range of physical commodities. He aims to provide practical, commercial and solution focused advice to his clients which include major mining companies, oil majors, commodity traders and investment banks. Simon has acted on matters in connection with most of the major events to impact the commodities sector in recent years including, for example, the Qingdao metals warehousing frauds, defaults arising during the COVID-19 pandemic and the war in Ukraine.
Please call him on +65 8922 6192 or click here to email him to discuss anything contained in this Client Alert or any other related queries.
The information contained in this Client Alert is intended to be a general guide only and not to be comprehensive, nor to provide legal advice. You should not rely on the information contained in this Client Alert as if it were legal or other professional advice.