Russia’s full-scale invasion of Ukraine on 24 February sent shock waves around the world. The response from many governments has been the imposition of sanctions on Russian businesses, particularly those with links to the Kremlin. In addition to this, many businesses have chosen to terminate their interests in Russia: household names such as Ikea, Starbucks, Microsoft, and many others have closed stores and stopped serving Russian customers, and payment giants Mastercard, Visa and American Express have also suspended operations in the country meaning that Russian-issued credit cards from these companies will no longer work outside Russia and new cards will no longer be issued within Russia. Airlines have stopped flights to and from Russia, and most countries have blocked Russian airlines from their airspace. Insurance and maintenance contracts have been withdrawn across the industry.
“In the current situation, we regard our position as untenable. We will now stop new investments into our Russian business, and we will start the process of exiting our joint ventures in a manner that is consistent with our values. Our top priority in this difficult situation is the safety and security of our people,”
– Anders Opedal, President and CEO of Equinor
In the energy sector, companies have been queuing up to terminate their Russian involvement. BP is to sell its 19.75% stake in oil producer Rosneft, while Shell has announced it will withdraw from its involvement in all Russian hydrocarbons, including crude oil, petroleum products, gas and LNG, and will immediately stop all spot purchases of Russian crude oil, shut its service stations, aviation fuels and lubricants operations in Russia. Norwegian oil company Equinor has announced its intention to exit its Russian joint ventures, and TotalEnergies will no longer provide capital to ventures in Russia.
In Britain, Centrica announced that it will exit its trading agreements with Gazprom, putting a spotlight on the activities of Gazprom Energy, which has about 21% of the business and commercial gas and electricity supply market in Britain, and Gazprom Marketing & Trading (“GMT”), which is a major market counterparty and gas shipper. Organisations across the country, particularly within the public sector are now evaluating whether they can terminate their supply contracts with Gazprom, and British Land has announced its intention to end GMT’s office lease agreement.
But for all of these grand announcements – and I am in favour of all legal actions to deter the Russian government from continuing its aggression in Ukraine – it is difficult to see how, some of these goals can be achieved. Take the BP-Rosneft situation as an example…BP owns just under 20% of Rosneft’s shares. Rosneft shares are listed on both the Moscow and London stock exchanges, but the Moscow exchange has been closed since the conflict began and is not going to re-open in the coming week, and LSE suspended trading in various Russian companies including Rosneft – the last trades recorded being on 3 March. It would be difficult to sell 20% of a large company through block trades on exchange under normal circumstances, but right now it is fully impossible. So BP’s only option is to sell the stake to someone else, but the pool of willing buyers has shrunk significantly: few Western businesses would consider such a move for the same reasons that BP is selling, and Russian buyers with the financial resources to buy such a large stake are likely to be subject to sanctions. A deeply discounted sale to Chinese investors may be one of the few options available.
It will also be difficult for businesses, NHS trusts and councils in Britain to end their supply agreements with Gazprom. Although Gazprom Energy is a major supplier in the UK, the gas being supplied is not Russian gas. In the British market, Gazprom is a trading counterparty and not a major producer, but while it will not be difficult for organisations to find new suppliers, they may run into difficulties with the legality of such a move. These Gazprom entities are not subject to sanctions to the degree that would enable contracts to be terminated on the basis of legality (most contracts contain provisions stating that if it becomes no longer legal to operate the contract it can be terminated – this would be the case if it became illegal to make payments to Gazprom entities under sanctions provisions).
Exiting these contracts could be difficult
Organisations now have a difficult balance to strike – there is pressure from the public and politicians to terminate these relationships, but underpinning the relationships are contracts and also laws. Contracts cannot simply be torn up because people no longer feel like dealing with Russian businesses and local authorities for example are prevented by law from discriminating against companies for non-commercial reasons, such as country of origin or political affiliation unless under the direction of central Government. Directors of companies have a fiduciary duty under the Companies Act towards shareholders which might be breached if decisions are not in the best interests of the organisation, although the recent introduction of the concept of “Enlightened Shareholder Value” probably providers directors with more discretion than they may have felt they had before.
“Given this invasion, it is right that everyone, not just the public sector reviews where they are buying Russian oil and gas. We know ultimately that money goes to support Putin‘s war machine and everyone should be looking to put an end to that. That certainly applies to NHS Trusts as well and they are a few that have had contracts with Gazprom and I am sure that they will all be looking now what’s the best way they can bring an end to that relationship very quickly,”
– Sajid Javid, Secretary of State for Health and Social Care
Absent Gazprom entities being further included in sanctions regimes or direct legislation affecting the legality of these contracts, it’s not immediately clear what legal basis there would be for buyers to terminate these deals without penalty or the risk of litigation. LinkedIn has been full of discussions around the use of force majeure clauses, but this does not seem like a particularly sound approach unless Gazprom becomes unable to deliver gas and electricity under these contracts which is not currently the case. The restrictions placed on Gazprom’s abilities to raise finance (Gazprom has also been suspended by the LSE) might provide some scope under clauses designed to ensure parties remain solvent and maintain suitable credit standings.
Otherwise, companies might be able to exercise early termination rights which permit a party to terminate on payment of a fee. Because market prices are now so much higher than they were when these contracts were entered, break costs even on fixed price contracts could be minimal, but organisations will be faced with finding replacement deals at higher prices, and for public sector organisations which are bound by a requirement to make decisions on an economic basis, this is where the main difficulty lies…they will almost certainly be faced with entering replacement contracts on a worse economic basis than the contracts with Gazprom.
The Government could resolve this by providing an exemption to these public sector and local government non-discrimination requirements that is either specific to Gazprom entities, or is defined in some way to capture wider Government policy such as not supporting businesses linked to the Russian state. Interestingly, Sheffield Forgemasters, which produces steel for Britain’s nuclear submarines and which was nationalised last year, has been instructed to terminate its supply agreement with Gazprom.
For private-sector companies, directors could contemplate two justifications to shareholders: the first would be that they are acting under an expectation that it will become increasingly difficult to trade with Gazprom, and so it will become inevitable that the contracts need to be replaced and that a delay in responding to this risk may have a worse outcome as market prices could rise further in the meantime; and the second is that although there may be a short-term economic impact from replacing these contracts, this is considered by the directors to be lower than the reputational and other damage that might be caused by not acting, and continuing to maintain a business relationship with an entity that is ultimately controlled by the Russian state.
Companies which are using GMT as a gas shipper have a different set of concerns. Many of these agreements will include shipping and supply and are structured as master agreements under which individual trades are made in addition to the shipping service. Termination of master agreements once any of the individual purchases have expired is normally fairly simple and can be done at any time subject to certain notice periods. The challenge for these companies is finding another shipper….there are few companies offering third party shipping services following the demise of CNG las year. Possibly the best option for these companies is to sign a short-term agreement with an alternative shipper on whatever terms are offered, and secure their own shipping licences as soon as possible.
Ofgem could usefully intervene and invite Centrica, which arguably set this ball rolling when it announced its intention to terminate its own agreements with Gazprom, to step in to support what are primarily smaller suppliers, until they are able to establish their own shipping operations. There is an argument to be made that being unable to manage your own physical gas logistics is incompatible with being fit and proper to run a supply business, and that suppliers should have the operational capability to operate without undue reliance on third parties, with robust contingency measures relating to third party services (this should extend to other operational areas such as metering, billing, and customer services).
Both energy consumers and those using Gazprom as a shipper need to consider their next steps carefully. The more businesses that terminate contracts and trading arrangements with GMT, the less market liquidity it will be able to access, which may in fact at some point compromise its ability to fulfil its remaining contractual obligations. While this would give rise to a clear termination right, it might also necessitate replacing supply and shipper contracts at short notice which is far from ideal.
The impact of the crisis in Ukraine is being felt across the British economy, and is having a direct impact on businesses and public sector organisations of all sizes. It is vital that organisations evaluate these new risks carefully, and resist the urge to act without thinking through the full impact of these decisions. My LinkedIn feed is also full of warnings about unscrupulous TPIs and brokers cold calling energy users and presenting misleading and in some cases entirely false information about the Gazprom situation. It is not currently illegal to trade with Gazprom in the UK, and Gazprom is not bankrupt. Both of these might become true, but they are not true at the moment, and energy buyers should not be mis-led by such claims into rushed decisions to break contracts which might have serious legal consequences.
It has never been more important to have well defined and carefully thought out energy risk management policies, and robust procurement strategies.