In June 2017, the Japan Fair Trade Commission (JFTC) issued its conclusion on an earlier market study on liquefied natural gas (LNG) resale restrictions and cautioned that (i) destination clauses, (ii) diversion clauses, (iii) profit-sharing clauses and (iv) take-or-pay clauses in LNG sale contracts may fall afoul of the country’s antimonopoly laws.
JFTC’s Views and Conclusions
Destination Clauses. The JFTC found that, in relation to FOB contracts (where risks and title are passed to buyers at the time LNG is loaded on vessels at the shipping port), restrictions posed by destination clauses are neither necessary nor reasonable. The JFTC explained that, since liabilities and title have already been passed to buyer at the loading port, it would be difficult to justify an FOB contract provision that requires LNG to be unloaded at only certain designated terminals. In addition, since buyers are responsible for transportation after LNG shipments are loaded onto vessels, destination clauses cannot be said to be necessary in those scenarios. As a result, a destination clause in an FOB contract is likely to violate the antitrust laws in Japan. With respect to DES contracts (where risks and title are passed to buyers at the time LNG is unloaded from vessels at the destination port), the JFTC considered that destination clauses are necessary because (i) risks, liabilities and title are passed to buyers at only the destination port, and (ii) sellers are responsible for transportation under those contracts.
Diversion Clauses. The JFTC took the view that diversion clauses conditioned upon seller’s consent in most cases do not sit comfortably with Japanese antimonopoly laws for both FOB contracts and DES contracts. Diversion clauses allow buyers to divert LNG cargoes to an alternative terminal (whether within or outside Japan) not listed in the relevant contract. For reasons discussed above, the JFTC decided that it would be unreasonable if buyers can only divert LNG cargoes upon seller’s consent under FOB contracts. With respect to DES contracts, the JFTC accepted that, given that sellers are responsible for transportation under these contracts, conditional diversions are permissible if sellers only refuse buyers’ requests for diversion based on acceptable reasons that meet the “necessary and reasonable” criteria (but not for anticompetitive reasons).
Profit-Sharing Clauses. Diversion clauses often require buyers to share with sellers a portion of the profits from a resale of the diverted cargoes. The JFTC concluded that, in FOB contracts, a profit-sharing mechanism indirectly disincentivizes LNG buyers to resell LNG cargoes (which they already have title to) freely and therefore would not be appropriate. However, in DES contracts, a profit-sharing mechanism is compensatory in nature for a change in the pre-existing contractual arrangement between a seller and a buyer. As such, a reasonably structured profit-sharing mechanism (e.g., taking into account the seller’s contribution to the relevant resale and whether the mechanism would effectively prevent the buyer from reselling) could be acceptable from an antitrust perspective.
Take-or-Pay Clauses. The JFTC acknowledged that take-or-pay clauses guarantee sustainable and full payment from LNG users/buyers, which is imperative to any LNG project investment decision. As such, take-or-pay clauses are not themselves problematic. Whether a particular take-or-pay arrangement would offend the antitrust rules depends on the relative bargaining power of the LNG buyer and seller on a case-by-case basis. In a case where the LNG seller has already recovered its initial capital investment and yet unilaterally imposes a strict minimum purchase obligation without having it adequately negotiated with the LNG buyer, the JFTC may be more ready to find the take-or-pay arrangement to be anticompetitive.
Implications for Japanese LNG Importers
The JFTC findings are consistent with the EU Commission’s general approach toward export bans, which it views as hardcore restrictions contrary to EU competition law. The positions of the JFTC and the EU Commission on profit-sharing arrangements also share some similarities.
Bearing in mind that Japan is the largest LNG importer in the world (accounting for approximately 30 percent of total global net imports in 2016), the recent JFTC findings certainly have far-reaching implications for Japanese LNG importers and other stakeholders in the field. Most notably, it is unclear what, if any, immediate actions the JFTC may take in light of these findings against existing LNG contracts. Most of these clauses are commonly seen in current long-term LNG contracts, and industry players would naturally be keen to find out whether they are expected to renegotiate existing contracts or whether they should be taking some other course of action. As one of the concluding remarks, the JFTC said at the end of market study conclusion paper that “as for the existing contracts before the expiration, LNG sellers, at least, should review competition-restraining business practices”—despite the observation, little light is shed as to what LNG buyers need to do in response.
At a minimum, however, in any Japan-related LNG contracts, it would be advisable to note the following based on the JFTC’s guidance provided in its report:
- An LNG seller should not request a breakdown of resale cost in detail (nor evidence relating to that) as part of any profit-sharing arrangement. Any information-sharing obligation directed to an LNG buyer should be minimized.
- An LNG seller may consider using net profit (instead of gross profit) as the basis to calculate resale profit in order to avoid an argument that the LNG buyer is deprived of a resale opportunity. A calculation method and the percentage of sharing allocated to sellers should also be agreed in advance.
- Sellers and buyers should preagree on a list of circumstances that would render seller’s consent to diversion “reasonable and necessary” in LNG contracts. Generally speaking, if a diversion request will not disrupt the seller’s operations (with any additionally incurred expense to be paid by the buyer), it would not be reasonable for the LNG seller to withhold its consent to a diversion request. The mere possibility of a potential disruption may not be a reasonable ground of refusal.
- An LNG seller should not refuse to consent to a diversion request on the basis of any of the following (considered to be competition-restraining in nature by the JFTC):
- The diversion is a diversion/resale to an existing/a potential client of the seller.
- The purpose of the diversion is for the buyer to make a commercial profit.
- The diversion request is a result of a reason other than issues relating to the buyer’s operations.
Implications for Non-Japanese LNG Importers
Although the JFTC review was carried out under the framework of existing Japanese antitrust laws with application limited to Japan-related LNG contracts, it is (as noted above) consistent with findings already handed down by the EU Commission on export bans/destination restrictions and profit-sharing arrangements under EU-landed LNG contracts. This does indicate a widening trend among national regulators to rule against the sellers in respect of these provisions. We await with interest to see whether the antitrust/competition regulators in jurisdictions like South Korea and China take a similarly proactive approach to regulating resale and profit-sharing terms to achieve more favorable outcomes for buyers of LNG in those jurisdictions.