Electricity, and the business of its wholesale trading, have particular characteristics which set them apart from the trading of other goods. It is for this reason that electricity trading is specifically excluded from the United Nations Convention on Contracts for the International Sale of Goods (see Article 2(f)).
Electricity is very difficult to store on a large scale, even with today's technology. This technical shortcoming has led to contracts being based on the assumption/condition that electricity is available on demand. A wholesale trading company consequently needs to balance the volume of electricity it has contracted to sell with the volume of electricity it has contracted to buy (known as portfolios) at all times. Wholesale traders will often have very large portfolios, usually with no particular transaction on the buy side correlating to any particular transaction on the sell side; transactions can be long term and short term and for large or small quantities of electricity, among other things.
Obtaining the cheapest price on the buy side of the portfolio and the most favourable price on the sell side of the portfolio is, of course, the primary task of the trader seeking to maximize profits. In doing so, the trading company will need to take into account its other costs, which will include cross-border charges (the price charged by each country to use its grid from the moment the electricity crosses the border) and overheads, among other things.
Given the variables that exist, the question arises as to how to determine the loss incurred by a trader if there is a delivery failure (i) by the selling entity from which the trader has bought electricity or (ii) by the buying entity to which the trader has sold electricity. The inter-relationship between the buy side contract and the sell side contract is critical to any analysis as to who bears the risk of any such failure to perform.
Much has been written during the Covid-19 crisis about the applicability of force majeure or availability of hardship relief arising as a matter of contract or by operation of law. Under the terms of many force majeure provisions, Covid-19 alone will not excuse parties from their obligations to perform commercial contracts. In addition, even if a buy side contract- under the terms of that contract's force majeure provisions, excuses the parties from performing that contract, it is by no means the case that the trader will enjoy the same relief under the sell side contract. This is because, as noted, no particular contract on the buy side correlates with a contract on the sell side (with the possible exceptions of very short-term trading actions or where the origin of electricity is an essential part of the agreement between the parties on the sell side)
We anticipate that these issues will become increasingly relevant in the current circumstances created by the Covid-19 crisis.
Generally, in case of delivery failure, the side affected by such failure is entitled to indemnification for the loss. However, in the absence of a contractual provision governing the matter, proving the loss incurred is not straightforward given the absence, generally, of a correlation between the buy side and the sell side contract and that the breach may extend over relatively long periods of time. Also, for the same reason, it would probably be impossible to determine if any replacement transactions had been concluded as a result of the breach. Indeed, an expert would be required to determine the situation in a but-for world on the basis of a series of assumptions, and then compare it to the actual (concrete) developments in relation to the entire portfolio of contracts, both on the buy side and the sell side. Such expert would be required to have access to (and then produce in court or arbitration proceedings) sensitive business information. This exercise is necessarily very complex and is dependent on assumptions which can be the subject of further dispute.
An alternative approach is to insert a liquidated damages provision in the relevant contract allowing for the straightforward calculation of the damages due upon breach, without the need to prove one's loss by resorting to several assumptions and experts. Having a clear contractual damage calculation mechanism may also prevent the need to initiate legal action, as traders may find they are easily able to calculate the damages due and take action accordingly by adapting their trading position with the breaching counterparty and/or entering into settlement discussions.
An example of such a clause is contained in the European Federation of Energy Traders' (EFET) "General Agreement Concerning the Delivery and Acceptance of Electricity" (the "EFET General Agreement"), issued on 21 September 2007.
Clause 8.2 of the EFET General Agreement applies in the case of a failure to accept electricity on the part of the entity buying from the trader. It states:
"2. Failure to Accept: To the extent that the Accepting Party fails in whole or in part to accept the Contract Quantity in accordance with an Individual Contract and such failure is not excused by an event of Force Majeure or the other Party's non-performance, the Accepting Party shall pay the Delivering Party as compensation for damages an amount for the quantity of non-accepted electricity equal to the product of:
a) the amount, if positive, by which the Contract Price exceeds the price at which the Delivering Party is or would be able to sell the quantity of non-accepted electricity in the market acting in a commercially reasonable manner; and
b) the quantity of the non-accepted electricity.
Such amount shall be increased by any incremental transmission costs and other reasonable and verifiable costs and expenses incurred by the Delivering Party as a result of the Accepting Party's failure."
There is a corresponding provision for the "Failure to Deliver" electricity at Clause 8.1 in which an identical mechanism is used in order to calculate damages. For the purpose of illustration, the remainder of this note will consider the scenario where there is a failure to accept electricity rather than a failure to deliver.1
The part highlighted in bold in Clause 8.2 above refers to two methods to calculate damages if one party defaults, namely what is known in the industry as the concrete method on the one hand ("is ... able to sell ...") and the abstract calculation method on the other ("would be able to sell ...."). There thus seems to be a choice of the methodology to be used for the party availing itself of the provision.
This EFET General Agreement is often used in the industry as a template. Yet the provisions it contains relating to an event of breach on a failure to accept or deliver electricity could benefit from further clarification as will be examined below.
The concrete damages calculation method – which has been set out above – is, on the whole, ill-suited to the portfolio nature of electricity trading for the reasons explained, namely that the aggrieved party will find it very difficult to demonstrate its actual loss. As noted, this method may be suitable for a situation where the origin of electricity is an essential part of the agreement between the parties, e.g. a supply defined with a specific route and conditions of delivery.
On the other hand, the so-called abstract calculation of damages will be preferable in all other instances. As noted in the clause, the abstract methodology allows the aggrieved party to calculate its loss by reference to a "market" on which it "would be able to sell". This thus avoids the need for the engagement of experts operating under assumptions and also the need to disclose sensitive business data.
Should the parties wish, the provision could further be tailored to provide greater detail in order to give more clarity in the event of a dispute.
First, parties could choose to specify the "market" in advance, and for this to be a liquid and transparent exchange. Electricity is also traded on platforms without a central clearing system and bilaterally, but a major exchange will provide a more reliable and straightforward way in which to determine the price at any given time. If this is not specified, parties may have differing views as to which "market" should be taken as the reference. Should it be at the place of performance, if it exists,2 or where the seller could be reasonably expected to offload the non-accepted electricity? If there are several exchanges that could be deemed to have a reasonably connection with the performance, should the availing party be free to choose? It should be noted that the differences in the price of electricity at different geographic locations can be substantial.
Second, power exchanges set various prices depending on the nature of the product being sold, including intraday (same-day), day-ahead (the most transparent), week-ahead and month-ahead prices. Again, parties could agree on this in advance and specify accordingly in their contractual provision.
Third, in order to avoid any dispute arising from an allegation that the loss was in fact less than that which would be due under the clause, the parties could specify that this argument is excluded.
In sum, parties should consider providing for express liquidated damages clauses in their contracts as a way to narrow down or avoid conflict in the event of non-performance. In so doing, they can adopt the language in the EFET General Agreement or a variation thereof which takes into account the additional points raised above with a view to reduce disputes even further.
1 Clause 8.2 refers to a failure to "accept", as noted. The question arises whether this clause applies where there has been a legitimate suspension of delivery further to a failure to make payment under the contract. The answer should be in the positive given that the breaching party's failure to pay for past deliveries would be tantamount to a failure to offtake the energy that the seller was ready to supply in accordance with the contract but entitled to withhold until its previous deliveries were paid (further to Clause 9). However, the provision could be clarified in this respect.
2 There may not even be a "market" at the place of performance, as there may be insufficient buyers in the short term that are willing and able to purchase the electricity offered by the seller.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.