Oil, Gas & Energy Law Intelligence

the stage of development of the market and used contractual structures and pricingmechanisms.5.1 Contractual structures, pricing mechanisms and market stagesAt the initial stage of gas markets development, the price can be established onlywithin a pair "producer - purchaser" and only as a term/contract price for the period notshorter than the payback period of the given investment upstream project. This is afirm requirement of project financing: to provide guarantees of financial flows(monetary receipts from selling gas produced) to pay-back project CAPEX coveringcosts of gas production and its transportation to the delivery point which in case ofRussian export gas supplies are located thousand kilometres away to the West from thewell-head. The contract price at this stage may be fixed in monetary terms and bedetermined on the "costs plus" basis.Such a price reflects the minimum acceptable price for the producer – this is theirminimum investment price, a project financing price. This price should cover all costsand provide the reasonable rate of return (ROR) on investment. And it is not theproducer, but financial institutions who consider and evaluate risks and uncertainties ofthe given project in the given country. And it is a result of their evaluation of risks thatthe value of reasonable/acceptable ROR for the project is calculated. Financialinstitutions are currently providing debt capital for about 70% of project CAPEX incapital intensive upstream energy projects. So they are looking for the shortestdurations of pay-back periods in order to minimize the risk of possible non-return of thedebt capital they have provided. So they are aimed at as high a contract price as ispractical. And as nowadays oil indexation provides the highest possible price levels,project financiers are in favour of oil indexation.At the early market stages - with the absence of alternative supplies/suppliers - aconsumer usually has no alternatives to select supplier/supplies and should/must acceptthe given cost-plus price. In such cases the "cost plus" mechanism is the "investment"pricing mechanism for non-competitive markets and the price, determined in such away, is the bottom (minimum) "investment" price. It reflects the "fair" price level of the32