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Emissions Regulation & ‘Future-Proofing’ Commodities Contracts

The COP26 summit has produced a number of headline-grabbing statements around the reduction of global greenhouse gas emissions. If these statements are to result in meaningful action, then (amongst other things) the energy commodities sector can expect continued and increased regulation of its greenhouse gas emissions throughout the entire supply chain.

For industry participants, the prospect of increased regulation presents a number of potential risks. For example, increased capital and operational expenditure in pursuit of compliance, the risk of sanctions for regulatory infringement, and, potentially, a reduction in the marketability (or market value) of products whose supply chain evidences a more damaging greenhouse gas footprint than competitor products. However, these risks sometimes go alongside the potential for reward. For instance, government-backed economic incentives for compliance, participation in schemes for the trading of ‘credits’ in relation to greenhouse gas emission, improved public perception and, perhaps, a premium payable in respect of products with a provably ‘green’ supply chain.

The challenge for contract negotiators lies in assessing the level of risk and reward, and addressing its allocation between the parties in circumstances where the regulatory regime driving the concern is  incomplete and/or subject to material change during the lifetime of the contract.

This challenge must be addressed by adopting a creative and forwards-looking approach to medium- and long-term commodities contracts which takes account of the trend for increased regulatory oversight by (i) making fair provision for those regulatory changes which we know are coming or can reasonably expect to come in the future, whilst (ii) including sufficient flexibility to accommodate a variety of approaches to implementation and enforcement, and (iii) providing for the falling away of regulatory regimes (and associated schemes and incentives) over time- in each case without unwarranted interference with the commercial bargain struck between the parties.

On mitigation, the persistent gap in emissions has been clearly identified and Parties collectively agreed to work to reduce that gap and to ensure that the world continues to advance during the present decade, so that the rise in the average temperature is limited to 1.5 degrees. Parties are encouraged to strengthen their emissions reductions and to align their national climate action pledges with the Paris Agreement.

Tags

oilandgas, commoditiestrading, energy, esg

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