Legal Definitions - market-out clause

A market-out clause is a specific provision found in certain long-term contracts, particularly within the energy sector, such as oil and gas agreements. It allows a buyer of a commodity to propose a reduction in the agreed-upon purchase price if significant changes in market conditions make the original price economically unsustainable or unprofitable for the buyer. If the buyer invokes this clause, the seller then has a choice: either accept the new, lower price offered by the buyer or terminate the contract altogether. This clause provides a mechanism for long-term agreements to adapt to unpredictable market volatility, offering a degree of flexibility when economic circumstances shift dramatically. It is sometimes also referred to as an economic-out clause.

Here are a few examples to illustrate how a market-out clause might apply:

• Natural Gas Producer and Local Distribution Company (LDC):

  Imagine a natural gas producer has a long-term contract to supply gas to a Local Distribution Company (LDC) at a fixed price for several years. Suddenly, a new, highly efficient drilling technique leads to a massive increase in natural gas supply across the country, causing wholesale market prices to plummet far below the contract rate. The LDC, as the buyer, finds itself purchasing gas at a significantly higher price than it could obtain on the open market, making its operations unprofitable.

  In this scenario, the LDC could invoke the market-out clause. It would propose a new, lower purchase price to the producer, reflecting the current market realities. The producer then has two options: accept the reduced price to maintain the long-term contract, or reject the offer and terminate the agreement, forcing them to find new buyers for their gas, likely at the prevailing low market rates.

• Crude Oil Producer and Refinery:

  Consider an independent crude oil producer that has a multi-year agreement to sell a specific grade of crude oil to a regional refinery. The contract stipulates a price based on a global benchmark plus a fixed premium. A sudden global economic downturn, coupled with a significant increase in oil production from other regions, causes a sharp and sustained drop in crude oil prices and a reduction in demand for refined products. The refinery, as the buyer, finds that the fixed premium in its contract makes its input costs too high, severely impacting its profitability compared to competitors buying crude at lower effective prices.

  The refinery could activate the market-out clause, proposing to eliminate or significantly reduce the fixed premium, thereby lowering the overall purchase price for the crude. The crude oil producer must then decide whether to accept the lower revenue from this established buyer or terminate the contract and attempt to sell their crude on a highly competitive and depressed spot market.