Blockchain in Oil & Gas: The difference between legal contracts and smart contracts
Chris Gabriel, Founder
There has been a long running debate since the inception of the smart contract in blockchain applications as to whether smart contracts are equivalent to legal contracts. The answer is ‘no’ in my opinion, but the two are related. Having worked in supply chain for an oil & gas major, I often had to consult with both the legal and contracts departments at my company. I negotiated with suppliers on such things as price and delivery terms, but the standard boilerplate legal terms and conditions were always provided by the company legal department and were specifically structured to address things such as contract term length, limits of liability, insurance requirements, etc. Although this is not an exhaustive list of what can be contained in a legal contract, you get the idea.
Pricing of goods and services is often handled in an exhibit or attachment to the contract that contains the negotiated pricing structures that all parties to the contract agree to in the outcome of a negotiation. In short, all parties typically pre-agree on the terms and conditions prior to transacting with one another. On a blockchain network, smart contracts can be thought of as the non-legal parts of the agreement that can be converted from negotiated terms (on paper) into computer code for the purposes of executing end-to-end transaction processes in a much more efficient manner, thus reducing costs as very little human verification is required.
Simply put, smart contracts are coded to enforce some contract terms automatically as certain requirements of the agreement are met such as milestone payments to the supplier based on the acknowledgment of goods receipts at the purchaser for example. Taken a step further, price validation against a received invoice can also be automated in a smart contract.
Smart contracts in blockchain applications should be thought of as complimentary to legal contracts, and the real value of them as a means to reduce costs in oil & gas (and many other industries) becomes apparent in situations where there are repetitive goods and services purchases where terms do not change very often, are mostly longer term in nature, and are not ‘one-off’ transactions.
In unconventional plays where companies are in ‘manufacturing mode’ on their developments, a smart contract coded to automate goods and services purchases with drilling companies, trucking companies, pipe suppliers, and other contractors can really magnify the benefits of converting these agreements and running them on an enterprise permissioned blockchain network with standardized and automated business process flows. The benefits of cost reduction accrue to all parties in the transaction since they are on the same network, not just the purchaser. Legal contracts however, are still required as the foundation on which the smart contract is based, so you probably will not be getting rid of your legal department any time soon.