Thought Leadership

The FSRU Time Charter Party - Time for a Rethink?

Client Updates

Introduction

Floating storage and regasification units (“FSRUs”) play a significant role in the LNG industry.  The first FSRU commenced operations in 2005 and, as of February 2020, there were 24 FSRUs in operation at LNG import projects worldwide.[1]  Whilst this only represents roughly one sixth of the existing LNG import terminals, in recent years there has been a growing trend towards the increased use of FSRUs for LNG import projects, especially in new LNG importing countries.[2]

FSRUs have many advantages, including the ability to launch LNG import projects more quickly and with less upfront capital.  Less upfront capital is required because FSRUs typically cost 40% to 50% less to construct than onshore facilities.  In addition, FSRUs can be chartered rather than being owned outright by the project.  FSRUs are almost always chartered under a time charter party (“TCP”).  Under a TCP, the FSRU continues to be owned and operated by the shipowner, who provides the master and crew. A TCP allows the project developer to pay a monthly hire rate and to direct the usage of the FSRU, without the need to invest upfront capital to purchase or construct the FSRU.

TCPs are not new to the LNG industry.  They have been used for decades to charter LNG carriers to transport LNG around the world.  Thus, when FSRUs were first introduced, shipowners looked to the TCP as the standard contract for the provision of an FSRU.  The TCP was the natural choice; with a few tweaks, an LNG carrier TCP could be converted into an FSRU TCP, giving the charterer the ability to both semi-permanently moor the FSRU at an LNG import terminal and to use the FSRU as an LNG carrier.

This article reviews changes in the LNG industry and the use of FSRUs since FSRU TCPs were first introduced and analyzes whether the terms of FSRU TCPs need a rethink.

The Times are Changing

The use of FSRUs has changed over time.  The first FSRUs operated by transporting LNG cargoes from the loading port to the unloading port, rather than by receiving LNG cargoes from a conventional LNG carrier.  Even once ship-to-ship transfers of LNG started in 2007, the first ship-to-ship transfers were carried out in open waters, rather than at a jetty of an LNG import terminal.  The first at-the-dock ship-to-ship transfer was carried out in 2008, and nowadays FSRUs operate almost exclusively by being semi-permanently moored at an LNG import terminal.  An FSRU may pick up a commissioning cargo en route to delivery at the LNG import terminal at which it will be moored, and an FSRU may operate as an LNG carrier during periods when the FSRU owner is unable to charter it to an LNG import project, but these are the exceptions to the rule.

The LNG industry has changed markedly since FSRUs were first introduced.  The services initially provided by the first FSRUs were broadly the same as those provided by LNG carriers, with the obvious addition of regasification and natural gas send-out.  However, the scope of services provided by FSRUs has expanded considerably in recent years, with FSRUs now capable of: (i) reloading LNG from storage onto LNG carriers; (ii) providing LNG as bunkers, either directly to visiting vessels or to LNG bunker vessels for onward delivery; and (iii) providing gas-up and cool-down services to LNG carriers.

As the way in which FSRUs operate and the services that they provide have changed, FSRUs have become less and less like LNG carriers and more and more like land-based LNG import terminals.  However, the TCP forms used for the chartering FSRUs have not necessarily kept pace with these changes.  This can be seen in the terms of a typical FSRU TCP, as many of the provisions are relevant and appropriate when the FSRU is operating as an LNG carrier but not when the FSRU is semi-permanently moored at an LNG import terminal.

The nature and scope of the LNG import projects at which FSRUs are employed has also changed in recent years.  The first FSRU projects were established in order to import LNG into the U.S. and the U.K., both of which were already large, liquid markets with established downstream infrastructure.  The next wave of FSRU projects saw FSRUs being chartered, for the most part, by large state-owned utilities in order to import gas for onward supply to the local grid.  However, in many cases FSRUs are now being chartered by independent project developers, and often solely for the purposes of supplying a single, or a small dedicated group of, independent power projects (“IPPs”) or industrial users.  One of the difficulties faced by this new wave of project developers and projects is that the liability regime under a typical FSRU TCP does not always align well with the requirements for these projects.  This is particularly the case with LNG-to-power projects.

All of these changes raise the question of whether the terms of FSRU TCPs need a rethink.

Standard TCP Provisions

Many standard TCP provisions are appropriate when the FSRU is operating as an LNG carrier but not when it is semi-permanently moored at an LNG import terminal.  For example, some TCPs include a clause paramount.  A clause paramount expressly incorporates by reference a cargo liability regime, such as the Hague rules or the Hague-Visby rules, into the TCP.  This potentially cuts right across the liability regime otherwise agreed under the TCP and could mean that, in the event of any loss of or damage to the FSRU’s cargo, it will be unclear whether the cargo liability regime under the FSRU TCP or the cargo liability regime in the clause paramount prevails.

Similarly, most FSRU TCPs include a piracy clause and war risks/additional war expenses clause.  The intention of these clauses is to ensure the FSRU owner is not obliged to undertake voyages, or to operate in areas, that would pose an unacceptable risk to the FSRU and its crew.  Such clauses typically permit the owner to remove the FSRU from any area if the risk of war, piracy, capture or seizure arises or is increased after the FSRU has entered the relevant area. These clauses typically provide that the FSRU shall remain on-hire for any period during which it is out of service due to war, piracy, capture or seizure, and oblige the charterer to indemnify the FSRU owner for any additional costs incurred as a result of such risks.  Whilst this approach makes sense when the FSRU is operating as an LNG carrier and can be employed anywhere worldwide, this approach is not necessarily appropriate if the affected area is the LNG import terminal at which the FSRU is intended to be semi-permanently moored for an extended period of time.

In addition to the above, there are other standard form clauses that are often included in the TCP for an FSRU, but that are either not appropriate or are less relevant when the FSRU is operating semi-permanently moored at an LNG import terminal.  These include, among others, the both-to-blame collision clause, the new Jason clause and the salvage clause.

TCP Liability Regime

The typical TCP liability regime is well established and works well in circumstances where the services to be performed by a vessel are to undertake voyages and load and unload cargo, in accordance with the instructions of the charterer.  In the context of an FSRU, however, where the services to be provided are much more extensive, this liability regime is less appropriate and, in certain circumstances, can result in the charterer effectively having little or no remedy for certain performance failures by the FSRU and its owner.

An overriding principle in a TCP is that the charterer is obliged to pay hire for the duration of the charter, unless expressly provided otherwise by the terms of the TCP.  The liability regime under an FSRU TCP therefore typically works on the basis that, following acceptance of the FSRU by the charterer and other than in respect of any damages payable by the FSRU owner in respect of demurrage and excess boil-off, the rights to make a deduction from hire or to place the FSRU off-hire (and not pay hire for such off-hire period) are the charterer’s sole and exclusive remedies in connection with any performance failures by the FSRU.  Therefore, if the FSRU is unable to regasify and send out natural gas at the rate requested by the charterer, hire will typically be reduced on a proportionate basis or, in cases of extreme non-performance, the FSRU will be off-hire.

Whilst the TCP liability regime works well when applied to the regasification and send-out of natural gas, it does not work very well when applied to the receipt of LNG.  If the FSRU fails to receive a cargo from an LNG carrier, the charterer may incur substantial liabilities, including take-or-pay liabilities to its LNG supplier and liabilities to its downstream buyers for a failure to deliver natural gas.  In such circumstances, the charterer will likely only be entitled to place the FSRU off-hire during the period that it was unable to receive LNG, which may have only been a relatively short period of time.  This liability regime is unlikely, therefore, to compensate the charterer for the losses it has suffered.  The same analysis applies to an FSRU reloading LNG onto an LNG carrier, where an inability to reload for a relatively short period of time could result in a failure to deliver LNG and substantial liabilities for the charterer.

The TCP liability regime also presents challenges for FSRU charterers when an FSRU is ending an “off-hire” period and coming back “on-hire”.  TCPs are often drafted on the basis that if there is an interruption in the ability of the FSRU to perform the required services, then the FSRU will be off-hire until such time as it is again “in an efficient state to resume her service”.  This does not necessarily mean that the FSRU will be off-hire until it is able to perform all of the services that may be required of it.  In fact, case law suggests that the FSRU will be deemed to be back “on-hire” once it can again perform the next service that is required of it.[3]  The vessel still may not be able, however, to perform a specific service, e.g., the receipt of LNG or the reloading of LNG.  Some TCPs even go so far as to provide that the FSRU will not be off-hire where it is capable of sending out regasified LNG above a certain threshold.  In circumstances where the FSRU can send out natural gas but cannot receive LNG, this would mean that the FSRU would arguably not be off-hire and the charterer would have no recourse against the FSRU owner, notwithstanding that the charterer may be incurring substantial liabilities under other project agreements.

These liabilities incurred by the charterer can be particularly significant in an LNG-to-power project, where the TCP liability regime for the FSRU may not align with the electricity tariff structure under the Power Purchase Agreement (“PPA”).  This is because PPAs typically provide that the electricity tariff is not payable if the power plant is not available due to force majeure, whereas FSRU TCPs typically provide that hire continues to be payable during periods of force majeure.  In addition, PPAs are often structured on an availability basis, such that the electricity tariff is only payable if the power plant is available for dispatch.  This conflicts with the off-hire regime under many TCPs, under which the FSRU will only be off-hire if it is unable to perform the relevant services when actually required to perform such services.  As a result of these two conflicting regimes, an LNG-to-power project may be required to pay hire to the FSRU owner under the TCP even though the project is not being paid by the power purchasers under the PPA.  This misalignment can pose a critical threat to the economic viability of the project.

Moving Forward

The TCP clearly presents challenges in the context of today’s FSRU projects.  It is, however, well established in the maritime industry and unlikely to be replaced in the near future.  As such, the future success of FSRU projects will likely depend on the ability of the industry to adapt to the requirements of those projects, with appropriate adjustments to many standard TCP provisions and to the allocation of risks under the typical TCP liability regime.  The focus of those adjustments should be to move the FSRU TCP closer to the provisions and liability regime found in a typical LNG terminal use agreement or through-put agreement for a land-based LNG import terminal, replacing off-hire concepts with liquidated damages when the FSRU fails to perform an obligation that is central to the performance of the import project, such as taking delivery of LNG or sending out natural gas.

However, any such adjustments to the FSRU TCP are not without cost.  As risk is shifted to the FSRU owner, the FSRU owner will need to be compensated accordingly, and that will likely increase the hire rate of the FSRU.  There will therefore be a trade-off for FSRU charterers between better risk allocation/reduced project risks and increased hire rates.  Ultimately, it will be the specific requirements of a project, including from any project lenders, that will dictate whether the increased hire rate is justified.

Furthermore, FSRU TCPs should shift towards a much clearer delineation in the TCP between those provisions that apply when the FSRU is semi-permanently moored at an LNG import project and those that apply when the FSRU is operating as an LNG carrier.  This would avoid the risk of conflict between these two regimes and avoid any uncertainty as to the terms that therefore apply.

FSRUs and TCPs are here to stay.  With a good rethink, the TCP can continue to serve a critical role in connecting FSRU owners with FSRU charterers in many LNG import projects to come.

 

References:

[1] International Gas Union World LNG Report – 2020 Edition, p. 9.

[2] International Gas Union World LNG Report – 2020 Edition, p. 84.

[3] The Berge Sund, [1993] 2 Lloyd’s Rep. 453 (C.A.).

 

ABOUT BAKER BOTTS L.L.P.
Baker Botts is an international law firm of approximately 725 lawyers practicing throughout a network of 14 offices around the globe. Based on our experience and knowledge of our clients' industries, we are recognized as a leading firm in the energy and technology sectors. Since 1840, we have provided creative and effective legal solutions for our clients while demonstrating an unrelenting commitment to excellence. For more information, please visit bakerbotts.com.

Industries

Read More

Related Professionals