LNG Transportation – Legal Aspects

By
Pushpa Pandya

With the exception of Russia, which has large reserves, LNG tends to be found in parts of the world where the sun is abundant supply and to all appearances the future of the LNG trade is just as sunny, whilst the transportation of LNG by sea has certainly become the so-called “sexy” sector of the shipping industry. It is rare nowadays to open a shipping publication without reading something about the LNG trade, whether it be about yet another new project or an update on existing projects, reports of new orders for LNG carriers, or of new players joining the LNG market.

In the past few years there has been a massive increase in the momentum of the LNG business, not only in the expansion of existing projects but also the development and commissioning of new projects. This momentum is due in part to the energy demands of the emerging economies, particularly India and China, alongside the established and seemingly insatiable energy demands of the USA. It also due in part to the recognition of the fact that, unlike other kinds of fuel such as petroleum and coal, LNG is relatively safe (with a hitherto exemplary safety record) and environmentally friendly (if it is spilled, it evaporates and has no long term adverse effect on the ecosystem and so poses little or no risk of pollution) and does not therefore attract the protests of environmentalists.

So far so good? While the conclusion of new projects may be good news for the relatively small number of lawyers involved in the drafting of the various types of agreement that arise from the trade, we lawyers tend as a rule to prefer to look on the gloomy side of things and imagine what may be in it for us if things go wrong. A little perversely then, when preparing this paper on the LNG trade, I thought I would see if there might be a darker side to the trade and the issues that may arise in the LNG trade to keep the lawyers busy. Of course there is not enough time today to offer any exhaustive review but I will at least try to highlight some of the more obvious points.

New kids on the block
The transportation of LNG is an integral part of the LNG project. In addition to its exemplary safety record and the fact that LNG is environmentally friendly, it is also non-corrosive. This makes LNG a very attractive commodity to carry. Add to this the lucrative regular income it can attract and it is easy to see why there are a lot of excited ship owners, or would-be ship owners, out there!

Because of the non-corrosive nature of LNG the working life of an LNG carrier is longer than for most other types of vessel, and even the oldest LNG vessel, the 41 year “Cinderella”, still has its appeal with talk of commercial re-activation still in the air. This will inevitably attract more and more new players to join LNG bandwagon. Until now LNG owners have been a small and select group. New players will inevitably include ship owners who may (or may not) be experienced in other fields of shipping but certainly no experience of the unique considerations that apply to the transportation of LNG.

LNG projects are of course very capital intensive with LNG carriers attracting prices of the highest order. At the same time they offer the potential for very lucrative, and often long term, regular income. Add to this the fact that the high freight markets of recent years have made many ship owners cash rich and the potential undoubtedly exists for new players with little experience in the field to enter the LNG market whereas once it was the domain of the very few.

Changing trading patterns
Until recently 90% of the LNG trade was conducted under long term contracts of affreightment or by owners of LNG carriers who were the actual traders in, or users of, the LNG and who saw the obvious advantages of having their own fleet of LNG vessels available to satisfy their own in-house or captive requirements and reduce transportation costs. Now, however, shipping companies anticipating the increase in LNG demand are building new LNG carriers to trade on the spot markets with no underlying LNG contracts in place. What has been termed a “more tradeable LNG business” may now emerge.

Reports of LNG cargoes being stored on vessels to cash in on anticipated high winter gas prices in Europe and of ship-to-ship transfers offer a glimpse of the way in which the market may develop. Just as significantly, there are reports of operators in Taiwan declaring themselves committed to operating LNG carriers like taxis that are available to pick up any passing LNG cargoes on the spot market. All these point to the LNG market shifting towards a trading environment similar to the oil market. If this happens disputes will no doubt arise where before there were none because of the previously close and tied nature of the trade.

Building the new fleet
As all sectors of the shipping market continue to prosper, the order books of the major shipyards with experience of building LNG carriers are full. How then will the demand for capacity be satisfied? Inevitably other and newer yard may cash in on the situation. As we have seen in other - and less sophisticated - sectors, though, the quality of build (and even the existence of facilities to build) at some of these yards may give cause for concern, or more tangibly lead to disputes involving potentially substantial sums.

Just as significantly, delays in the delivery of new buildings may give rise to disputes, not only with the yards but also with the ship owners’ LNG customers. Where LNG new buildings are ordered on the back of specific LNG projects or for long term time charters (as will no doubt continue to be the case in many instances), the losses caused by such delays may, again, be substantial. Particular care will therefore be required in the drafting of provisions for late delivery as the ship owners balance their interests under new building contract and employment contract for the vessel.

Adapting to new trading limits
Often in the past LNG carriers have tended to spend long periods of time serving in dedicated trades for a specific project, acting as a “floating pipeline” for the passage of LNG through a limited range of terminals, well suited to the vessel and well known to its crew. As LNG becomes more of a trade the range of terminals at which LNG carriers will have to call is bound to increase.

Just as new players are emerging on the ship owning side so, too, new players are emerging on land. New receiving terminals for LNG are rapidly being developed. In India alone LNG terminals in Dahej, Kochi, Hazira, Ratnagiri, Mangalore and Kakinada are in various stages of development or proposal. These terminals are owned mainly by state owned utilities or oil or gas majors such as Shell (in the case of Hazira), although private funding is now beginning to emerge. The number and size of the terminals is growing in response to the larger size of the expanding LNG fleet worldwide. Many of the existing terminals were designed for vessels of a maximum size of 135,000 cubic metres. Recent new orders have however involved vessels with capacities of 210,000 – 260,000 cubic metres. Clearly therefore existing receiving and storage facilities will need to be upgraded.

The development of these new LNG terminals (including off shore terminals), and the upgrading of existing facilities, will raise questions as to the ability of vessels to comply with the requirements of a new wider range of facilities when trading worldwide. In anticipation of this, terms of charter parties for the carriage of LNG make provision for the allocation of responsibility for the time and cost of any modifications necessary to allow the vessel to trade to different terminals worldwide. As an example of this, the ShellLNGtime1 form clause 4 (d) warrants that the vessel is compatible with the LNG terminals listed in Appendix A without modification. If any modification of the vessel becomes necessary the cost of such modification is to be for the owners account and the vessel will be off hire during the period of the modification. Such matters may well to give rise to problems for vessel’s fixed to trade within wide geographical limits as new LNG terminals come on line.

On the other side of the same coin, when new terminals are opened or existing ones expanded to deal with the increasing size of LNG carriers questions may well arise as to the safety of those terminals. Both the Shelltime 4 and the ShellLNGtime 1 form only requires the charterers to use due diligence to ensure that the vessel is employed between and at safe places. These clause expressly state that the charterers do not warrant the safety of any place to which they order the vessel and are only liable if any damage or loss is caused by their failure to exercise due diligence, a low standard for charterers to comply with where the potential level of damage that may be sustained is so high.

Maintenance obligations for LNG
As already observed, LNG shipping has an exemplary safety record to date. As however the LNG fleet expands rapidly with new buildings coming into service and as the nature of the trade changes a priority must be to maintain that exemplary record.

The maintenance obligations under clause 1 of the ShellLNGtime 1 form are wider than those for oil tankers and require the vessel to be “at the date of delivery of the vessel under the charter and throughout the charter period” fit to load discharge and measure LNG, as well as being tight, staunch and in good order and condition and every way fit for the service.

An obvious concern in this respect is the continued supply of properly trained and competent crew for an expanded LNG fleet. LNG vessels are technologically advanced and require crew with experience and a working knowledge of the technology and its operation. There are concerns that the rapid expansion of the world LNG fleet will outpace the training and recruitment of experienced crew leading to obvious dangers and problems of under manning and poor maintenance. In particular, with the rapid increase in the number of LNG vessels it is becoming difficult to find skilled seafarers who hold a steam turbine qualification let alone ones that are experienced in dual fuel electric engines. Problems that cannot be dealt with promptly and effectively may lead to offhire, and possibly even more serious, disputes and claims.The maintenance provisions of Clause 3 of the ShellLNGtime1 form are based on the Shelltime 4 form. Unfortunately they are not straightforward and have already been the subject of a number of legal decisions. More are to be expected.

Charter party terms particular to LNG
There is in some respect little difference between the chartering of a large LNG vessel and a large crude oil tanker. For that reason the LNG trade has tended to adopt and adapt oil tanker charter party forms. The characteristics of LNG, particularly at extremely low temperature, and the technology required to transport it safely are however different. It is logical therefore the terms for the carriage of LNG should reflect the specialised aspects of the trade.

Until recently there was no charter party in use that was dedicated to the LNG trade. Until the ShellLNGtime1 form came in use in April 2006, the shipment of LNG was mostly done by the Shelltime 4 and Asbatankvoy forms with rider clauses to suit the LNG trade. The ShellLNGtime1 form has been approved by BIMCO and I understand from Shell that in the three month period from April to July of this year the charter has formed the basis of about 100 contracts, none of which to date has given rise to a single dispute. As any good lawyer will tell you, there is no such a thing as a perfect contract and the fact that no dispute has arisen to date may be due to the fact that most of the contracts are still long term ones under which any minor disputes are likely to be ironed out over the period of the charter in the interests of the commercial relationship between the parties. This does not mean that disputes will not arise in the future as the LNG fleet and number of players in the market increases both in number and size.

Monitoring the vessel’s performance
The key issue for charterers of LNG vessels may often be not only the vessel’s performance as such but also its ability to meet its prescribed arrival and discharge times. Scheduling at LNG terminal is complex and any delay in arrival or during discharge of the vessel can have a substantial financial impact on the partners involved. Appendix C of the ShellLNGtime 1 from sets out in detail the parameters which are to be taken into account in calculating the vessel’s performance in terms of speed warranties, scheduled arrival times, fuel consumption and boil off. These will no doubt give rise to disputes as the LNG trade expands and embraces new players.

CONCLUSION
At the beginning of this paper I referred to the sunny aspects of the LNG trade. There can be little doubt that the future of the LNG trade is bright. Thus far the limited and restricted nature of the trade, and an exemplary safety record, has left it relatively unscathed by lawyers and disputes. Complacency can often, however, breed trouble. As, however, the nature of the trade develops, expands and changes new challenges will arise and it seems inconceivable that disputes will not arise in the future. This paper has highlighted at least some of the areas where such disputes may arise. For the time being at least, though, my plans to buy a new Porsche from fees charged to the LNG trade may have to be placed on hold.


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pushpa.pandya@consultmarine.co.uk