Pitfalls in FPSO contracts

Paul Aston
Holman, Fenwick & Willan
Singapore

Tanker owners, eager to meet the fast-growing demand for floating production, storage, and offloading (FPSO) vessels, are struggling to accommodate the tougher commercial terms sought by field operators, who are increasingly eager to pass on hydrocarbon development risks.

Marginal fields in South East Asia will require large numbers of floaters over the next decade. However, new players in the market - including vessel owners with potential candidates for conversion - find it increasingly difficult to assess the financial viability of complex terms proposed by field operators, who are attempting to reduce their risk at the expense of the provider of the floater.

The field operators are seeking to reduce their risk by proposing shorter periods for fixed term utilization contracts. Such attempts are commonplace even in cases where a high specification FPSO is required.

In the past, FPSO providers expected at least 10 years, but some terms negotiated are as short as 3-4 years. This makes it virtually impossible for a FPSO provider to achieve an acceptable return, except in unusually favorable circumstances.

Inexperience

Much of the development risk associated with marginal fields is now passing into hands that lack experience in the complex world of offshore oil and gas production. Not surprisingly, the new players are looking to third parties to provide the all-important expert evaluation of risk-sharing proposals put forward by field operators. This is why a number of leading banks in the Asia-Pacific region have established teams of experts in reservoir assessment.

My firm recently assisted a client who had encountered problems during the conversion of his vessel into a sophisticated floater. The conversion schedule slipped, and eventually, began to erode the fixed term charter negotiated with the field operator.

Fortunately, the client successfully negotiated an extension and so maintained his potential for generating satisfactory returns on a very considerable investment. Yet, this case did serve to highlight the lack of options available when a conversion project is delayed.

There is little room for maneuvering, since demand for floaters exceeds supply and most requirements for floating systems are highly field-specific. Project viability, of course, remains the key issue. The main objective of the floating system provider should be to cover conversion costs at the mobilization/hookup phase. The aim is to obtain payment of daily rate on a "ready, willing, and able to perform" basis.

Accounting for delays

Looking beyond that phase, however, the ability to generate attractive profits has been reduced by the field operators' insistence on even shorter fixed term contract periods. In some cases, the floating systems provider's position is aggravated by proposed contract provisions that would involve him in subsea works.

In many cases, deals of this type take the FPSO provider well beyond his "comfort zone." Yet this has positive aspects, as it widens the FPSO provider's experience base.

Many Asia-Pacific shipping groups are eager to explore new opportunities offshore. The FPSO provider can reduce commercial risk by establishing a clear set of commercial principles that are not negotiable. Certainly, one priority should be to ensure that any "permissible" yard delays during conversion can be passed on, in order to preserve the term of the utilization contract.

Other potential risks arise in connection with financial responsibility for "loss of function." Many floaters are designed to perform various functions (storage, processing, pumping, and power generation).

Contracts should recognize that these functions have different levels of operational, commercial, and financial significance. Lack of attention to this issue could result in an FPSO provider incurring unreasonably harsh damages, out of proportion to the consequences of a temporary loss of a single function.

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