By Nick Cooper and Tim Donisi, Clayton Utz
KEY point: A poorly drafted (or non-existent) set-off clause could generate a costly and time consuming dispute about mitigation of loss and redeployment, but contractors can help avoid this pitfall.
Like many pieces of equipment in the offshore oil and gas sector, floating, production, storage and offloading (FPSO) vessels are bespoke assets designed and constructed, at great capital expenditure, to comply with a specific regulatory regime and to meet a range of specific field requirements. Thus, redeploying an FPSO is not as easy as simply sailing it to the next available field.
And yet, as a result of the contractual arrangements underpinning its operation and management – specifically, the right to terminate an FPSO services agreement for convenience – a field titleholder (company) may contend that an FPSO contractor has failed to take up an available field and therefore not mitigated its loss.
This problem is not that unlikely either, given that it is common for a field titleholder / operator to reserve the right to terminate an FPSO services agreement for convenience (i.e. at any time) in addition to terminating for default. This usually comes at the cost of an Early Termination Fee (ETF) payable by the company to the contractor.
The agreement may also expressly require the contractor to use “all reasonable endeavours” to contract the FPSO to third parties in the event of a termination for convenience, and those fees earned are set off against the ETF. This is an express recognition of the duty to mitigate one’s loss. But if that is not properly drafted, the contractor might find itself expected to undertake mitigation that is very difficult, if not completely impractical.
There is, however, a solution for the prudent FPSO contractor, which we will explore below.
FPSOs and their characteristics
The first floating, production, storage and offloading (FPSO) unit was built in 1977, and since then their construction and use has increased significantly due to the need for exploration and production of oil and gas in unfriendly and harsh environments.
As at 2017, there were over 270 FPSOs deployed worldwide. At the same time, there were 51 idle floating production systems in the global offshore market, 25 of them FPSOs. In fact, only 36 FPSOs have ever been redeployed to a least one other field after completing their initial contract.
FPSOs are designed and constructed to meet the particular health, safety and environmental requirements of the relevant regulatory regime (such as the Australian oil and gas regulatory regime administered by NOPSEMA), and the unique characteristics of the field. Those characteristics include average water depth, weather conditions (for example, FPSOs located in regions subject to tropical cyclones may be equipped with a disconnectable turret mooring system), and the type of reservoir together with its fluid properties and characteristics.
Termination for convenience and the Early Termination Fee
A termination for convenience clause allows a party to a contract to terminate the agreement at any time. The company will usually want to reserve the right to terminate the services agreement for convenience, in addition to terminating for default. This will usually come at a cost to the company in the form of an ETF. The ETF may be calculated in a number of ways but to be enforceable it must be a genuine pre-estimate of loss and usually structured as a declining or pro rata basis (to reflect the fact that the amount of loss a contractor will suffer from a termination decreases the further into the term the termination occurs). Another common feature may be the express obligation on the contractor to use “all reasonable endeavours” to contract the FPSO to third parties in the event of an early termination on the basis that the fees earned by a third party contract of the FPSO are set off against the ETF.
This is merely a reflection of the long-established principle of mitigation of loss (or rather the obligation not to act unreasonably): a contractor cannot sit idly by and do nothing to minimise its loss. But an important feature of that principle is the courts look at the circumstances of the individual case, in determining if the contractor has acted reasonably or used “all reasonable endeavours” to contract the FPSO to a third party. Thus, the individual circumstances of the case, such as the
FPSO’s characteristics and that of the field, are very important in assessing any redeployment.
The FPSO redeployment challenge
Redeploying an FPSO, while possible, is not easy, as FPSOs are designed for a specific regulatory regime and field requirements, including the weather conditions, water depth, oil and gas characteristics, as well as gas, water and / or chemical injection for reservoir management.
In his 2017 article, David Boggs identified a good example of the difficulty in redeploying the FPSO Falcon ordered by Exxon. This vessel was designed to be suitable for a wide range of field properties, weather conditions, and water depths. The FPSO Falcon operated in Nigeria’s Yoho field for four years and then was laid-up. Despite this generic design and large processing capacity of 165,000 bpd of oil, 95 MMscfpd of gas, 90,000 bpd of water injection, and 2 MMbbl storage capacity, the FPSO Falcon never operated on another field and was eventually sold for demolition in 2016.
Depending on the differences between the fields, redeployment can require modifications ranging from relatively minor refurbishment to extensive modification or replacement of the topsides and mooring. The capital expenditure involved in a conversion or modification is generally very significant. As a result, only 36 FPSOs have been redeployed to at least one other field after completing their initial contract.
The proposed solution: making sure the mitigation principle is properly recognised
If the company wishes to expressly introduce the mitigation principle when calculating an ETF under the services agreement then we suggest it is only fair and appropriate that the full and true scope of that principle be also recognised in the agreement.
This means that the particular challenges confronting a contractor in redeploying to another field ought to be expressly articulated in the services agreement and those challenges used as the yardstick to determine the meaning of “reasonable endeavours” – those challenges should include the technical, regulatory and commercial circumstances unique to the FPSO.
At the same time, a contractor should never confer on the company the right to determine whether the endeavours taken by the contractor are reasonable.
By taking these two steps at the negotiation and contracting stage, a contractor can help protect itself against contentions by the company that it has sat idly by and failed to use “reasonable endeavours” – which could turn out to be extremely impractical and expensive measures – to mitigate its loss