The International Comparative Legal Guide to:

Gas Regulation 2010

A practical insight to cross-border Gas Regulation work

Published by Global Legal Group in association with Ashurst LLP , with contributions from:
LEX Aguilar, Loera, Cortina & Martnez Estudio Glvez Abogados Fortunati & Asociados OFlynn Exhams Pachiu & Associates Rolim, Godoi, Viotti & Leite Campos Advogados Rosenberg, Hacohen, Goddard & Ephrat - Law Office Schnherr Rechtsanwlte GmbH Studio Legale Bonora e Associati Travieso Evans Arria Rengel & Paz Ura Menndez Vellani & Vellani Wardynski & Partners

Ali Budiardjo, Nugroho, Reksodiputro Garrigues Allens Arthur Robinson Azmi & Associates Bell Gully CMS Cameron McKenna Criales, Urcullo & Antezana Denton Wilde Sapte Dewey & LeBoeuf LLP Guerrero, Olivos, Novoa y Errzuriz Haavind IndoJuris Jankovic, Popovic & Mitic JeantetAssocis AARPI Lovells LLP Loyens & Loeff N.V.

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Chapter 2

Floating LNG Regasification: Legal Issues

Ashurst LLP
Anthony Patten

Introduction
Anthony Patten, a partner at Ashurst London, considers the increasing popularity within the LNG industry of floating regasification and the specific issues which need to be considered in respect of the long-term lease or charter of a floating storage and regasification unit. LNG (liquefied natural gas) is formed by the cooling of natural gas to -163C (-260F), resulting in its condensation and conversion into a liquid. Liquefaction causes a significant reduction in volume1, meaning that LNG can be transported much more costeffectively over longer distances than natural gas via utilisation of purpose-built road tankers, railway tankers and LNG carrier ships. On arrival at an unloading destination, the LNG is regasified for distribution to the end-user. If the LNG has been transported via an LNG carrier ship (an LNGC), a floating storage and regasification unit (FSRU) allows regasification to be undertaken offshore. Specifically, an LNGC moors alongside the FSRU and unloads its LNG cargo into tanks onboard the FSRU for storage prior to its passage through the FSRUs onboard regasification system. The regasified natural gas is then piped to shore for onward distribution to the end-user via the existing gas pipeline network.

the long-term charter by the Dubai Supply Authority of an FSRU from Golar. The FSRU will be constructed by conversion of the LNGC Golar Freeze and will be moored at Jebel Ali Port, Dubai. Golar Freeze will remain classified as an LNGC, but is intended to be used only for FSRU service and will be permanently moored at Jebel Ali Port; the purchase from Golar by OLT Offshore LNG Toscana S.p.A. (OLT) (a joint venture company of which E.ON and Iride are the major sponsors) of the LNGC Golar Frost, for subsequent conversion into an FSRU, which is to be permanently moored at OLTs offshore LNG terminal in Livorno, Italy (delivery of the FSRU is scheduled for the second half of 2010); and the charter by Kuwait Petroleum Corporation of a regasification vessel from Excelerate Energy, which will be stationed at the existing Mina Al-Ahmadi jetty facility in Kuwait and form the basis of Kuwaits first LNG import terminal. Interest in FSRU utilisation is increasing as parties seek to take advantage of the associated benefits (please refer to table 1). With this in mind, summarised below are the main issues which parties should consider when negotiating the long-term lease or charter of an FSRU (please note that our commentary assumes an arms length charter hire relationship between owner and charterer, being one where the owner does not have an equity stake in the receiving gas terminal).

Reliance on FSRUs in Todays LNG Market

The worlds first FSRU based on conversion of an existing LNG vessel commenced operation in Pecem, Brazil in January 2009. Chartered by Petrobras from Golar LNG Limited (Golar), the conversion of the Golar Spirit (a 1981-built ship) into an FSRU was completed in June 2008. While primarily intended to provide storage and regasification services, Golar Spirit has also retained its ability to operate as an LNGC. In contrast, other FSRUs forsake this flexibility and are, instead, designed to remain permanently moored at the LNG unloading port (other than for relocation due to drydocking or in emergency circumstances). Currently, a number of other FSRU (or similar) projects are ongoing including: the long-term charter by Petrobras of a second FSRU from Golar, which is intended to be moored in Rio de Janeiro, Brazil. The FSRU was constructed by conversion of the LNGC Golar Winter (completed Q2 2009) and will retain the flexibility to operate as a LNGC; the utilisation of shuttle and regasification vessels (SRV) in the Gulf of Mexico Gateway Scheme and the Teesport Project (Teesside, UK). An SRV is a form of intermittent FSRU as it operates as a shuttle vessel which serves both as an LNGC and, on arrival at the unloading destination, an LNG regasification plant;

Table 1 - Potential benefits of FSRU projects Potentially lower costs than on shore LNG regasification terminals, with quicker development time. Flexibility of location - an FSRU is a converted LNG vessel and can therefore be relocated if necessary. More simplified decommissioning than onshore LNG regasification terminals. Ability to meet seasonal peaks in gas demands. Extension of life for ships converted into an FSRU. Ability to meet a shortfall in gas production during an interim period, e.g. while a permanent energy production facility is being constructed. Ability to access rapidly high-value gas markets. Decreased construction and delivery risk for the host country (although consideration must be given to the potential repercussions for the host country if delivery of the FSRU is delayed). Potential reduction in carbon dioxide emissions - commentators believe that use of an FSRU may result in increased burning of gas rather than diesel for energy generation, which, in turn, will significantly reduce carbon emissions.

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Issues for Consideration in the Long-term Charter of an FSRU
Timing of transaction
Typically, a long lead time follows execution of an agreement for the long-term charter of an FSRU. This is because construction of an FSRU or conversion of an LNGC into an FSRU is both timeconsuming and costly, thus generating significant capex costs for the owner which are not typically incurred on a speculative basis.

Floating LNG Regasification: Legal Issues

more general definition (i.e. an event or circumstance that is beyond the reasonable control of a party, acting as a reasonable and prudent operator, and materially and adversely affects the ability of a party to perform its obligations under the TCP). An exhaustive list of force majeure events does, arguably, offer more certainty to the parties with respect to identifying whether an event of force majeure has occurred, but is dependent on each event being adequately defined and the list of force majeure events being sufficiently comprehensive. Extent of force majeure. How far along the LNG value chain should a force majeure event be permitted to run? For example, should the charterer be permitted to seek force majeure relief under the TCP for a force majeure event affecting a downstream gas buyer or upstream LNG supplier? Should the owner be permitted to seek force majeure relief for a force majeure event affecting the shipyard at which the FSRU is being built? No definitive answers can be given to these questions as the equitable solution may largely depend on the relationships (if any) between the various parties along the LNG value chain and, ultimately, the level of control that the owner and/or the charterer may have over such parties. Relief. The occurrence of a force majeure event typically relieves a party from performing its obligations under an agreement and thus prevents that party from being in breach. With respect to a TCP, the primary obligations for which the parties will seek relief are payment of charter hire (charterer) and provision of services (owner). Consideration must therefore be given to the extent to which relief is granted and for how long. For example, should a termination right accrue for the non-affected party and/or the affected party after a prolonged period of continuous force majeure? Extension of term. If a force majeure event occurs, should the charter term be extended by a period equal to the duration of the force majeure event? Any such extension may provide an opportunity for the charterer to make good any shortfall in gas delivered to its downstream gas buyer(s) during the force majeure period or, alternatively, allow the owner to recoup any shortfall in charter hire received. However, the charterer must consider whether the supply contracts under which it provides natural gas to its downstream buyer(s) permit it to make good any such shortfall and/or whether the contracts will remain in place during the extension period. Conversely, the owner must have regard to any future arrangements (i.e. post-charter period) that are already in place for the FSRU. Off-specification. An FSRU is designed to receive and regasify LNG within defined specifications. Any LNG received outside these specifications (Off-spec LNG) may cause damage to the regasification unit. An FSRU is also designed (and typically contracted) to produce natural gas within defined specifications - gas not falling within these specifications (Off-spec Gas) may be unacceptable to the downstream gas buyer and, potentially, cause damage to the receiving gas network while exposing the charterer to a claim for damages. Consideration must therefore be given to what recourse should be available to the owner and charterer for accepting delivery of Off-spec LNG and Off-spec Gas respectively. Options include: a right for the receiving party to refuse to accept delivery of the Off-specification product; a reduction in charter hire if Off-spec Gas is delivered; and

Form of agreement
The form of agreement typically used for the charter of a ship is a time charter party (TCP). Depending on whether the FSRU is to be permanently moored or is to retain its flexibility to operate as an LNGC, an FSRU project may adopt characteristics of: (i) an LNGC; (ii) a land-based regasification facility; and/or (iii) an offshore floating crude oil storage or production unit. One may therefore need to consider issues deriving from each of these types of project.2

Charter hire
Commencement date. Consideration must be given to the date upon which the FSRU is deemed to be on-hire and, thus, from which charter hire is payable. Specifically, the owner will want to ensure that charter hire is due from the date the FSRU is delivered in accordance with the owners obligations under the TCP. This may be the date that the FSRU is actually delivered at the unloading port or, if the charterer is unable to accept delivery, a deemed delivery date. Conversely, the charterer will want to ensure that payment of full charter hire only commences as and when the FSRU is delivered in accordance with the contracted specification. Terms of charter hire. The charter hire is typically a fixed daily fee which is due if the FSRU is performing within certain defined limits. The owner has no ability to manage the extent to which the FSRU is utilised and should therefore carry no risk in respect of underutilisation. However, consideration should be given to what recourse is available to the charterer if the FSRU is underperforming. Potential recourse includes a proportionate reduction in the charter hire and/or an extension of the charter hire period. Creditworthiness of counterparties. As is the case with other long-term contracts, consideration should be given during TCP negotiations to the creditworthiness of each party. The owner will primarily be concerned about the charterers ability to pay the charter hire when due. If the charterers creditworthiness is inadequate, a letter of credit may be requested by the owner or, alternatively, the ultimate parent company of the charterer (or a group company with sufficient credit strength) may act as guarantor of the charterers obligations. In contrast, the charterer will want to ensure it is sufficiently protected in the event that the owner fails to deliver the FSRU on time. Such protection may include the payment of liquidated damages by the owner. Force majeure. Although the occurrence of force majeure in the LNG industry is relatively rare, the consequences can be significant. Careful consideration must therefore be given to the extent to which force majeure relieves a party from its obligations under the TCP. Scope of definition. Thought needs to be given to whether the definition of force majeure includes an exhaustive list of agreed force majeure events or a

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granting of an indemnity to: (i) the owner for any costs incurred in cleaning or remedying the FSRU and/or venting the Off-spec LNG; and (ii) the charterer for loss suffered as a result of unknowingly accepting Off-spec Gas (e.g. inability to fulfil contractual obligations to its downstream gas buyer(s)). Regulatory concerns. Consideration should be given to what regulatory permits, licences and other forms of consent (together, Permits) are required for mooring and operating the FSRU at the unloading port. This requirement will vary depending on the country in which the unloading port is located. Sufficient time and resource must be dedicated to ensuring all Permits are secured prior to the FSRUs arrival. Furthermore, the TCP should expressly state which party is responsible for securing the Permits. Typically, a distinction is drawn between those Permits necessary for FSRU mooring and operation, which are for the owners account, and those Permits required for construction and operation of the LNG terminal and mooring platform, which are for the charterers account. Third party access regimes. A further regulatory concern which should be considered is the applicability of third party access regimes. In various jurisdictions (such as in the EU), local law requires the owner of certain infrastructure to make available to third parties (on reasonably competitive or regulated terms) some or all of that infrastructures capacity. Consequently, the owner is prevented from awarding 100 per cent of the infrastructure capacity to one party and, by extension, an FSRU owner may be prohibited from contracting 100 per cent of the nominal regasification capacity to a sole charterer. Liability and indemnity. The parties to a TCP should give careful consideration to the liability regime which they wish to rely on. The two options which typically underpin liability regimes are: guilty party pays, whereby one party (party A) indemnifies the other party (party B) for any liability incurred by party B as a result of the acts or omissions of party A; and mutual hold harmless (also known as knock-forknock), whereby one party (party C) is responsible for and indemnifies the other party (party D) against any liability incurred by party D which relates to personal injury, illness or death of personnel employed by party C (or party Cs affiliates) or damage to property belonging to party C (or party Cs affiliates) (and vice versa). Consequently, the indemnity provided by party C is effective even if liability accrues due to the actions of party D. The parties may agree not to apply knock-for-knock principles where the non-indemnifying party has committed gross negligence or wilful misconduct. Arguably, the mutual hold harmless approach allows for strict allocation of liability as each party bears responsibility for its own property and personnel (which responsibility it could ordinarily seek to manage through insurance). In contrast, the guilty party pays approach requires determination of fault and, thus, scrutiny of the actions of each party, which may result in dispute if the parties fail to agree. The parties should also consider whether to exclude liability for consequential loss. Permitting recovery of consequential loss potentially exposes the parties to loss which may be difficult to foresee at the time of entry into a TCP.

Floating LNG Regasification: Legal Issues

Rights of compensation for nonperformance. The ability of a party to claim compensation for a counterpartys failure to perform its obligations under an agreement is always an area of focus during pre-contractual negotiations. With respect to a TCP, the owners primary concern is to ensure that the charterer continues to pay full charter hire in the event of charterer default (e.g. failure by the charterer to provide, operate and/or maintain a mooring berth for the FSRU at the unloading port, failure to secure all necessary permits, etc.). Conversely, the charterer will seek relief from payment of the charter hire if the owner is in default (e.g. late delivery of the FSRU). Furthermore, the charterer may seek liquidated damages as a means of compensation for any loss suffered under gas supply contracts with downstream gas buyers. Termination rights. To avoid future uncertainty, the termination rights of each party to a TCP should be expressly identified. Typical termination rights may include: a right for the owner to terminate for non-payment of charter hire. The daily charter hire is typically a considerable amount, therefore the owner may require a termination right after a short period of non-payment to limit any compounding effect and, ultimately, its financial exposure to the charterer; a right to terminate for prolonged force majeure. When considering if and/or when a termination right accrues following a force majeure event, thought should be given to, among other factors, how long the force majeure event must continue prior to a termination right accruing and which party the termination right accrues to (i.e. non-affected party only or both the affected and non-affected party); a right for the charterer to terminate for prolonged late delivery of the FSRU. Given that the charterer is likely to have gas supply contracts in place with downstream buyers, late delivery of the FSRU may have significant consequences for the charterer. The charterer may therefore seek a right to terminate the TCP in such circumstances and negotiations are likely to centre on what period of delay must pass before any such termination right accrues; a right for the non-affected party to terminate for bankruptcy and/or commencement of insolvency proceedings; and a right for the charterer to terminate for loss (actual or constructive) of the FSRU.

Endnotes
1 2 LNG is estimated to have less than 0.2 per cent of its original natural gas volume. Note that this article does not consider any specific marine law issues (e.g. salvage, outbreak of war, additional war expense and New Jason clauses), but such issues should be taken into account by all parties during TCP negotiations.

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Ashurst LLP

Floating LNG Regasification: Legal Issues

Anthony Patten
Ashurst LLP Broadwalk House, 5 Appold Street London EC2A 2HA United Kingdom Tel: Fax: Email: URL: +44 20 7859 2464 +44 20 7638 1112 anthony.patten@ashurst.com www.ashurst.com

Anthony Patten is a partner in the energy, transport and infrastructure department in London, specialising in corporate and project development work in the oil and gas and wider energy sectors. He has particular expertise in the upstream oil and gas and LNG sectors, having advised clients on upstream developments, natural gas liquefaction projects, shipping and trading and LNG regasification projects across a wide range of jurisdictions, including throughout the Middle East.

Ashurst operates at the heart of the energy industry worldwide. With a global energy team of over 80 lawyers we can assemble teams to provide the highest quality advice tailored to our clients needs. We have helped hundreds of companies, financial institutions and governments deal successfully with challenging energy projects by developing innovative solutions. Our lawyers provide a comprehensive service to the energy and natural resources industry in the following areas: Upstream oil and gas LNG Power Renewables Nuclear We advise on all aspects of work in the energy industry: Mergers, acquisitions and corporate finance Project and acquisition financing Environmental law Commercial agreements Contact Geoffrey Picton-Turbervill, Head of Ashursts Global Energy Team. Tel: +44 (0)20 7859 1209; Email: geoffrey.picton-turbervill@ashurst.com Greenfield projects International law Joint ventures Litigation and arbitration Pipelines Refining and petrochemicals Mining Water

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