Liquefied Natural Gas ("LNG") is currently the fastest-growing gas supply source. Shell's LNG Outlook 2019 Report predicts a compound annual growth rate in the market of 4 per cent between now and 2035. By 2025, US$240 billion is expected to be invested into LNG projects worldwide, leading to an additional 180 million tonnes per annum of LNG in circulation. (Forbes 13 September 2019, "LNG's Surfing the Wave" by Simon Flowers.)
The increase in LNG demand has led to innovation and growth in the LNG shipping world. The increasing prevalence of sales contracts without destination clauses enables charterers to nominate discharge ports to suit the latest market demand. The resulting effect has been noticeable, with LNG spot trades and short-term contracts (four years maximum) accounting for nearly 100 million tonnes of LNG imports in 2018, an increase of nearly 30 per cent from 2017. Separately, the global LNG vessel order book has seen 64 LNG carriers commissioned in 2018 (compared with 23 in 2017), with a further 136 expected to be ordered between 2020 and 2023. (LNG World Shipping, March/April 2019.)
In this context, we are witnessing an increase in the number of LNG charterparty disputes, concerning, in particular, performance warranties. This article will consider some of the more specialist Performance Clause calculations used to assess an owner's compliance with its performance obligations, namely, boil-off warranties and fuel consumption warranties. We will also review the interrelationship between these Performance Clauses and how best to approach claims spanning across multiple performance warranties.
This review is conducted in the framework of the standard ShellLNGTime 1 form which is a far more prevalent charterparty than the more recent ShellLNGTime 2.
The most contentious area of law relating to ShellLNGTime 1 is the interrelationship between the speed, consumption and boil-off warranties, which leads us to frequently be faced with disputes involving, to some degree, the overlapping application of each of these warranties.
One commonly cited example is a situation where a vessel breaches its speed warranty but, as a result, makes a saving on its fuel consumption. Another example is when a vessel has:
i. breached its boil-off warranty and generated excess boil-off; and
ii. in parallel, uses that same excess boil-off in breach of its fuel consumption warranty.
In this latter scenario, the question is whether or not the charterer would be entitled to claim for a deduction of hire twice under the breach of the fuel consumption warranty and the breach of the boil-off warranty. These questions are each addressed in turn.
Transportation of natural gas is only economically viable when it is in liquefied form (i.e. LNG) because it occupies 600 times less volume than in its gaseous state. To achieve this, LNG vessels must be capable of maintaining the cargo at a temperature equal to, or less than, the boiling point of natural gas (approximately -162 degrees Celsius), to prevent it returning to its gaseous state. Although a vessel's cargo tanks are insulated, the cargo will inevitably warm up over time, producing boil-off gas (or "boil-off").
The increased pressure in the tanks, generated by the boil-off must be regulated by, either:
(i) burning the boil-off gas within a Gas Combustion Unit;
(ii) using the boil-off as fuel; or,
(iii) on a very small number of vessels, re-liquefying the boil-off gas.
Option (iii) is less common as it requires costly specialist on-board equipment.
Unless it is re-liquefied, the boil-off gas reduces the volume of cargo that will ultimately be discharged. It is this negative correlation between the generation of boil-off gas and the resulting reduction in the volume of cargo delivered which charterparty performance warranties attempt to balance. Under Article 7 of Annex C of ShellLNGTime 1, an owner warrants that boil-off gas shall not exceed a certain percentage of the overall cargo loaded, per day, during the voyage (the daily guaranteed maximum boil-off or DGMB).
The DGMB is a point of negotiation and, while this should take into account the structural insulation of the vessel's tanks, other factors should also be considered, for example, weather conditions. In adverse weather conditions, the LNG will slosh and make contact with the top of the tank which is not normally submerged and, therefore, slightly warmer, causing an increase in the rate of boil-off. Unless ShellLNGTime 1 has been amended, bad weather days are not taken into account when considering if an owner has breached the boil-off warranty. Accordingly, sufficient tolerance in the DGMB should be factored in for this. A typical DGMB figure (excluding bad weather days) would be between 0.09 per cent and 0.15 per cent per day, although we are increasingly seeing lower figures.
The DGMB is located at clause 26(g) and 26(h) of ShellLNGTime 1 and is expressed as two figures:
i. the laden DGMB; and
ii. the ballast DGMB.
This distinction is made because an LNG vessel will often retain a certain amount of LNG following discharge (the "Heel") to ensure the vessel's tanks are kept at a sufficiently low temperature. This is to avoid unnecessary delays, at the next load port, cooling the tanks in preparation for receipt of the next LNG cargo. The need for a ballast DGMB is reflective of the period when the vessel only carries the Heel, during which time one can expect a greater rate of boil-off gas generation (as the LNG will make contact with a larger surface area of the unsubmerged internal tank surface when sloshing as compared to when the vessel is fully laden).
To establish whether an owner has complied with its boil-off obligations, the actual boil-off must be compared with the guaranteed maximum boil-off (Appendix C, article 8(a)).
Actual boil-off is calculated by subtracting:
(i) the volume of LNG contained in the vessel's tanks at gauging after the sea passage, from
(ii) the volume of LNG that was loaded at the start of the sea passage (Appendix C, article 8(b)).
Guaranteed maximum boil-off is calculated by multiplying the applicable DGMB by the time between gauging as set out above (Appendix C, article 8(a)). Note that periods of off-hire are not included when considering the time between gauging for the purposes of this calculation (Appendix C, article 8(c)).
If the actual boil-off is equal to or less than the guaranteed maximum boil-off, the owner will have complied with the boil-off warranty. On the other hand, where the actual boil-off exceeds the guaranteed maximum boil-off, the owner will have failed in its obligations under the boil-off warranty. In such instances, the charterer may deduct from hire the balance of the boil-off multiplied by the LNG Price (as agreed by the parties during pre-fixture negotiations and defined in clause 50) (Appendix C, article 8(d)).
Voyage orders resulting in owner's deemed compliance
It is worth noting that ShellLNGTime 1 takes into account instances where a vessel is ordered by the charterer to manipulate the boil-off gas equilibrium so as to generate increased boil-off. In such instances, the charterer's orders will result in the owner's deemed compliance with the boil-off warranty. There are several situations when this may occur. First, where the charterer orders the temperature, or the tank pressure, to fall during the voyage (Appendix C, article 7(b)). Secondly, where the charterer orders the owner to force vaporise the LNG so the vessel can substitute its use of fuel oil for the use of boil-off gas (Appendix C, article 9(b)). In both instances, the owner is required to increase the boil-off gas generated and, accordingly, it is only fair that they are not held accountable under the normal operation of the boil-off warranty.
Fuel consumption warranties
The fuel consumption warranty is the owner's warranty as to the vessel's fuel consumption efficiency. In a similar manner to the boil-off warranty, whether an owner has complied with its fuel consumption warranty is determined by comparing the actual fuel consumption for a given voyage to the guaranteed fuel consumption, i.e. the fuel expected to be consumed (Appendix C, article 5). Guaranteed fuel consumption is calculated by multiplying the maximum daily consumption (as listed in article 26(e)) by the duration of the voyage (Appendix C, articles 3 and 5). A complicating factor to this equation, however, is that most LNG vessels have the capability of burning boil-off gas instead of bunkers.
Fuel Oil Equivalent Factors
As most LNG vessels are capable of burning boil-off gas instead of bunkers, ShellLNGTime 1 introduces a conversion rate which allows parties to establish the equivalent fuel oil consumption when boil-off gas is being consumed (clause 26). This is calculated using the Fuel Oil Equivalent Factor which sets out the conversion rate of 1m of LNG correlating to the equivalent mass of fuel oil in metric tonnes. As with the DGMB, this conversion factor is a point of negotiation.
It is worth noting that ShellLNGTime 1 assumes a constant calorific value of boil-off gas, irrespective of whether it occurs naturally or is being forcibly created by the vessel, an assumption which in practice is incorrect.
Fuel Consumption Calculation (Appendix C, Article 5)
To determine whether an owner has complied with its fuel consumption warranty, one must compare the actual fuel consumption for a given voyage with the guaranteed fuel consumption (Appendix C, article 5). The fuel consumption warranty does not apply to periods between two voyages (Appendix C, article 5(c)).
The calculation to determine actual fuel consumption is set out in Appendix C, article 6, which states that this is the sum of:
(i) the fuel oil consumed during a voyage excluding any fuel oil used in any off-hire period; and
(ii) the fuel oil equivalent to the total volume of cargo lost as boil-off during the voyage, excluding boil-off in any off-hire period and excluding any boil-off in excess of the guaranteed maximum boil-off under the provision of article 8.
Guaranteed fuel consumption is calculated by multiplying the maximum daily consumption (as listed in article 26(e)) by the duration of the voyage (Appendix C, articles 3 and 5).
When calculating both actual fuel consumption and guaranteed fuel consumption, an adjustment must be made by taking into account what the charterparty defines as "Restricted Periods" (Appendix C, article 2(e)). These include instances of, for example, congested water or attempts to save life.
As soon as practicable after the receipt of the necessary voyage performance data, the charterer shall provide the owner with its calculations determining fuel consumption for each voyage (Appendix C, article 5(d)). At the conclusion of the charterparty, or annually (whichever occurs first), the quantities of additional fuel actually used and/or saved across all voyages shall be added up. If there is an overall saving of fuel, the owner has complied with its fuel consumption warranty. If, on the other hand, there has been a net excess of fuel used, the charterer shall be entitled to make a deduction from hire. The deduction amount is calculated by multiplying the net amount of excess fuel by the weighted average price paid by the charterer for fuel oil, for the vessel, over the period of the charterparty.
Voyage orders resulting in owner's deemed compliance
As with the provisions of the boil-off warranty, certain voyage orders will result in the automatic deemed compliance of an owner with its fuel consumption warranties. This occurs when the charterer issues the following orders, so that the vessel may reach the destination port by the scheduled arrival time: (i) the vessel is to travel at a slower speed than the minimum service speed; and (ii) the vessel is to travel at a faster speed than the applicable service speed (both defined by clause 26).
The justification for these carve outs is simple; when entering into a charterparty, an owner only warrants the fuel efficiency of the vessel when travelling within a range of pre-agreed speeds. The owner does not warrant the fuel efficiency of the vessel outside these parameters.
Balancing speed and consumption warranties
In addressing the first scenario (breach of speed warranty but saving in fuel consumption), it is useful to consider the approach adopted in ShellTime 4, the basis on which ShellLNGTime 1 was drafted. ShellTime 4 deals with the speed and consumption warranties under a single calculation (clause 24(b)). The effect of this drafting is that a better than guaranteed performance in respect of bunkers may be taken into account as cancelling out, in whole or in part, an underperformance in respect of speed (or vice versa) ("INTERTANKO – A Comparison of Shelltime 1984, Shelltime 2003 and ShellLNGTime 1", para 24.10). By contrast, the provisions dealing with speed and consumption within ShellLNGTime 1 were completely redrafted so that each calculation is treated separately. This compartmentalisation of each calculation within ShellLNGTime 1 means that owners gain no credit for exceeding the guaranteed figures but will suffer a deduction from hire if one of these calculations produces a figure less than was guaranteed. Accordingly, unlike ShellTime 4, an owner cannot look to offset a saving in the speed calculation against a loss in a consumption calculation (or vice versa) under ShellLNGTime 1 ("INTERTANKO – A Comparison", para 24.12).
The above conclusion, however, is not as problematic in the context of LNG vessels as one might anticipate. This is due to the added dimension of boil-off (which is not, nor needs to be, addressed in ShellTime 4). As LNG vessels have the free use of boil-off (Appendix C, article 9(e)) and there is an expected generation of boil-off gas up to the guaranteed figures (clause 26(e)), the vessel will almost always be able to make use of this boil-off gas to ensure it does not breach its fuel consumption warranty (irrespective of whether the vessel is compliant with its speed warranty). Of course, this would be subject to the negotiated terms of the charterparty, but we find owners often ensure sufficient margins in the agreed guaranteed fuel consumption and boil-off figures to avoid this exposure. In fact, it is not uncommon for the guaranteed boil-off alone to be sufficient to ensure the vessel steams at the warranted speeds during large parts of the voyages.
Balancing boil-off and fuel consumption warranties
Given the compartmentalisation of the Performance Clauses within ShellLNGTime 1 described above, one might assume that an owner may be held liable twice in respect of the same boil-off: once in respect of the excess boil-off generated under the boil-off calculation, and then again for excessive fuel consumption of the same boil-off gas. However, a closer inspection of the drafting of the actual fuel consumption calculation reveals that excessive boil-off is expressly excluded from this calculation.
The first limb of the calculation governing actual fuel consumption concerns "fuel oil consumed during the voyage". Excessive boil-off, or indeed boil-off generally, cannot be included under the term "fuel oil". This is because article 4 of Appendix C, when defining "fuel" as the collective term for both "fuel oil" and "boil-off", further clarifies that "fuel oil refers only to the oil component of the fuel".
The second limb of the calculation expressly states: "... excluding any Boil-Off in excess of guaranteed maximum boil off under the provisions of Article 8", i.e. the excess boil-off gas that would be compensated for under the boil-off calculation provision.
Accordingly, while ShellLNGTime 1 may have compartmentalised the various performance warranty calculations, the express wording of the fuel consumption calculations is such that a charterer is prevented from including the excess boil-off (otherwise remedied via the operation of the boil-off warranty) within its claim for underperformance in respect of fuel consumption. Certainly, this is the same conclusion reached by the authors of "INTERTANKO – A Comparison" (at para 24.30).
This interpretation ties in with the other provisions of Appendix C, namely article 9(e), which states that an owner has free use of any boil-off gas generated and, further, they are required to exercise due diligence in minimising the venting of boil-off into the atmosphere. As such, irrespective of whether the boil-off generated is excess, the owner is arguably entitled to use such boil-off as fuel (or return it to its liquid state using a regasification unit if possible) to avoid venting it into the atmosphere. It would be illogical for an owner to be punished a second time (after being liable under the boil-off warranty) for using the excess boil-off as fuel in compliance with its obligation under article 9(e).
We recognise that the misunderstanding of the relationship between the consumption and boil-off warranties is largely down to the somewhat confusing drafting of ShellLNGTime 1. Certainly, this was recognised in the process of drafting of ShellLNGTime 2 which introduced additional wording to clearly establish the position in respect of these clauses. While ShellLNGTime 2 maintains the same approach to the calculation of actual fuel consumption as ShellLNGTime 1 (i.e. the same terminology of "fuel oil" and excluding excess boil-off otherwise covered by the boil-off warranty), an additional article in the relevant appendix is now included stating:
"In a case where charterers order the vessel to proceed on dual fuel or gas only then the boil-off element of the actual measured fuel consumption shall be deemed equal to the actual daily boil-off or the guaranteed maximum boil-off, whichever is lesser. This is to ensure that there is no double counting with excess Boil-Off calculations under Article 6 (Boil-Off Performance) below." [Our emphasis.] (Appendix A, article 6(h).)
This additional wording is a welcome amendment and expressly confirms our interpretation of ShellLNGTime 1. Given the possible misunderstanding of these clauses within ShellLNGTime 1, we would advocate the inclusion of this wording from ShellLNGTime 2 to the standard form ShellLNGTime 1, whenever it is used. This would ensure that both parties to the charterparty better understand their performance warranty rights and obligations, which in turn would avoid costly and unmeritorious performance claims being advanced.
ShellLNGTime 1 Performance Clauses require a combination of legal and technical expertise in order to successfully negotiate sensible charterparty terms and minimise the risk of disputes which may relate to them. In the current market, we are witnessing an increased level of performance clause disputes, with parties often taking for granted the detail required to understand their practical application.
First published in Maritime Risk International, November 2019
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.