Global M&A trends and risks
Powerful new forces shaping in the M&A landscape
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Global | Publication | April 2020
The oil market has seen a dramatic fall in prices due to an excess supply and a substantial decrease in demand due to, amongst other things, the coronavirus. The stark extent of the collapse in the market can be seen by the oil price temporarily falling below zero meaning that, in principle, sellers would have to pay buyers to take oil off their hands. As a result, traders are looking to store oil for several weeks or months in anticipation (or hope) of a recovery in the oil price.
A surge in demand and a shortage in availability of shore-based storage has pushed traders to look elsewhere. One option is chartering Very Large Crude Carriers (VLCCs) or Ultra Large Crude Carriers (ULCCs) for use as floating storage at sea. While this may be an attractive option, both owners and charterers must be aware that using vessels as floating storage has practical and legal implications.
Vessels provide a significantly more mobile and flexible option for storage. They can be directed to proceed or wait almost anywhere and, once the market recovers, they can be ordered to proceed to a discharge port to deliver the cargo to a buyer. There may also be significant customs duty and tax implications for storing cargo on land.
Most charterparties are geared towards the transportation of cargo from one place to another rather than for storage. They have been developed and evolved to deal with known or anticipated risks and to allocate these between charterers and owners. Parties need to plan for and deal with the issues that may arise by changing the intended use of a vessel.
Voyage charterparties are, generally speaking, aimed at carrying cargo from one place to another as quickly as possible. They do not cater for a laden vessel under charter sitting in one place for several weeks or months. Owners charge freight for a voyage rather than time – although there are penalties and incentives for loading or discharging cargo slower or faster than the agreed rate in the form of demurrage and despatch. It is to owners’ advantage to complete the voyage as quickly as possible so that they can undertake the next fixture. Issues like maintenance and drydocking are usually performed by owners outside of voyages – but this may not be possible if the vessel is chartered for several months.
Some voyage charterparties have incorporated terms that allow a charterer to elect to order a vessel to wait for orders – effectively turning the vessel into storage. The charterparty will often provide for a substantially higher demurrage rate if the vessel is used for storage. In those circumstances, owners may be happy for charterers to instruct the vessel to wait as they know that they will be compensated well for the lost time. However, the charterparty (and the parties) must be absolutely clear about what demurrage regime will apply. For example, in the Zaliv Baikal, the charterparty provided that if the charterers ordered the vessel to stop and wait for further orders then a significantly higher demurrage rate would apply. The charterers did not provide any orders and the vessel sat for several days. The owners claimed the higher rate of demurrage whereas the charterers were only willing to pay the standard demurrage rate. The court interpreted the demurrage clause to only impose the higher demurrage rate if an express order to stop and wait was given. The court refused to read into the charterparty an implied term that a failure to give an order amounted to a stop and wait order which would have incurred the higher demurrage rate. Accordingly a charterparty must be clear about what rate the parties intend to apply if the vessel is used for storage.
Time charterparties are more geared towards use as storage because charterers charter the vessel for a set period of time and are generally free to order the vessel to proceed to any destination or wait subject to any agreed trading or cargo limitations. Sometimes charterparties do expressly provide that a vessel can be used for storage but often this is a throwaway clause included without much thought as to the implications of using the vessel for long-term storage.
There are practical considerations that need to be taken into account: how long and where will the vessel wait?
Charterers will need to speculate how long they will need to charter the vessel. If the charter is too short, owners may refuse to extend it and the oil price may not have sufficiently recovered. The charter hire for tankers capable of use as floating storage has rapidly risen due to the increase in demand. The oil price needs to have increased sufficiently to offset the cost of hire, otherwise charterers will not realize any benefit. If charterers charter the vessel for too long, they may be stuck with a vessel which they no longer need and paying a very high rate of hire. Charterers will want flexibility while owners will want to lock charterers into a favorable hire rate for longer. For existing charters, charterers may wish to extend on old hire rates while owners may want to terminate to conclude more profitable charterparties.
Most vessels are not designed to sit in one place for too long. A vessel that sits in one place will likely experience hull fouling and marine growth which may require ongoing maintenance and for the vessel to be drydocked at the end of the charter. Who will foot the bill?
Long-term storage may also be subject to regulatory, maintenance and safety concerns. International sanctions applicable to certain countries or entities may change over the course of several months. Some countries may restrict or prohibit a fully laden VLCC or ULCC sitting within a country’s territorial waters for several months. A long-term floating storage may be subject to additional weather, piracy and political risks. In light of the coronavirus, some ports have imposed severe restrictions on working cargo, provisioning vessels and embarking or disembarking crew. If a crew member becomes ill or is otherwise not able or willing to work, and owners are not able to put new crew on board, then a vessel may not comply with safe manning requirements, rendering the vessel unseaworthy.
Both charterers and owners must also be aware of potential cargo issues – owners are obliged to provide a seaworthy vessel which includes the ability to safely store and carry cargo. Whether a vessel can safely store cargo for several weeks or months without damage or degradation will depend on the nature of the cargo and the vessel. The vessel must be capable of ensuring that the cargo is maintained and monitored for several months to ensure that the cargo will not be damaged.
Charterers, owners and cargo owners must ensure that they have adequate and appropriate cargo, P&I, charterers’ liability and pollution insurance in place and establish who will bear the cost of any additional premiums. Parties will need to notify their insurers or brokers, review their existing cover and establish what additional insurance they need. For example, cargo owners need to be aware that the ICC clauses (which are the standard cargo insurance clauses) are not designed for long-term storage. Vessel owners and charterers need to consider whether they have increased exposure to liability for pollution or cargo damage.
The option of chartering vessels for floating storage may be highly appealing to both owners and charterers but parties must ensure that they that appreciate and plan for the risks associated with doing so.
Nina Varumo is a freelance portrait and documentary photographer based in Stockholm. A recent project of hers Kvinnor till sjöss (‘Women at sea’) is on ongoing photo series highlighting the working life of female seafarers in order to change the stereotypical image of what and who is a seafarer.
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