Petroleum operations and facilities – who calls the shots?
'Ships' versus 'installations'
Why push for flag state jurisdiction?
Challenge for investors and regulators
What are the legal consequences for a coastal state which accepts a permanently placed production facility that is a foreign-flagged ship or vessel within its exclusive economic zone (EEZ) and on its continental shelf?
Technology and the economy have aligned to enable an increasing number of projects based on floating production, including floating liquefied natural gas (FLNG) production projects. The legal and contractual regime for offshore exploration (and even the traditional maritime transportation of goods or persons) does not address the challenges faced by floating production. With these new technological and production concepts, tried and tested legal and contractual solutions have had to be revisited and often refined.
When an FLNG unit is registered under a foreign flag it is subject to the flag state's jurisdiction. In general, the flag state's laws apply to all shipping matters – from ownership, corporate governance, technical and other standards, safety and pollution and other liabilities to the establishment and enforceability of collateral security and economic and social matters. These rules are well known, widely used and appear to work in practice, while at the same time these matters are core components that a coastal state would normally wish to retain jurisdiction over. For resource management, rent collection and industrial development purposes, the coastal state would normally want to retain unchallenged control over an installation and the personnel undertaking petroleum-related operations and exploiting its petroleum resources.(1)
As they have sovereign rights and exclusive jurisdiction over the exploration for and exploitation of natural resources, coastal states are clearly acting within their public international law jurisdiction if they elect to refuse the operation of a floating production unit under a foreign flag.(2) However, coastal states may need to look at alternative approaches and the subsequent consequences for coastal state governance.
Petroleum operations and facilities – who calls the shots?
The short answer is the coastal state. Public international law allocates jurisdiction between sovereign states and establishes the outer limit of the jurisdictional reach of their domestic legislation. The development of public international law over the past 50 years has determined the reach and nature of a coastal state's jurisdiction. Comprehensive multilateral efforts to regulate jurisdiction over vessels, facilities and activities in maritime areas culminated in the United Nations Convention on the Law of the Sea 1982 (UNCLOS). This key maritime convention codified and expanded international law with regard to the continental shelf and introduced the legal foundation for coastal states' right to a 200 nautical mile EEZ. The adoption of UNCLOS has had a decisive impact on many public international law instruments, including those developed under the International Maritime Organisation (IMO).(3)
Articles 56 and 77 of UNCLOS establish that, within its EEZ and on its continental shelf, the coastal state has "sovereign rights for the purpose of exploring for and exploiting… the natural resources".
Articles 60 and 80 of UNCLOS state that, for this purpose, the coastal state has exclusive "jurisdiction over the establishment and use of artificial islands, installations and structures". However, Article 89 also makes clear that "no state may validly purport to subject any part of the high seas to its sovereignty".
Under Article 90, "every State… has the right to sail ships flying its flag on the high seas". However, pursuant to Article 91(1), the state must determine the "conditions for the grant of nationality to ships" and for the registration of the ship's nationality.
Lastly, under Article 92(1), "ships shall sail under the flag of one State only". The state in which the ship is registered and under whose flag it sails is customarily referred to as the 'flag state'. This exclusive jurisdiction is accompanied by obligations for the flag state to effectively exercise its jurisdiction.(4)
In the preparation and adoption of UNCLOS and its predecessors, the 1958 Geneva Conventions, the legal consequences of expanding coastal state jurisdiction to include areas that had previously been subject solely to high seas freedoms established under customary law were discussed. UNCLOS maintained that the freedom of navigation remained intact beyond the 12 nautical mile territorial sea. Coastal state jurisdiction over exploration for and exploitation of natural resources on the continental shelf, as codified in the 1958 Geneva Convention on the Continental Shelf, was expanded in UNCLOS.
'Ships' versus 'installations'
Floating units for use in offshore petroleum activities take many forms – some are based on hull designs comparable with those used for traditional shipping, while others are unique in shape or form. It appears that, due to a lack of clarity regarding public international law as it has manifested itself through state practice, a floating unit such as an FLNG unit may under public international law qualify as both an 'installation' and a 'ship'.
Flag and coastal states have different interests in offshore activities and may have different interpretations of public international law. The interests associated with the legal and contractual regimes governing the traditional maritime sector are not shared by resource owners. Requirements imposed on ships – whether treaty or domestic law-based – are typically limited to the functionality of navigation, maritime crews and the protection of goods and passengers. The nature of offshore petroleum operations is non-navigational in nature. Floating units are generally not self-propelled (aside from occasionally being fitted with thrusters designed to assist positioning on location). The unit's near permanent placement or mooring, its capacities (which are usually specifically designed to produce designated resources) and its physical connection to the sub-sea facilities and wells extracting petroleum from a specific self-contained resource support coastal state jurisdiction and control.
UNCLOS and customary international law do not expressly determine whether an FLNG unit is a 'ship'(5) or an 'installation'.(6) It could be argued that UNCLOS does not take a position on the physical appearance of an object used for exploring or exploiting natural resources.
The traditional purpose of a ship is to sail or navigate – moving crew, goods or passengers from one harbour to another. That is not the core function of a petroleum production unit. According to the commentary on Article 90 of UNCLOS, a ship or vessel may "take on a different hue according to the zone of the sea concerned by reason of the acknowledged rights of the State to which the ship/vessel belongs". However, the United Nations Registration Convention's definition of a 'ship' excludes an offshore production unit, such as an FLNG, in most cases.(7)
The United Nations Registration Convention aims to strengthen the genuine link between a state and the ships flying its flag. The flag state must effectively exercise its jurisdiction and control over such ships with regard to accountability for owners and operators. The convention's stated objective strongly suggests that the flag state's jurisdiction has prevalence once a flag is afforded to a ship or vessel. The convention contracting parties must enable registration on the basis of specific minimum information and thereby establish the ship's nationality. However, strictly speaking, the convention does not prohibit sovereign states from including units in a register other than those immediately understood to be ships.
UNCLOS refers to "artificial islands, installations or structures", rather than ships when addressing the exploration for and exploitation of natural resources. The term 'artificial islands' conjures up the image of an immovable object permanently embedded on the seafloor. Clearly, UNCLOS did not intend to limit the ability to move or reuse installations or structures. UNCLOS terms must be interpreted to include movable units if the convention is to have any meaning in an exploration context. A production facility, whether fixed to the seabed or floating, will also have to be moved, partly or completely reused on another deposit or scrapped when the deposit's exploitation is no longer economically viable.(8)
The UNCLOS commentary on installations refers to proposals from several delegations to include floating units used in exploration and production as installations.(9) However, this language was not adopted (although the reason for this is unclear). Unfortunately, no further clarity or guidance may be gained from the language of UNCLOS or from the commentary.
Why push for flag state jurisdiction?
Coastal states may allow a production unit to carry their national or a foreign flag, but simultaneously remain a production installation subject to coastal state exclusive jurisdiction, natural resource law and regulation. If an FLNG unit flies the coastal state's flag, no public international law issue arises. The sovereign state holds both coastal state and flag state jurisdiction.
Several jurisdictions with offshore production have no, inadequate or limited petroleum and maritime legislation to address the associated challenges. Foreign flag registration may therefore be justified by the underdevelopment of the coastal state's petroleum and maritime regime. By subjecting the unit to the commonly used flag state's rules, yards, owners, users and lenders can gain access to a familiar legal environment of technical standards ensuring the seaworthiness of the unit, which international lenders in particular may wish to rely on when establishing collateral security over the floating unit itself.
Viewed in isolation, registration creates clarity with regard to ownership and the establishment, maintenance and priority of collateral security against other creditors. Classification societies and the insurance industry (provided that the upstream exclusive rights holders do not rely on their habitually applied captive insurance schemes) are well acquainted with the legal consequences of ship registration, making their assessments more efficient and possibly less risky and expensive.
However, there are potentially substantial legal uncertainties associated with the effects of permitting a foreign-flagged vessel to operate as a production installation for offshore petroleum production. These uncertainties relate to the extent and nature of the conflicting or concurrent executive and judicial powers of coastal states versus flag state authorities and courts in relation to – among other things:
- the ownership, administration, management and operational control requirements of the unit;
- the unit's crew, structural integrity and safety;
- liabilities for incidents, environment protection and pollution;
- general law enforcement; and
- financial security enforcement.
These concerns are of a different nature than those concerning exploration or support functions that are short term, specific and may be substituted relatively simply. As in commercial shipping, such units are regularly brought to a yard for mandatory inspection, maintenance and upgrades. Offshore production units cannot regularly be disconnected or taken out of service; rather, they must stay in place and operate safely on a daily basis, in some cases for 25 years or more.
The ownership and financing of a floating unit may depend or rely on special purpose entities (SPEs) to ensure that collateral security may be established separately from exclusive petroleum rights. If the borrower SPE, owner SPE, sponsors or exclusive production rights holders default, the lenders will usually want to access their security, including by taking control of the assets, and exercise so-called 'step-in' rights, in-ship financing and so-called 'sail away' rights. This is inconsistent with coastal state obligations to ensure the orderly decommissioning and removal of unused installations. It may also be contrary to exclusive rights holders' obligations to hand over the production facilities to the resource owner for continued use if the deposit is not entirely depleted when production rights expire.
Challenge for investors and regulators
The coastal state clearly has the strongest genuine link to a production unit and the activities that it performs, and the resource owner or coastal state regulator has the strongest motivation to clarify this matter. Several arguments, particularly in relation to resource management, operational control and rent collection, far exceed traditional crew concerns, and seaworthiness assessments. Environmental protection concerns also support the notion that an FLNG unit should be considered subject to, and thus defined by, a single coastal state jurisdiction.
Some jurisdictions determine that floating production facilities are installations(10) when used for the purpose of petroleum operations and govern them as installations regardless of their flag.(11) Others accept them as foreign-flagged vessels, with various degrees of reference to or influence from domestic laws, while some jurisdictions have not addressed the issue.
Legal scholars appear to have been predominantly focused on how harbour state jurisdiction extends to foreign-flagged ships. This is irrelevant for offshore facilities. UNCLOS clearly states that offshore installations will not be considered to be permanent harbour works.(12) As regards offshore facilities, the focus has been on drilling rigs. However, drilling rigs raise different legal, operational and resource-related issues than production facilities, as they undertake distinct, repetitive and brief assignments. Even with regard to this issue, state practice is not uniform and scholars do not agree.
If the coastal state cannot control all aspects of floating production within domestic law, a constructive and responsible way forward is to seek international collaboration with recognised shipping nations with relevant and adequate legislation and monitoring authorities. An alternative solution is to establish a coastal state petroleum law-mandated registry and rules, rights and obligations comparable to those following from ship registration or the onshore mortgaging of business or property assets. Any regulation must enable the establishment of collateral security for project financing purposes, which requires harmonisation with existing coastal state law. Such rules must also include appropriate enforcement mechanisms, both of which are found only in mature jurisdictions.
For further information on this topic please contact Bjørn-Erik Leerberg at Simonsen Vogt Wiig Advokatfirma by telephone (+47 21 95 55 00) or email ([email protected]). The Simonsen Vogt Wiig Advokatfirma website can be accessed at www.svw.no.
(1) See United Nations Registration Convention, Article 9 on the manning of ships.
(2) UNCLOS, Articles 56(1)(a) and (b) compared with Article 60(1)(b).
(3) IMO LEG/MISC.8, January 30 2014, Implications of the United Nations Convention on the Law of the Sea for the International Maritime Organisation.
(5) United Nations Convention on the Law of the Sea 1982, A Commentary, Volume III, Articles 86 to 132 and documentary annexes, Satya N Nandan CDE and Shabtai Rosenne (volume editors) and Neal R Grady (assistant editor), Centre for Ocean Law and Policy, University of Virginia School of Law, 1995, Martinus Nijhoff Publishers.
(6) United Nations Convention on the Law of the Sea 1982, A Commentary, Volume II, Articles 1 to 85, Annexes I and II, Final Act Annex II, Satya N Nandan CDE and Shabtai Rosenne (volume editors) and Neal R Grady (assistant editor), Centre for Ocean Law and Policy, University of Virginia School of Law, 1993, Martinus Nijhoff Publishers.
(7) The language of Article 90 of UNCLOS is identical to that of Article 4(1) of the United Nations Convention on Conditions for the Registration of Ships, February 7 1986.
(8) Following the completion of UNCLOS, on October 19 1989 the IMO adopted Resolution A 672(16), the Guidelines and Standards for the Removal of Offshore Installations and Structures on the Continental Shelf and in the Exclusive Economic Zone.
(9) United Nations Convention on the Law of the Sea 1982, A Commentary, Volume II, Satya N Nandan CDE and Shabtai Rosenne (volume editors) and Neal R Grady (assistant editor), Centre for Ocean Law and Policy, University of Virginia School of Law, 1993, Martinus Nijhoff Publishers.
(10) Scholarly articles on Texas jurisprudence appear to be in line with this view.
(11) Sections 1 to 5 of the Norwegian Petroleum Act take this approach, as any facility used for petroleum activities is subject to all Norwegian laws. Obviously, this is not a convincing solution in the context of an international public law conflict or concurrent jurisdiction perspective.