Keeping pace with the changing nature of the liquefied natural gas (LNG) sector, the traditional long-term LNG time charter market is evolving and charter periods are becoming shorter. This trend has a number of commercial, financial and legal implications which are considered in this update.
The LNG industry in general has seen several interesting developments in recent years. LNG prices in the Far East have dropped significantly and several projects have been cancelled or postponed. LNG carrier charter rates have at the same time plummeted and cross-basin trading has significantly reduced. This is largely the result of prevailing negativity in the LNG market, although it is expected that this trend is likely to be relatively short-lived. There are already signs of improvement in charter rates and project activity is likely to pick up when the price of oil increases and the self-imposed restrictions on energy companies' capital budgets are eased. However, the trend of LNG carriers being fixed on shorter-term and increasingly flexible contracts is likely to continue for the foreseeable future.
Traditionally, LNG carriers were built as 'project vessels', meaning that they were dedicated to a particular charterer and served a specific LNG project for most, if not all, of their working life. Time charters with a duration of 20 years were the norm, often with charterers having the option to extend the total duration of the charter to 30 years as well as having the option to purchase the vessel on the expiration of the charter. The Snøhvit LNG project, for which Statoil chartered three LNG carriers for 20 years from Norwegian and Japanese owners, is a good example of this traditional project-linked charter structure. The three vessels were effectively intended to function as floating pipelines transporting LNG from the Melkøya liquefaction plant in Northern Norway to Statoil's buyers under long-term LNG sale and purchase agreements.
There are several answers to this question. First, certain owners have shown a willingness to take on the market exposure and risk that comes with shorter-term charter contracts. Some owners even appear to favour this type of contract in an attempt to capture the peaks in the market when they repair their vessels. This is in stark contrast to the more risk-averse owners who prefer to lock-in their vessels on charters with the longest possible duration and with a stable, albeit lower value, stream of income.
Second, charterers have less appetite to commit to longer-term contracts than was previously the case. This is partly due to owners such as those mentioned above that are willing to provide vessels for shorter durations. This is also a reflection of the LNG market in general having become less rigid, with recently concluded sale and purchase agreements and offtake agreements often being more flexible and lasting for shorter periods than in the past.
The new realities of the shorter-term LNG charter have led owners to look to adopt new financing structures. Owners have traditionally financed vessels on long-term contracts by way of project financing, but it is difficult to apply the same financing structure to vessels on short-term contracts. Therefore, owners and their financiers have adopted shorter-term asset and corporate finance solutions, which often involves owners having to invest more of their own capital into the project. This is in some respects positive as banks are not necessarily comfortable in taking on long-term debt risks. However, it also means that banks are more exposed to the refinancing and residual value risks for the vessels they finance, since the loan will not be repaid during the period of the charter contracts.
Another consequence of the reduced charter periods is that owners cannot enjoy the security of a long-term fixed income stream and are more exposed to the fluctuations in the LNG shipping market. Further, owners have to accept more risk in respect of operating costs as vessels are fixed on a flat-rate basis as opposed to more traditional rate structures under which the operating costs are either passed on to the charterer, escalated annually or subject to periodical reviews.
Charterers' are now being given much greater flexibility as to how they fulfil their LNG shipping needs. Owners are still willing to provide vessels under more traditional long-term contracts but, at the same time, a growing number of owners are prepared to provide shipping under short-term or even spot fixtures. Charterers make their choice based on the view they take of the LNG shipping market, developments in the LNG market in general, their obligations under sale and purchase and offtake agreements and their trading requirements.
From a contract negotiation perspective, charterers need to consider that owners may be prepared to accept more charterer-friendly provisions for shorter-term contracts. For example, the off-hire clause in LNG time charters commonly provides charterers with the right to terminate the charter if the vessel remains off-hire for a specified number of consecutive days or in excess of a certain numbers of days within a certain time period. The early termination of a 20-year charter is likely to have a far more severe impact on owners than the early termination of a five to seven year charter and therefore owners may be amenable to accept more stringent off-hire provisions for charters of a shorter duration.
The fixing of LNG carriers on shorter-term and more flexible contracts is a sign that the LNG industry is becoming much less rigid. It has resulted in owners and banks having to adjust their traditional approach to LNG ship financing and agreeing to more market exposure. Conversely, charterers are being afforded increased flexibility and the ability to charter LNG vessels on terms that are more closely tailored to their shipping needs.
For further information on this topic please contact Clare Calnan or Mads Ødeskaug at Wikborg Rein by telephone (+44 20 7367 0300) or email (firstname.lastname@example.org or email@example.com). The Wikborg Rein website can be accessed at www.wr.no.
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