Risk allocation in offshore E&P projects 22 February 2012

Sandra Sinclair-Hughes

Floating E&P: recent trends & issues

• Developments in harsh and/or deep water locations

• New technology / new applications of technology

• More complex resource structures

• Increased operational risks and costs

• Changing and more complex regulatory regimes

Increasingly “bespoke” approach to project development and contracting strategy & contract forms

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Risk analysis or allocation

Insufficient risk analysis or insufficient risk allocation

EQUALS

Cost Overruns Delays Disputes

Risk mitigation & management

Project management and execution

Project Risks

Technical Solutions

Contract Structure Insurance

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Identifying & allocating risk

Avoid surprises:

• Complete a detailed risk analysis at an early stage/the outset

• Complete risk allocation before commencing work on project documentation

• The party best able to manage and control a particular risk should assume it

• Do not park risk with the project company

• Choose the ‘right’ contract form when using standard contract forms and be aware of its ‘quirks’

Key objectives for agreeing a contracting structure for offshore construction projects

• Allocating responsibility for achieving functionality of the unit/vessel and related equipment

• Establishing certainty regarding the standards and the state of completion for acceptance of the unit

• Determining a workable and clear remuneration structure

• Allocating responsibility for compliance with laws and regulatory requirements

• Devising an objectively determinable and workable regime for downtime, deficient operation/performance and related compensation

• Establishing an efficient and workable liabilities and indemnities regime that complements the parties’ insurance arrangements

• Devising a contract structure that fits the project and its and the parties’ requirements

– Clarity + Consistency = Certainty

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Specific Interface & risk issues

• Scope of works

• Performance and remuneration

• Compliance with law and regulatory requirements

• Termination rights

Scope of Works

• Fundamental element of the contract

• Defining the boundaries of responsibility in the context of functional specifications

• Completion / integration risk – managing the sub-contractors and the integration of major / long lead equipment packages

– Whose sub-contractors are the suppliers of major equipment packages?

– Transfer of the sub-contractsWhat are the issues?

– Timing of transfer

– Consensus – novation

– Contractor due diligence + related time line

– Consequential adjustments to contract terms

– Guarantees and payment arrangements

– Indemnities regime

– Fall – back position

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Scope of Works (2)

• Design Responsibility: “design & build”?

• Responsibility for FEED

• Responsibility for technical data

General warranty by Contractor

"The CONTRACTOR shall be deemed to have satisfied itself, before entering into the CONTRACT, as to the extent and nature of the WORK including but not limited to the services, personnel, materials and equipment, plant, consumables and facilities required for the WORK, the correctness and sufficiency of the rates and prices stated in Section III - Remuneration, general and local conditions including seabad and subsoil conditions [(so far as practicable and having taken into account any information in connection therewith which may have been provided by the COMPANY)], climatic, sea, other water and weather conditions, and all other matters which could affect progress or performance of the WORK.

Any failure by the CONTRACTOR to take account of matters which affect the WORK will not relieve the CONTRACTOR from its obligations under the CONTRACT." (source: LOGIC General Conditions of Contract for Marine Construction and for Supply of Major Items of Plant and Equipment)

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Scope of Works (3)

• Qualifications regarding Company information/data - ‘rely upon’ information

- Well stream data

- Environmental data

- Metocean data“If during the execution of the WORK the CONTRACTOR encounters seabed and/or subsoil conditions, which conditions could not reasonably have been foreseen by a contractor experienced in the types of work to be carried out under the CONTRACT, due account having been taken of the TECHNICAL INFORMATION, the COMPANY shall, subject to the CONTRACTOR having given prior notice in accordance with the provisions of Clause [14], authorise a VARIATION if the CONTRACTOR can show that it has suffered delay and/or incurred additional cost as a direct result of encountering such seabed and/or subsoil conditions and has taken all reasonable steps to mitigate or avoid the impact of such unforeseen conditions.” (Source: LOGIC General Conditions of Contract for Marine Construction)

Compare with this sample clause: “The Company acknowledges that… the Contractor is relying upon the accuracy of the information provided by the Company as set out in Appendices [x] and [y] (including information relating to the properties of the oil reservoir of the [FPSO] Site and the soil and environmental information given by it), and the Company warrants that the said information is true and accurate in all material respects.”

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Scope of Works (4)

• Variations, modifications and upgrades

Amendments should:

– be within original contract scope

– be in writing and signed by both parties

– not be used to mask poor performance or serious underlying problems

What are acceptable amendments?

– basic purpose of contract has not changed

– change in any timeframes, deliverables and value for money is proportional to original contract terms

– query whether the amendment shifts the overall balance of risk

Beware of:

– inadvertent amendments to the contract; and

– unintended effects of changes on the contract

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Performance and Remuneration

• Completion and acceptanceApplicable standards and criteria Key concerns

– Challenge: how to demonstrate the unit’s ability to meet its functional and operational targets

– Where does Contractor responsibility end?

• Completion activities

• Minor vs. major defects

– Functional testing

– Full acceptance testing

Delay: – “Permitted Delay” & the prevention principle

• Adyard Abu Dhabi LLC v SD Marine Services [2011] EWHC (Comm)

– Liquidated Damages What is “Permitted Delay”?

“any delay to the performance of this Contract by the Contractor:

(a) Caused by any act or omission of any member of the Company Group, to the extent such delay impacts the Contractor’s schedule; or (b) Resulting from the Company’s facilities not being ready in material respect when required for installation, testing and start up of the [FPSO] System in accordance with this Contract and provided the Contractor’s facilities are ready in all respects to commence said operations,”

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Performance and Remuneration (2)

• Remuneration

What is covered? – CAPEX, OPEX, taxes etc.?

Defining relevant tariff rates and when they apply

Rates, reviews and escalation adjustment provisions – Hess Corporation v (1) Stena Drillmax III Ltd (2) Stena Carron (Hungary)

KFT [2011] EWHC 1340 (Comm)

Performance targets and bonuses – definition of target – applying and calculating bonuses

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Compliance

• Regulatory requirements

– increased risks due to potential voids in regulatory framework for new technology or new technology applications

– local authorisations, approvals and registrations

– environmental requirements

• Who is responsible for compliance and the related costs?

• Who bears the risk of post-acceptance regulatory charges?

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Termination

• In principle 3 types:

“Convenience”

– When may the right be exercised?

– Termination payments

• compensation for profit element / loss of bargain or not?

• distinguish between ‘internal’ motivations and external intervening factors

– BP Exploration Operating Company Ltd v Dolphin Drilling Ltd [2009] EWHC 3119 (Comm)

Mutual agreement

– right to terminate with mutual consent of both parties

For cause

– right to terminate for default of counter-party

– follow terms and procedures set out in the contract

– Beware: Shell Egypt West Manzala GmbH & Another v Dana Gas Egypt Ltd [2010] EWHC 465

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Conclusion

Things to watch out for:

• Failure to identify or isolate risk

• Inefficient risk allocation

• Vague and unclear contract terms

• Failure to choose suitable standard term contract or make appropriate amendments/additions

• Insufficient tax and/or regulatory due diligence

• Failure to engage specialist advisors

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