FLNG or Floating Liquefied Natural Gas platforms provide a solution for gas to be processed, liquefied and stored offshore before being loaded on tankers and exported. The concept has been on the drawing board of most, if not all, large oil and gas players for some time. It offers a cost effective solution to the development of stranded fields.

Of particular importance to oil and gas companies is the ability to relocate the vessel to other fields once the original field is depleted, which not only reduces decommissioning costs but also the relative cost of getting new fields online.

However, despite all of the benefits that FLNGs offer, not a single project that has made it past the drawing board. This appears set change. The technical difficulties of offshore liquefaction appear to have been addressed and FLNGs will soon join the growing fleet of Floating Production Storage and Offloading (FPSO) vessels.

Comparing FLNG and onshore LNG projects

Potential FLNG projects face very different obstacles to onshore facilities. While cost and flexibility of use make FLNG a very attractive supply solution, it does face considerable hurdles. As a navigable floating solution, the FLNG will most likely be a ‘ship’ and consequently it must satisfy flag state requirements and class requirements in addition to the requirements of the gas producing state.

Unlike the FPSO market, which sees a large proportion of vessels converted from old tankers, the FLNG market will most likely be dominated by new-builds. The production and storage equipment required will mean that these new-builds are of a considerable size. The early media releases regarding the proposed Royal-Dutch Shell FLNG indicate a vessel of approximately 475 metres in length with a rumoured capacity of 3.5 million metric tonnes per annum (MMt/a).

The principal challenge that FLNG projects face is the large cost over-runs that may occur due to design changes and re-engineering. However, even if the rumoured budgeted cost of $US2 billion ($3 billion) was doubled during construction it remains comparatively cheap compared to onshore facilities, which generally average $US1.5 billion ($2.25 billion) per MMt/a.

Risk analysis – FLNGs and onshore projects compared

The yards likely to be chosen to undertake the construction of FLNG are those with experience in building LNG ships and offshore projects. However, the construction contract for an FLNG is likely to be considerably more complex than a standard shipbuilding contract, including for LNG carrier (LNGC) vessels.

The benefit of the traditional shipbuilding contract over construction contracts is that the shipbuilding contract is one for sale of future goods by description rather than or the provision of work and materials meeting an agreed scope of work, which is typical in offshore construction. There is a far greater obligation on the yard to comply with the description of product under the shipbuilding contract than there is under a typical construction contract.

The owner should ensure that if the FLNG is entered into with a long term charter or operating and management contract, that it does so on back-to-back terms with the building contract. This is to ensure that the owner is not left in the unenviable position of being stranded with a FLNG and no charter or a charter and no FLNG.

These back-to-back acceptance clauses will ensure that the risk of the design/construction causing a dispute later as between charterer/operator and owner is minimised as the charterer/operator will have accepted the design/construction prior to the owner accepting the ship under the shipbuilding contract. Further protection is provided to the owner by the delivery clauses, which if they remain standard, will limit the owners' exposure to damages.

Design and construction

One of the concerns that arise with vessel construction contracts is the design package. The key issue for an FPSO project is that the design must ensure that each of these four characteristics complements the others. In short, the offloading throughput must be sufficient to guarantee that the storage capacity adequately ensures continuous LNG production using the limited space and stability constraints of a floating platform.

An important inclusion into the contract should be the right to introduce variation orders. These can arise from technical requirements from the field formation, further design development or demands from the Charterer. It is inevitable that the design will change during the construction process and the owner must have the right to impose these changes on the yard. Consequently, the standard shipbuilding form limits this right and will require amendment to provide for the use of variation orders at the owner's option.

The nature of FLNG projects means that vessel design will be directly linked to a specific field development. As such, there is limited utility in cancellation rights unless the construction is so defective or delayed that an alternative new build is economically viable. In these circumstances, it is improbable that a yard would agree to cancellation rights. Consequently, step-in rights should also be included in the build contract, allowing the buyer to take over construction, either by intervening in the yard or by taking delivery of an incomplete construction and completing elsewhere.

Delivery and installation

The general provisions of a build contract will provide for a set delivery date. This may be extended by permissible delays, such as variation orders and force majeure events. If the vessel is not delivered by the contractual delivery date the yard will generally become liable for liquidated damages.

However, such damages are rarely sufficient to counter the exposure that would exist under the production agreement. Consequently, it is critical that these agreements are ‘back-to-back’, whereby delivery under the production agreement will not occur prior to delivery under the build contract. Oil and gas companies are generally willing to agree to back-to-back agreements, subject to a longstop cancellation right, although they will not necessarily be offered as standard. This arrangement will likely require the charterer/operator to be included in the building and trial process.

With such a complicated suite of equipment, a range of specific tests is likely to be required to be completed before the FLNG is finally accepted under the production contract. In many cases these will be beyond the tests that the yard is prepared for or capable of conducting.

This may mean that the acceptance provided by the counter party to the production contract is conditional. The obligations to pay full day rates under the production contract may not commence until these additional tests have been satisfactorily completed to establish that the FLNG is fully functioning, i.e. maximum liquefaction, boil-off, offloading and other key characteristics. This is the largest potential area for dispute, since once delivery by the yard has been completed, the owners' rights of redress against the yard are limited to warranty rights.

Financial issues

There are not many banks that can single-handedly underwrite the cost of these projects. Considering the current global market, syndication will also be difficult. However, with appropriate guarantees in place and well drafted payment provisions in the production contract, a strong cash flow will make project finance attainable.

Where finance is being provided for an operator to purchase the vessel, consideration must be given to downtime risk. This will occur where the FLNG is not receiving the full operating daily rate due to equipment failure, necessary repairs, weather and other contract specific incidents and occurrences. With FLNG a particular acute risk is that of shut-in, if offloading is not able to be carried out before the LNG tanks are full. It may be possible during negotiations to agree to split the Operating Rate into its capital expenditure (CAPEX) and operational expenditure components and that in all, or most, circumstances the CAPEX component will be paid.

Whether these vessels will have a residual value is presently unknown. While there is a market for FPSOs once the initial contracts have been fulfilled, the fact that FLNGs are likely to be project specific rather than a more generalised design may limit their prospects of obtaining secondary use. Retro fitting and re-engineering may be economically viable to permit such reuse. This is clearly a factor that must be considered by both financiers and owner.