Offshore Floating Production

Edited by Stuart Beadnall; Simon Moore; Max Lemanski

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CHAPTER 4 Conversions, refurbishment and modifications

Max Lemanski

A Introduction

4.1 When an FP Contractor is invited to bid for a new project it has three options as to the vessel it may use. 4.2 First, it may have an existing asset. This may fit at least some of the technical requirements of the project. However, the stars rarely align quite so neatly. FP Contractors are not like commercial ship owners. An asset that is well suited to a new project may be unavailable, and it will almost certainly require some level of modification to meet the particular requirements of the reservoir characteristics, local standards, updated regulatory changes and so on. This may entail a complete replacement of the processing equipment and, in some instances, the required modifications will be very substantial. 4.3 Second, the FP Contractor can contract with a shipyard to build a new FPSO from scratch. This of course requires considerable investment and usually takes longer than upgrade, refurbishment or conversion work. 4.4 Third, the FP Contractor may convert an oil tanker or a floating storage unit (which it may already own, or which it buys in specifically) or, in the case of an FLNG unit, an LNG carrier. The FP Contractor will need to enter a substantial conversion contract, or separate contracts, each to cover the conversion work, module fabrication and final integration. Sometimes substantial changes are needed, not just to install the process train, but also to upgrade and convert the ‘shipping’ parts of the vessel, such as the hull, accommodation and engine systems. The final product may look quite unlike how it started and have completely different technical capabilities. 4.5 It is common in the offshore industry for projects to utilise an existing vessel which is converted for a new application or deployment, rather than build one from scratch. Similarly, refurbishment and modification are also common and may become increasingly necessary in order to meet new carbon emissions targets. Decarbonisation is already causing significant change in the industry. For example, new projects may require electrification of the FPSO itself and of the process train. If so, what is the source of that electricity? One trend is to utilise windfarm technology, including connecting to existing local windfarms (where possible) or even deploying dedicated floating turbines. There may be a requirement to use green fuel such as ammonia or hydrogen. All these changes may require substantial modifications of the power systems and engines used on traditional FPSOs. 4.6 In this chapter we will use the word ‘conversion’ to describe all types of conversion, modification and refurbishment projects.

B

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Conversions versus newbuild projects

4.7 There are many reasons why an FP Contractor may choose to convert an existing asset for a new project instead of commissioning a new FPSO. These include cost and speed. Conversion is in theory cheaper (for example less steel means a reduction in costs) and quicker (after all, much of the vessel is already built). If a conversion project goes to plan, an FP Contractor can be on field, and therefore earning, more quickly. Further, if the FP Contractor uses an existing asset, it does not have to pay to lay it up during the conversion phase. 4.8 However, as relatively straightforward as this may sound, some of the most hard-fought conflicts involving FPSOs have been conversion and refurbishment disputes. The situation is not unlike a time-critical renovation of an old house. The walls and the foundations may be sound (or at least appear to be so). The builders may well say they cannot quote for a particular part of the work until the plaster is removed, or the floorboards taken up. And then, when the plaster comes off or the boards are pulled up, the builders encounter something unexpected which adds time and money to the renovation works. The homeowner becomes frustrated (was this included in the price?) and the builders may well be too (have they quoted a lump sum or promised someone else that they can start on another job for which they will now be late?). Often the houseowner might lament that, on reflection, they would have been better off buying new, or simply knocking down the house and starting again. 4.9 FPSOs are complex, high-value assets and it is not difficult to see how, for example, a contract for the conversion of an existing asset can quickly turn sour. It is a similar story for conversion of LNG carriers to floating liquefaction facilities. As such, the FP Contractor should be careful to ensure that there is as much certainty as possible in the terms of its contract with the EPC contracting yard or yards.1 4.10 In this chapter we explore some of the pitfalls, and consider key contractual provisions, specific to a conversion project. To do so we examine the different stages of such a project, starting with finding the right vessel (and its suitability for the proposed work) through to delivery under the construction contract and post-project.

C Acquisition of vessels

(i) The vessel for conversion

4.11 First, the FP Contractor needs a vessel to convert. This may be an existing FPSO; it may be an oil tanker. The FP Contractor may already own the vessel, but it may need to go into the market to buy one. In the latter situation, a key issue between the FP Contractor and the seller is the allocation of liability for the condition of the vessel at the time of purchase, and its suitability for the proposed conversion work. 4.12 This needs to be adequately covered in the acquisition contracts. Risks inherent in acquiring vessels for conversion were illustrated in the case of Kellogg Brown & Root Inc

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v Concordia Maritime AG and others 2 There, the FP Contractor (the claimant) entered into a long-term charter for two FPSOs to operate in Brazil for Petrobras and sought to acquire two suitable VLCC oil tankers to be converted in a Singapore shipyard. 4.13 The charter, as usual, imposed deadlines for first oil in Brazil and hefty liquidated damages for lateness, with an option of termination. The FP Contractor calculated that the first oil deadline could be achieved with a fast-track timetable based on acquisition of the two tankers and delivery to the Singapore yard, a short period in dry dock, with topside integration in parallel, and transportation from Singapore to Brazil for acceptance tests to be performed by the oil company. 4.14 Some renewal of the tanker’s steel plates was anticipated, in order to meet Petro-bras’ requirements. The sale contract provided that KBR would be liable for the cost of the first 150 tonnes of steel renewal, with the buyers being liable for the cost of any additional steel renewal. The vessel tanks were blasted on arrival in Singapore to prepare them for recoating, at which point significant steel wastage due to chronic pitting was discovered. The full extent of pitting and the necessary level of repairs (filling, welding or plate renewal) required a painstaking and lengthy mapping and measurement process. To avoid the expected delay and extra cost, FP Contractor requested Petrobras to accept a modified steel wastage criteria, on the basis that, despite the wastage that had occurred, the original thickness of the hulls remained sufficient for the purpose of the intended FPSO operations. Petrobras refused to accept any modification to its specification, on the grounds that the specification had been agreed, and had to be complied with. It reserved its rights to enforce its contractual remedies if the FP Contractor did not proceed with all necessary repair and conversion work without delay. 4.15 The yard proposed that the quickest method of repairing the hulls to meet the oil company specification was to return them to dry dock for an extended period to replace the pitted bottoms entirely, at huge additional cost. The FP Contractor agreed, believing the additional cost could be transferred to the ship owner who had supplied the tankers in a poor condition. A claim was brought against the ship owner’s parent companies, who had provided guarantees, in the English High Court. The FP Contractor’s claim failed on the ground that the ship owner’s contractual obligation had been to deliver the vessels in the same condition as when inspected, which they had done, even though that condition was poor. The FP Contractor further alleged that the ship owner had provided a representation that the vessels were suitable for conversion to FPSO. This claim failed on the ground that a buyer should not rely on a seller’s opinion as to the quality of the asset being sold. 4.16 The case shows that, when purchasing a vessel for conversion, the buyer and seller need to be particularly mindful of risk allocation recorded in the sales contracts, as statements made outside those contracts may not be considered by the court to be relevant to the contract between the parties. This is particularly relevant with regard to the condition of the vessel, which often cannot be conclusively determined until the vessel is dry docked prior to the conversion work. Questions to consider include: are the vessel’s as-built drawings up to date? Will the vessel’s existing machinery/equipment need to be renewed/replaced in order to function as an FPSO? If such issues are ‘known unknowns’, what about ‘unknown unknowns’ that the parties may not have contemplated? Who should

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have liability for those? In view of the Kellogg Brown decision, it will be important for the parties to consider carefully the allocation of risk between themselves. 4.17 It is also important to keep in mind that the standard industry form used in the purchase of vessels in these types of transactions is on terms that the sale is on an ‘as is, where is’ basis; i.e. the buyer inspects the vessel and the seller’s obligation is to deliver the vessel in the same condition as it was at the time of the inspection (fair wear and tear excepted), excluding statutory or other implied terms.3 It is does not assist to suggest, as the buyer did in the Kellogg Brown case, that the buyer could not see the pitting in the steel before it was dry docked (i.e. after the sale). A buyer should consider either a more thorough inspection before sale, or include some kind of contractual warranty as to condition in the sale contract.

(ii) Incorporating the vessel into the design

4.18 Turning to the conversion process itself, how will the buyer (now the owner) of the existing vessel and the conversion yard deal with potential issues arising from the suitability of the vessel for the basis of design for the conversion? The vessel to be converted may have been selected after the preliminary design was prepared. The design will need to be developed before the chosen vessel arrives at the construction yard, based on the vessel’s as-built drawings. Verification will be needed that those drawings have been revised to take into account any repairs or modifications to the vessel during what may be a long trading history. Further, do the as-built drawings include all the information needed to complete the design? And what if the vessel or its equipment are materially different from the assumptions made in the preliminary design? The drawings would not indicate the current condition of the vessel. What if condition issues come to light upon arrival at the yard and this affects the planned conversion schedule (e.g. delay due to steel renewal, as in Kellogg Brown, or an unexpected aspect to the vessel’s design that makes it impossible to enter dry dock)? The yard will want to allocate this liability to the owner and will want any additional work required due to unforeseen condition issues to be dealt with as a ‘variation’ to its work, with knock-on cost and schedule adjustments. 4.19 Fundamentally, the question is: who is responsible for ensuring that the vessel used is suitable for conversion to a fully functioning FPSO? In a newbuild project, it is perhaps more reasonable to expect a yard to be solely responsible for unexpected work. However, where an existing vessel is procured by an owner for a conversion, the yard may well feel entitled to make the owner responsible for any surprise issues that arise as a result of that vessel’s condition.4

D The yard, scope of work and delivery

(i) One yard or two?

4.20 Once the FP Contractor has a vessel to convert, it will need a construction yard to carry out the work. This does not necessarily mean that there is only one yard. It may

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be that work on the hull and the marine systems is done at yard A, and the topsides work is carried out at yard B. This structure is typically used to save money or to satisfy local content rules. For example, the work required to strengthen a hull is not at as complex as the engineering, procurement and installation of the process train (i.e. the complex machinery used to process the crude oil before it is stored and eventually offloaded). So, whilst a highly skilled, specialist yard may be required for some of the work, it may be cheaper to have other, less complex, work done elsewhere. 4.21 This approach may save money, but it has its own risks. For example, there will be two deliveries: the first from yard A working on the hull and the second from yard B working on the topsides. If yard A is late, this may lead to consequential scheduling problems at the yard B (see further paragraph 4.34 regarding late delivery). The yard B may discover defects in the work carried out at yard A; but if the FP Contractor has accepted delivery under the contract with yard A, its sole remedy may be under the post-delivery warranty, which may itself not be effective until completion and delivery at yard B. This in turn may prevent or delay yard B finalising its work and entitle it to claim additional costs by way of variations. The FP Contractor will need to consider such risks in the relevant contracts.

(ii) Scope of work and fitness for purpose

4.22 The contract between the FP Contractor and the conversion yard is likely to be substantial, with detailed provisions on, for example, allocation of risk, the technical specification, pricing and variation work. A central issue is: does the scope of work include everything necessary to achieve the functional requirements of the basis of design? Here the FP Contractor finds itself in a precarious position. The ultimate client, the Company, (i.e. the charterer) will insist that the FPSO must achieve various performance and production criteria, both at the start of the charter (i.e. for acceptance) and going forward (i.e. as the basis of payment of hire).5 4.23 The FP Contractor’s obligation may be limited to verifying the ‘constructability’ of the design. Opinions may vary on precisely what this means, but it is generally understood to mean that the design is fit for performance of detailed engineering, but not necessarily fit for the purposes of the contractual functional requirements.

(a) Robin Rigg case study

4.24 It is helpful at this stage to consider the Supreme Court’s decision in MT Højgaard A/S v E.ON Climate & Renewables UK Robin Rigg East Limited and another 6 This case illustrates the issues surrounding the extent of the yard’s obligations in terms of whether the FP Contractor produces a vessel which conforms with the functional requirements of the contract (i.e. it does what it is supposed to do), as opposed to simply complying with the technical specifications in the contract. In May 2006, E.ON invited tenders to construct foundations for two offshore wind farms at Robin Rigg in the Solway Firth. MT Højgaard (“MTH”) were the successful bidders to design and install the foundations. Shortly after completion, the foundations failed. The issue was whether MTH was liable for the failure

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of the foundations, which involved construing “the somewhat diffuse documents which constituted, or were incorporated into, the ‘design and build’ contract in this case”.7 4.25 The technical requirements (‘TR’) document was incorporated into the contract and stated that the design requirements in the TR were the minimum standard. The contract also provided that the design had to be in accordance with J101 (an international standard for the design of offshore wind turbines published by the classification society, DNV) and had to ensure a minimum lifetime of 20 years for the foundations. The contract further provided that the foundations should be fit for purpose, which was defined as “fitness for purpose in accordance with, and as can properly be inferred from, the Employer’s Requirements”, which included the TR. MTH were also required to conform to ‘Good Industry Practice’, which was defined as those standards, practices, methods and procedures conforming to all Legal Requirements to be performed with the exercise of skill, diligence, prudence and foresight that can ordinarily and reasonably be expected from a fully skilled contractor who is engaged in a similar type of undertaking or task in similar circumstances in a manner consistent with recognised international standards. 4.26 J101 contained a mathematical error. One of the figures for calculating the shear strength of grouted connections was wrong by a factor of about ten. This resulted in the failure of the foundations after two years and €26.25 million being incurred in repair works. MTH argued that it had exercised reasonable skill and care and had complied with all its contractual obligations and so should have no liability for the cost of the remedial works. E.ON argued that MTH had been negligent, that it was responsible for numerous breaches of contract and was liable for the defective connections. The Supreme Court was asked to consider whether MTH was in breach of the functional specification in the contract because the foundations did not last for 20 years, in spite of the fact that MTH had used due care and professional skill, adhered to good industry practice and complied with J101. 4.27 The Supreme Court held that MTH was liable for the remedial works. Although it had not been negligent, MTH was in breach of a contractual requirement that the foundations last for 20 years. The contract contained two terms. One which required MTH to produce the foundations in accordance with a specific design, and another which required the foundations to satisfy specific performance criteria. The problem was that the functional/performance criteria could not be achieved by complying with the design. Reconciling these terms was an exercise in the ordinary principles of contractual interpretation to give effect to both terms. The Supreme Court acknowledged the unsatisfactory drafting of the contract but said that was not a reason to depart from the fundamental rule of construction of the contractual documents that the intention of the parties must be ascertained from the language that they have used in the light of the relevant factual situation in which the contract was made. The case law generally pointed towards giving priority to compliance with the criteria and the Contractor had to improve the design if it falls short of complying with the relevant criteria or take the risk of being in breach of the contract. 4.28 Although the two obligations were apparently inconsistent with each other, the contract also provided that “it is the responsibility of [MTH] to identify any areas where

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the works need to be designed to any additional or more rigorous requirements or parameters”. Further, where two provisions impose different standards, the correct analysis is that the more rigorous standard must prevail (i.e. the foundations must have a lifetime of 20 years), and the less rigorous standard (compliance with J101) can properly be treated as a minimum standard. This was supported by another clause in the contract which made it clear that, where there is inconsistency between the design requirement and the required criteria, MTH would still be liable because of its duty to identify the need to improve on the design accordingly. 4.29 The issues in the Robin Rigg case also arise in the context of a conversion. The FP Contractor would ideally prefer a turnkey contract (priced on a lump sum basis) whereby the FP Contractor, as owner, receives the keys from the yard to a fit for purpose, fully functional facility following completion of all work (and commissioning, where effected before handover). The yard, however, may be willing only to perform on the basis of the specification work, with the remaining work to be performed by the FP Contractor, or to be ordered by way of a variation. This can lead to problems with the interface between the yard’s work and the FP Contractor’s work. Do the two work scopes fit together and function? Further, how will this happen in practice? Having two teams working under time pressure is likely to be difficult. It will require procedures for safety compliance and access, and to avoid delay and disruption to the overall schedule. 4.30 In a conversion project it is also common for the pricing of the work to be split. Some (often most) aspects of the work are priced on a lump sum basis, with pricing for remaining parts based on agreed rates and estimated quantities that are then remeasured against actuals. However, there are alternative structures such as target sum pricing. We turn to these issues at Section E.

(iii) Delivery of the vessel to the yard

4.31 It is perhaps stating the obvious that, in order to perform construction work as planned, the vessel needs to arrive at the conversion yard on time. The FP Contractor will be obliged to deliver the vessel in accordance with the schedule set out in the conversion contract, which ought also to allocate the consequences of any delay. There may be added complexity if the vessel to be converted is not in the FP Contractor’s ownership at the time when the contract is agreed. 4.32 It is equally obvious that the yard must be ready to perform the work. In some circumstances, the FP Contractor may have a contractual right to cancel the vessel’s arrival entirely if the yard is not ready by the agreed deadline. One extreme illustration of this, from the cruise vessel market, was the dispute in 2000 between the Liverpool shipyard Cammell Laird and the Italian cruise line Costa Cruises. Costa contracted with Cammell Laird to lengthen its cruise ship Costa Classica by inserting a 45-metre new section amidships. The yard commenced work on the new section. However, when the yard failed to keep precisely to the contractual schedule, Costa cancelled the contract, even though the new 26,000-tonne section was almost complete and the vessel was already on its way to Liverpool. Whilst the exact details are confidential, a subsequent arbitration found that Costa had been entitled to terminate and Cammell Laird was ordered to pay damages. Cammell Laird went into receivership in 2001. 4.33

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A conversion contract will normally provide a fixed date (or a mechanism to fix a date) for the vessel’s delivery to the yard. The FP Contractor will want as much flexibility as possible, in case events delay the vessel’s arrival. For example, there could be delays in the purchase of the vessel (if the vessel is not already owned by the FP Contractor), delays in the completion of an existing deployment, or bad weather or other force majeure type events slowing the vessel’s progress to the conversion yard. The FP Contractor will want to build flexibility into the conversion contract to allow for such events (whether as a general force majeure mechanism or setting out specific situations in which the planned delivery time will automatically extend). 4.34 What if, for example, the vessel arrives late but the yard could not have begun work at the intended arrival time in any event (for example, if the yard was delayed in its engineering and procurement)? Consequently, an FP Contractor will want to ensure that the yard’s entitlement to additional time/costs is directly and solely linked to the yard’s inability to work on the vessel as a result of that particular delay. If a vessel does arrive late, the yard will want provisions in place to allow it to claim: (i) an extension of time to complete the work and (ii) any additional costs incurred as a result of the delayed arrival. Such costs can be complicated to predict or determine. The yard may argue that many extra costs were caused by the late arrival, including having an impact on other work. The FP Contractor will likely argue the other way, and try to minimise any additional time/costs claimed by the yard. The FP Contractor will insist that any claim as to late arrival is accompanied by evidence of actual delay or disruption.

E Pricing

4.35 For any kind of conversion/modification work, a number of pricing models are available to the parties, ranging from a pure ‘time and materials’ basis to an all-inclusive lump sum. For the FP Contractor, the more up-front clarity on pricing the better. For the yard, however, this may entail too much risk. For example, what if a project is expedited and parts of the work are not fully scoped at the time of contract signing? What if there are contractual variations to the work? The question then is: how will the extra work be identified and priced? 4.36 The yard contract is likely to include detailed provisions setting out what work is included within the lump sum and what work is not (if it does not, there is likely scope for dispute). It may also include some estimates on quantities which are then remeasured with actual quantities once the work has been completed. 4.37 Typically, in addition to the lump sum element, the conversion contract may include:

• A detailed schedule of agreed rates, often called ‘unit rates’;
• Details of the work to which those rates shall apply; and
• Aspects of the work that are to be ‘remeasured’, such that estimated quantities are replaced with actuals.

We explore each in turn, before turning to an alternative pricing (and contractual) model that is the ‘target sum’ contract.

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Offshore Floating Production

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CHAPTER 4

Conversions, refurbishment and modifications

B Page 55 Conversions versus newbuild projects