Should Sri Lanka engage a LNG floating regassification vessel for electric power?

Part 3

What are the Health Safety Security and Environment (HSSE) requirements? What are the key insurance requirements?

What are the legal complexities and the means of resolving disputes?

What are the risks to the Sri Lankan Tax payer?

This Part 3 is largely in response to questions raised via email by readers of Parts 1 and 2.

Nalin Gunasekera

has spent 40 years in the offshore oil and gas industry with Royal Dutch/Shell, Mitsui and Mitsubishi, global leaders in leasing vessels and in the LNG business. His experience has been in Australia, NZ, South East Asia, PRC, West Africa and South America. The writer trained in Engineering in University of Ceylon and was a post graduate Colombo Plan scholar at University College London and is the recipient of Anniversary Technical Excellence Award from Shell for project recognised as a ‘market trend setter’.

What are the Health Safety Security and Environment (HSSE) requirements?

Safety and security are always major concerns to those unfamiliar with such installations.

Offshore installations such as FSRUs are regulated by various authorities who have jurisdiction over them. These are subjected to regulation and standardization by the coastal state GOSL, flag state, class (Classification Society), international and national standardization bodies and maritime regulators such as IMO, MARPOL, SOLAS and their regional directives. In view of the floating nature of the FSRU there are several parties involved, whose relationships should be clearly understood.

A Classification Society

is an independent, impartial, technical organization that establishes and administers standards, known as the Rules, for the design, construction and periodic survey of ships, offshore structures including floating systems and their facilities. Their principal concern is safety of the facilities and its personnel. Classification is the process of verifying compliance to their prescriptive Rules. It is often a prerequisite for obtaining insurance, fulfilling regulatory requirements or may be voluntarily elected as a means of demonstrating due diligence or as a component part of project quality assurance. Classification societies are empowered to act on behalf of national authorities in a number of aspects in most countries. This is because most countries do not have specific rules, design codes and standards specific for such specialised offshore installations. The FSRU will be classed by the likes of Lloyds, DNV-GL, ABS or Bureau Veritas.

It was noted during a presentation by the writer in about 2018 in Colombo that there are no items classified by Class Society that were then in operation in SL (as reported by the then Lloyds Register representative in SL). This reflects the poor adherence to international standards by the agencies of GOSL, by not mandating even basic industry practices.

A Flag State Authority

is the regulatory authority of the government of the state whose flag a vessel is entitled to fly. Flagging of the FSRU is not mandatory should the vessel not be in transit, however most countries that do not have codes and standards for offshore installations register the vessels in a port of registry. Usually, the vessel carrying a flag of convenience offers the vessel as collateral for financing purposes, which is an important factor in securing bids in a tender. The Flag State also prescribes safety measures. The term ‘’ describes the business practice of a in a country other than that of the ship’s owners, and flying that state’s on the ship. Ships may be registered under flags of convenience to reduce operating costs by avoiding regulations, inspection and scrutiny by the owner’s country. Normally the nationality (i.e. flag) of the ship determines the taxing jurisdiction. The Flag State has the and responsibility to enforce regulations over registered under its flag, including those relating to inspection, certification, and issuance of and prevention documents. As a ship operates under the laws of its flag state, these laws are applicable if the ship is involved in an such as maritime and nautical issues and disputes. This should be understood by agencies of GOSL.

Coastal State

is Sri Lanka. The regulatory authorities of GOSL exercise administrative control over the waters and seabed in which the FSRU is operating.

The relationships, requirements, and responsibilities between them are complex and not easily understood. This is because of (a) the number of regulatory authorities that may have jurisdiction on a particular project, (b) differences in scope and content of the regulatory systems in different countries (and to a lesser extent the Flag states) (c) the fact that few regulatory authorities have adopted their requirements to specifically address FSRUs.

In the writer’s experience, the scope and certification the classification society is empowered to perform are different for each flag and coastal state authority involved on a particular project as well as for different types of floating systems. Based on the writer’s experience in a number of countries, it is essential to identify and define, as early in the project as possible, all the relevant regulatory jurisdictions and requirements and to identify any unique technical and jurisdictional issues for early resolution with the Classification Society and the relevant regulatory authorities. The classification societies assist in defining these areas and resolving interpretations of relevant technical requirements, when engaged for this purpose, then report to all parties.

Gas leaks and subsequent explosions are not like oil leaks. Oil leaks pose relatively minor risks. Gas explosions engulf the entire region, when the flammable gas is under pressure. In a few seconds the explosion could destroy the entire infrastructure and the results are catastrophic. If the FSRU is to be located at the entry to the port, this could pose the threat of destruction to the entire ports’ activities. FSRUs are now typically located well away from port activities, and in open water.

The natural gas is to be piped from the FSRU via offshore and land pipelines meeting stringent oil and gas industry practice requirements. Installation of natural gas lines on land in populated areas raises safety issues with natural gas leaks being highly volatile and a high fire and explosion risk. They are usually subject to NIMBY (Not In My BackYard) protests and have led to project cancellations and delays. Now they are subject to BANANA (Build Absolutely Nothing Anywhere Near Anyone) constraints given the very high risk with gas lines, leading to catastrophic environmental disasters. The existing oil lines in the Colombo Port to Kolonnawa region are known to be poorly maintained, although leaking oil lines are exposed to a much lower level of risk. Proposals to run highly explosive natural gas lines in densely populated areas should expect louder protests than those during the Port City project. An option for GOSL to avoid high levels of risk in densely populated areas is to locate the FSRU in the vicinity of power generating plants in sparsely populated locations.

The fact that NFE would be responsible for the pipeline operation and maintenance (and not the GOSL/CEB) is a consolation given that NFE is concerned with their global reputation with their large operational portfolio where any failures would impact on their current and future broader business opportunities. Such operational records are closely monitored and reported by the industry and any failures will impact on insurance premiums as well, which concerns NFE. Sri Lanka has a poor duty of care record, an example being the emissions from coal-fired power generation which has led to mass protests.

ISPS (International Ship and Port Facility Security)

is a security measure put in place in response to the 9/11 attacks by the IMO (International Maritime Organization) as part of the Safety of Life at Sea (SOLAS) Convention. With the continuing threat of terrorism, the FSRU is expected to provide ISPS security provisions. In the writer’s experience, measures in excess of the standard provisions may be sought, which are project specific. The residual threats to Sri Lanka from the civil war that ended in 2009 should be noted. Regrettably, the nation continues to face terrorism threats, with the 2019 Easter Sunday bombings being a tragic example.

FSRU will have a high focus on the Environmental Impact Assessment (EIA) process which is now mandatory for such projects. EIA is a process of evaluating the likely environmental impacts of a proposed project or development, considering inter-related socio-economic, cultural and human-health impacts, both beneficial and adverse.

An EIA will be carried out for the project as a tool used to identify the environmental, social and economic impacts prior to decision-making. This project has implications of the vessel being in the ocean in open water with a subsea pipeline as well as the pipeline on land via areas of high population density. Natural gas pipelines on land are always a concern and their operation and maintenance are covered by codes of practice such as by API and others. The EIA will identify the hazards and their mitigation of the complete installation, a risk analysis conducted, and methods of mitigation proposed. Today even the removal of the vessel is covered by EIA, in terms of what items are being left behind such as moorings and offshore structures.

The EIA to be carried out aims to predict environmental impacts at an early stage in project planning and design, find ways and means to reduce adverse impacts, shape the project to suit the local environment and present the predictions and options to decision-makers. By using EIA both environmental and economic benefits are achieved, such as reduced cost and time of project implementation and design, avoiding post project execution costs and in defining all the statutory consents required. The EIA reviews all hazards and their mitigation, assess and evaluate the impacts of the project and report the EIA including an Environment Management Plan and a non-technical summary for the general audience for public feedback and raise any concerns to be aired and resolved. The EIA should indicate whether the FSRU could provide the emergency response on a ‘stand-alone’ basis or with the support of facilities of SLPA or any other GOSL authority.

Safety systems continue to evolve as oil and gas operations become more challenging and they predominantly operate in a regime where the systems must meet requirements of prescribed standards. However, the legacy standards may not meet the requirements of highly complex industrial or technical systems such as offshore oil and gas installations in highly explosive environments where consequences of an accident can be catastrophic.

Thus, Safety Case is now being mandated by statutory authorities. Given the complexity of these operations most similar installations prescribe a Safety Case for these FSRUs. Major oil companies have mandated a Safety Case for all such installations since about 1995, which emerged from the Piper Alpha incident in 1988 with 167 fatalities. The writer has mandated a Safety Case for all the writer’s installations since about 2005. There have not been any reports of incidents where the facilities operated under a Safety Case regime. It is noteworthy that where major incidents with catastrophic events occurred, the facilities were not operating under a Safety Case regime, such as the Deepwater Horizon disaster in the Gulf of Mexico.

A safety case is a document produced by the operator of a facility which:

Identifies the hazards and risks

Describes how the risks are managed and controlled

Describes the safety management system in place to ensure that controls are effectively and consistently applied.

Safety cases must be produced by the operator of an installation such as NFE. The principle here is that those who create the risk must manage it. It is the operators’ job to assess their processes, procedures, and systems to identify and evaluate risks and implement the appropriate controls, because the operator has the greatest in-depth knowledge of their installation. The Safety Case must identify the safety critical aspects of the facility, both technical and managerial. Analysis of disasters almost always show a combination of technical and managerial flaws which have led to the event occurring.

This is an excellent opportunity for countries such as Sri Lanka to be exposed to global HSSE practices rather than be lagging behind having no duty of care as evidenced in recent events. The writer’s insistence in mandating a Safety Case in the region has been appreciated long after the writer’s departure having an incident free record in their operations.

Notably an EIA was issued by Sojitz (Sojitz ref project 0443480) based on their proposal for an FSRU dated 21 Aug 2019, for public comment. Extensive comments were issued by the writer to GOSL, having been responsible for similar EIAs in New Zealand, Australia, Indonesia and Thailand. The comments were ignored by GOSL which appears to be a total lack of very basic duty of care to the public at large, which is a serious concern in exposing these high risk complex projects to the oversight of the GOSL representatives today. Such disregard by the government sets a dangerous precedent when GOSL’s agencies such as CEB is clamouring to undertake such complex projects, unaware of even the basics of this industry.

What are the key insurance requirements?

There are a host of insurance requirements, the key items being the following.

The installation will require to procure Protection and Indemnity insurance, more commonly known as P&I insurance, this is a form of mutual maritime insurance provided by a P&I Club. Whereas a company provides “hull and machinery” cover for shipowners, and cargo cover for cargo owners, a P&I Club provides cover for open-ended risks that traditional insurers are reluctant to insure. They are backed by a group of reinsurers who spread the risk. Typical P&I cover includes: a carrier’s third-party risks for damage caused to cargo during carriage; war risks; and risks of environmental damage such as oil spills and pollution and damages by any catastrophic event due to any explosion. P&I insurance for these offshore floating installations are now mandatory, which typically exceed about USD 400 mil. P&I insurance has been a serious omission in the recent CEB tenders. The importance of P&I insurance should be known after the recent X-Press Pearl disaster, a Singapore-flagged container ship that caught fire and sank north of Colombo, causing extensive environmental damage. The P&I insurance will indemnify and include wreck and debris removal and a pollution liability in respect of the FSRU.

The replacement value of the vessel will be covered under marine hull and machinery insurance.

There are occasions when Business Interruption insurance must be procured when (a) the performance of certain items in the facility cannot be guaranteed for the duration of the contract when only warranties apply (b) as a form of relaxing the terms of payment guarantees, and (c) as required by the bankers to guarantee their revenue stream.

Disproportionately high demobilisation and removal costs (often in excess of USD 50 million) are being incurred globally with these moored floating systems . Statutory authorities are planning to introduce trailing liabilities to hold previous owners liable for decommissioning costs if they sold ageing assets to new owners that lacked the financial and technical capacity to decommission the facilities. Such incidents have taken place where the taxpayer has to fund such expenses running into more than USD 100 million. Some form of insurance to cover such eventualities is now being proposed. The best example is in Australia where the removal cost has exceeded USD 200 million paid for by the tax payer in removing the vessel. See Northern Endeavour debacle hits $209M with much more to come

The insurance is procured via brokers to whom the attributes as such as Safety Case will be given credit to lower the premiums, given the lower risk exposure from the extensive analysis and the precautionary measures taken. Naturally the lower insurance premiums would be reflected in lower electricity prices.

The EIA will give an estimate of the above scope for P&I cover and the scope of the emergency response required. The EIA should indicate whether the FSRU could provide the emergency response on a ‘stand-alone’ basis or with the support of facilities of SLPA or any other GOSL authority. Often regional facilities available are considered when determining the emergency response, such as from India. It is hoped that minimum standards of insurance be covered in these projects as practiced elsewhere with the minimum cover stipulated, without burdening the taxpayer. The buck stops with the insurance companies.

What are the legal complexities and the means of resolving disputes?

These vessels operate typically under multiple jurisdictions some of which overlap, which are notoriously complex to understand. It is necessary to check Sri Lanka’s cabotage policy of permitting foreign flagged vessels operating in Sri Lanka’s waters. The FSRU will be foreign flagged as explained under HSSE above and offered as collateral to banks. The cabotage policy governs the operation of vessels between two places along coastal routes in the same country by a transport operator from another country, practised by many nations worldwide including developed nations. For some of these nations, it is so strictly implemented that no foreign-flagged vessels are even allowed to operate within their domestic waters for long periods. Obtaining waiver in some cases have involved seeking parliamentary approval in the host country should there be no precedent. In the writer’s experience the powerful maritime lobbies of host countries prevent foreign flagged vessels from operating in their waters and the employment of expatriate foreign personnel, in the operation of the FSRU. These may cause delays should there be no such precedent; the writer has faced such challenges elsewhere.

The vessel will be under the jurisdiction of the port of registry of a flag of convenience such as Liberia and Panama. Marshall Islands is becoming popular as a flag of convenience as explained under HSSE. As a ship operates under the laws of its flag state, their laws are applicable if the ship is involved in an such as maritime and nautical issues and disputes. Admiralty law or maritime law is a body of that governs nautical issues and private maritime disputes. This should be understood by GOSL, who has limited jurisdiction.

The governing law of the contract for the lease and supply of LNG and export of natural gas would not be based on laws of Sri Lanka. This is because these companies, banks and financiers who participate, do not have the time and resources to scrutinise Sri Lanka’s laws and usually laws of Sri Lanka do not apply to such contracts. Applicable laws familiar to the lawyers from these companies and banks such as the laws of UK, New York or Singapore are common in these transactions which have been proven over the years offering a good balance between the parties involved in transactions.

Usually, the expectation is that these disputes are eventually settled by arbitration outside the host country such as in London, via London Maritime Arbitrators Association. Singapore International Arbitration Centre (SIAC) is becoming increasingly popular for disputes arising from leased FSRU type vessels. Singapore has well trained lawyers involved in drafting these contracts known to the writer. Several cases have been assigned to SIAC since these vessels are also typically converted in Singapore shipyards and Singapore’s banks are also involved in syndicate financing. A record of present case studies are available to settle disputes. Several banks who provide equity finance and debt finance for these projects in the region are in Singapore and their disputes have been settled via SIAC.

What are the risks to the Sri Lankan Tax payer including the ‘end-of-life-burden’?

One of the great risks from CEB’s tender is in separating the FSRU contractor from the pipeline contractor. Unforeseen delays with pipeline installations are common. Offshore installations rarely run-on schedule, with some being delayed by six months or more being extremely sensitive to weather downtime in Sri Lanka, which is subject to monsoons. Further delays in laying gas pipelines across high density populated areas are extremely likely with land acquisition issues, environmental protests by politicians and the public. Usually, FSRUs are delivered on time, within 22 months, with similar conversions gained over more than 100 conversions in Singapore, where the writer has worked since 1994. FSRU suppliers wish to have their revenue stream early from the date of award of contract and would impose liquidated damages for any delay in pipeline delivery, whilst unable to supply regassified LNG. This could be of the order of USD 150,000 to 200,000/day for six months coming from the taxpayer’s account.

Usually the installation of FSRU and the offshore pipeline would be undertaken by the same contractor, which would not be the case with separate contractors as with CEB’s tender. These mobilisations/demobilisations could be of the order of USD 10 mil, which could have been saved, if performed by the same contactor as proposed by NFE.

The above are the advantages of a single point responsibility as proposed by NFE versus CEB’s attempt to separate the tenders where CEB would be responsible for the interface, with CEB lacking any exposure, inter alia, to any form of offshore oil and gas industry standards, codes, practices, industry norms, risks, Classification Society rules, insurance

requirements, offshore health, safety, security, and environmental practices.

There has been a trend to contract an overall tolling rate where payment is on the basis of LNG regassified and is expressed as $/mmbtu (million BTU). However, the actual rate will be dependent on the terminal utilisation (load factor). The utilisation cannot be determined accurately without carrying out detailed met ocean studies which should be (a) acceptable to a Classification Society and (b) acceptable to by Insurance companies. Usually utilisation could be of the order of 50%, which would double the actual rate. QED Consulting quotes estimated tolling rates (tariffs) in the range $0.60-0.94/mmbtu based on a 50% load factor. The contract with Excelerate for the Puerto Rico FSRU Aguirre terminal states $0.47/mmbtu. The rate for the first Bangladesh terminal is also stated to be $0.47/mmbtu. For the second Bangladesh terminal $0.45 has been stated. Assuming a 50% load factor the actual rates will again be around $1/mmbtu. The above rates are based on studies carried out by Oxford Institute of Energy Studies.

CEB lacking any exposure to highly specialised offshore oil and gas business and taking responsibility for the complex contractual and technical interface between the pipeline and FSRU would be a monumental disaster in the making. NFE poses no such interface risks with a single point responsibility for the whole project.

The removal costs of the FSRU could be of the order of USD 50 million as a minimum, could even well exceed USD 200 million, which is a significant ‘end-of-life-burden’ to the taxpayer. Its mitigation via insurance and relevant contractual obligations are noted above.

FSRUs are generally leased for longer periods than 10 years proposed by CEB for the vessel, examples being Lumpung Indonesia 20 years, Grace Columbia 20 years, Bahrain FSU 20 years, Armada Mediterrana Malta 18 years, Punta-de-Sayag, Uruguay 20 years, Port Qasim-3, Pakistan 20+5+5 years. Amortising the vessel in 10 years incurs a higher lease rate for the vessel depreciated over a shorter term, incurring a higher charge to GOSL. The short lease period exposes a lower period of depreciation of the vessel for amortisation with a higher lease rate, with a higher cost of electricity payable by the taxpayer.

CEB’s tender has omitted both Bureau Veritas who has classed 17 FSRUs worldwide and ABS and included only Lloyds and DNV. Such omission could cost the taxpayer in change of class of a vessel when converting a candidate vessel and reflects preferential treatment in a open tender.

It is questionable whether GOSL/CEB would be in a position to ‘take over’ the FSRU operations, for which a highly specialised skills set is required and a competency audit in the form of due diligence to secure P&I insurance.

Typically, these FSRU projects are leased, operated and removed by the vessel owner, particularly in countries such as Sri Lanka, which is incapable of running even a very basic coal generation plant without interruption. Sri Lanka could well be left with an inoperable facility of negative value such as the Urea Fertiliser Plant which was sold as scrap soon after start up. FSRU is cutting edge technology. GOSL is taking unnecessary risks in placing CEB to undertake this project, unlike NFE taking responsibility for the entire project. NFE has inherited the portfolio of the previous owner GOLAR who pioneered this industry in 2009, it comes with a wealth of experience.

The Urea Fertiliser Project was a multibillion rupee project which was sold as scrap soon after starting. Ronnie de Mel, then Minister of Finance and Planning, said in an address to Parliament on 21 December 1977: “We propose to introduce legislation very soon to make chairmen and directors of corporations personally liable for their actions in those corporations. They will make it a point to study their projects a little more carefully when they know that they will be personally held liable and that they will be charged and surcharged for any losses or lapses on their part.”