21 February, 2016
Efficiency and cost reduction are an essential priority for oil and gas companies in the current period of low prices. In the context of drilling services, careful drafting of demobilisation clauses in offshore drilling contracts can improve the prospects of reducing demobilisation costs when a rig has work after the completion of a campaign.
In a market where there is reduced demand for rigs, there may be more opportunity to mitigate risks than in a market where demand for rigs is strong.
This article examines ways in which a charterer can mitigate the risk of a rig owner taking steps to prevent the rig from being in direct continuation for its own commercial purposes where the rig has ongoing employment.
A major cost
An outgoing charterer’s contractual obligations end on “rig release” at the “point of demobilisation”. When there is another charter immediately following, a rig is said to be in “direct continuation”.
When a rig is not in direct continuation, the outgoing charterer usually has an obligation to transport the rig to a major port. The cost can be signi cant and avoiding it a signi cant saving.
What is “direct continuation” and how is it de ned?
The term “direct continuation” is a term widely used in the offshore drilling industry. For example, rig owners frequently make announcements to the market and their shareholders that their rigs have secured employment in direct continuation of a previous charter. Operations personnel also use the term, as it determines the operational obligations of each party to a drilling contract on demobilisation of a rig. Sometimes where a rig has a contract in direct continuation, it is referred to as “follow-on work”.
Direct continuation normally refers to a situation where there is effectively no break between contracts for the charter of a rig. The rig will have constant uninterrupted employment enabling the rig owner to charge a day rate without any down time between drilling contracts.
As mentioned, it is standard practice that where the rig has not been able to secure future employment, the outgoing charterer pays the cost of demobilising the rig to a port where it can be safely anchored and marketed until it obtains future employment.
Depending on the contractual obligations and the remoteness of the location of the charterer’s drilling campaign, it can take weeks to transport a rig to the agreed port or location on demobilisation before rig release occurs.
Although there is a general understanding in the industry as to the meaning of direct continuation, the term is often not de ned in drilling contracts or drilling lexicon. This means that there is signi cant scope for ambiguity and misunderstanding as to the rights and obligations of the parties concerning demobilisation when the rig has work following the completion of the charterer’s campaign.
Given the high costs at stake, in the absence of a precise de nition, the parties may nd themselves in a dispute about direct continuation as a result of attributing different or nuanced meanings to the term.
Allocation of the costs of demobilisation
Once a rig reaches the point of demobilisation, the drilling contract comes to an end and the charterer’s obligation to pay applicable day rates for the rig generally ceases.
The cost of demobilising a rig is either:
- accounted for as a pre-agreed xed sum payable by the charterer to the rig owner on pulling anchors and/or other speci ed demobilisation activities being completed, such as the removal of the charterer’s equipment from the rig; or
- calculated after the drilling contract has terminated by applying a day rate, usually a standby rate which is less than the operating rate, to the number of days taken to transport the rig to the point of demobilisation speci ed in the contract.
The point of demobilisation will change depending on whether the rig is in direct continuation or not.
No direct continuation
When a rig has no work in direct continuation, the point of demobilisation is usually a port that is a convenient location for the owner to market the rig, or a port where there are suitable facilities (for example, dry docking facilities), which will allow the rig owner to conduct any required periodic surveys, repairs or maintenance works. The charterer is usually required to pay a day rate while the rig is being moved. For a tow or demobilisation of one month, the day rate can be anywhere between US$8m for a semi-submersible to US$15m for a drillship.1 In addition to this, if a rig is not self-propelled, the charterer will be required to charter support vessels and crew to tow the rig to port or to charter a heavy lift vessel to do so.
Direct continuation
Where a rig has been able to secure work in direct continuation, the point of demobilisation is usually in open waters with the rig on tight tow approximately one nautical mile from the outgoing charterer’s last well location with all of the charterer’s personnel and equipment of oaded. Sometimes, returning the rig owner’s equipment from the charterer’s supply base to the rig is also included as part of the demobilisation activities.
In a direct continuation situation, the nancial burden then shifts to either the incoming charterer or the rig owner, as they bear the cost of moving the rig to the incoming charterer’s area of operations from (or close to) the outgoing charterer’s area of operations.
It is important that the point of handover be clearly defined.
Clearly, it is in the outgoing charterer’s commercial interests that a rig is in direct continuation at the end of a charter, because the charterer’s obligation to pay the applicable day rate will effectively cease within a few hours of pulling anchors at its last well location. The charterer is also relieved of the attendant risk of moving the rig in open seas and into port. Ideally, charterers should try to have the rig owner charter the tow or heavy lift vessels to reduce the risks associated with moving the rig.
This shifting cost allocation is re ected not only in contracts for the charter of rigs, but also in other industry documents and accounting procedures. For example, the concept of direct continuation is re ected in the Norwegian Oil and Gas Recommended Guidelines for Joint User Costs for Mobile Rigs/Drill Ships (NOGR Guidelines).2
The NOGR Guidelines state that demobilisation costs vary from case to case depending on the contractual clauses that apply to demobilisation. In some cases, the rig is considered to be demobilised near the location of the last well when the anchors are stowed and the rig is on tight tow, whereas other contracts require that the charterer cover the day rate and other associated costs until the rig has been demobilised to a port. Where a rig is required to be demobilised to a port, the NOGR Guidelines provide that “demobilisation costs may nevertheless be low if the rig moves directly from the last location to a new operating company”.
Example demobilisation clauses
Despite the wide usage of the term “direct continuation”, there is inconsistency in the way in which the concept is expressed in drilling contracts.
Set out below are some examples of demobilisation clauses. Example 1 does not provide for a direct continuation situation. Example 2 provides for a situation where the parties may reach a later agreement without expressly referring to a direct continuation situation. Example 3 may provide for a direct continuation situation, but it is ambiguous. Finally, example 4 provides for a situation of direct continuation, with direct reference to the concept.
None of the examples de ne what direct continuation is and provide limited certainty in respect of the trigger points that will determine whether the rig will be in direct continuation or not. Direct continuation is a term that is rarely explicitly de ned in drilling contracts.
Example 1: Lump sum demobilisation fee – no direct continuation option
The demobilisation provision in one of the most widely used standard form drilling contracts, the International Association of Drilling Contractors (IADC), International Offshore Daywork Drilling Contract, provides for a lump sum demobilisation fee. It does not contain a clause allowing for a change in the payment obligation where a rig is in direct continuation.3
Termination
This Contract shall terminate:
(b) after the number of wells … are completed, and the Drilling Unit has been safely jacked up or moored, whichever is applicable, at the demobilisation location speci ed [in the drilling contract] (unless some other location or port is mutually agreed) and all of [Charterer’s] Items have been of oaded, whichever is latest; or
Demobilisation Fee
In addition to [Charterer’s] obligation to pay the Stand-by Rate … [Charterer] shall pay [Rig Owner] a demobilisation fee as speci ed in [the drilling contract] which shall be earned on the date of termination of this [drilling contract].4
Examples 2, 3 and 4 are taken from drilling contracts available as public records online.
Example 2: Direct continuation option
– no use of term
Demobilisation Fee
The [Charterer] shall pay the owner/ operator a lump sum [for demobilisation] within thirty days of receiving the owner/ operator’s invoice bearing the date the rig, ancillary equipment and supplies departs the [Charterer’s] last wellsite. If the owner/ operator has received another contract for this rig, to commence with release of this rig from the charterer’s last well, then
the demobilisation will be reduced by [various percentages in accordance with the distance].
Example 3: Ambiguous direct continuation option – no use of term5
[Charterer] shall pay Owner a Demobilisation Fee as speci ed in Appendix A to cover all Owner’s costs of demobilising the Drilling Unit. [Charterer] shall have no further demobilisation obligations other than the payment of the Demobilisation Fee. The foregoing notwithstanding, the Demobilisation Fee shall not be payable … if the Drilling Unit is demobilised to any other location than directly to the point of demobilisation on the termination of the contract.
Example 4: Direct continuation option
– use of term6
“Demobilization Point” means a location within the Host Country agreed by the Parties, except that, if the Rig is committed to another party in direct continuation after the completion of all Work for Operator on the last Designated Well, the Demobilization Point shall be one thousand feet (1000') from the location of the last Designated Well.
[Charterer] shall demobilise the Rig and [Charterer’s] personnel from the last well location upon the expiration of the term. [Charterer] shall pay and be responsible for all risks, costs and expenses … necessary to move and demobilise the Rig from the last designated well location upon operator’s noti cation to [Charterer] of Rig Release. Operator shall pay the Demobilisation Fee to [Charterer] on or after the date that the Drilling Contract terminates … Operator shall also not be required to pay the demobilisation fee if, upon the termination of this drilling Contract, [Charterer] has committed the Rig to another party in direct continuation after the completion of all work for operator on the last designated well.
All of the above example de nitions have varying levels of ambiguity as to the parties’ obligations on demobilisation. None of them specify with certainty the factual matters that will determine whether a rig is in direct continuation, nor do they provide a means by which the charterer can independently verify whether the facts satisfy the de nition of direct continuation.
The balance of power lies with the rig owner
Quite often, when the initial negotiations for the charter of a rig are conducted, the details of the next charter are not known or agreed. A rig owner may seek to obtain a windfall by requiring the outgoing charterer to pay full demobilisation costs. There is the potential for double recovery if the rig owner can negotiate mobilisation costs from the location of the prior charterer’s campaign.
Accordingly, they are unlikely to volunteer much (or any) information about the incoming charterer due to the commercial bene t the rig owner is likely to achieve if he can create a deliberate break between contracts to ensure that there is no direct continuation where, for all intents and purposes, the rig has continuing employment. This means that the owner of the rig usually holds the balance of power in respect of demobilisation, because the outgoing charterer is likely to have little precise knowledge of the incoming charterer’s contractual obligations due to con dentiality obligations even if drilling crews and management are aware of general details of the rig’s future work programme.
How can a charterer disrupt this balance of power?
Charterers do not have to accept standard form clauses concerning demobilisation which may not adequately address direct continuation situations. Charterers may have the opportunity to broaden the scope of the ordinary meaning of direct continuation through contract. The following are some steps that may be taken by charterers to protect their position:
- ensure that the points of demobilisation and demobilisation activities are de ned in the contract. In the event of an unforseen situation, there should be a way in which the parties may agree an alternative demobilisation point without having to amend the contract. For example, the point of demobilisation is port “A”, unless mutually agreed otherwise; ensure that the contract provides that, where the rig has ongoing employment, the rig will be deemed to be in direct continuation and handover will occur close to the outgoing charterer’s area of operations, usually one nautical mile from the last well; explicitly de ne the term “direct continuation” to minimise the risk of a dispute concerning its meaning; and de ne the triggers that will determine whether a rig is in direct continuation. For example, charterers should consider:
- the time at which the subsequent contract must be agreed; whether the agreement must be executed prior to the completion of the outgoing charterer’s contract or whether a memorandum of understanding or some other such document is suf cient;
- whether the rig is required to proceed “immediately” to the incoming charterer’s area of operations or can the rig be taken to a port or be otherwise diverted or delayed;
- whether a lump sum demobilisation fee will be payable on rig release; and
- whether to include a contractual obligation that requires a rig owner to immediately notify the charterer when the rig owner executes a contract in direct continuation.
A charterer may also wish to include an audit clause that enables the charterer to conduct an audit of the rig owner’s records to ascertain the factual basis for the rig owner’s assertion that the rig does or does not have work in direct continuation. This can greatly assist the charterer to clarify the true position in a timely manner.
A charterer may also consider a claw-back clause where a demobilisation fee has been paid and the rig owner subsequently secures work in direct continuation.
To ensure there is suf cient information to make an assessment of exactly how direct continuation should be de ned in a particular drilling contract, those involved in the negotiations for the charter of the rig (on a contractual, operational or technical level) should attempt to gain an understanding of the rig owner’s future plans for the rig and whether any works on the rig are scheduled or contemplated by the owner. If charterers obtain this information during the negotiating phase, it is possible to seek to negotiate speci c carve-outs in the direct continuation de nition so that delays caused by known future works or other diversions do not prevent the rig from being in direct continuation. This may
mitigate or eliminate the risk of the rig owner taking steps to create a deliberate break between two charters for his commercial bene t.
Example carve-outs
The following are various circumstances that a charterer may wish to set out in the contract as being ones that do not prevent the rig from being in direct continuation: • where works (or a signicant proportion of works) are undertaken on the rig between charters for the bene t of the owner or subsequent charterer(s) and such works are not primarily undertaken as a result of damage caused during the outgoing charterer’s drilling operations;
- where a subsequent third party drilling contract is contingent upon rig inspection and/or acceptance if that drilling contract was entered into during or prior to this charter;
- where a subsequent third party drilling contract is contingent upon regulatory or legislative consents or approvals being granted;
- where the rig diverts from a direct course to the subsequent charterer’s area of operations and stops at port for fewer than 30 days in circumstances where the rig has entered the subsequent drilling contract during this charter;
- where the rig is diverted and/or delayed due to speci ed types of work or speci ed scheduled works of fewer than 30 days in circumstances where the rig has entered into the subsequent drilling contract during this charter; and
- where the rig is diverted and/or delayed due to inclement weather or other events which are not unforeseeable or within the control of the outgoing charterer.
When referring to terms such as “works”, “maintenance works”, “upgrade” or “repair”, it is important to note that these are common English words and can be used quite loosely. Courts will very rarely give a word in common usage some specialised industry meaning.7 If a charterer is aware that the rig owner intends to perform particular works, they should ensure that both parties have a common understanding as to the nature of the work and whether it will be captured by a carve-out or not.
Dispute resolution mechanisms
Charterers may also wish to consider what dispute resolution mechanisms will apply if there is a dispute about demobilisation and/or direct continuation. Given the high-risk nature of the demobilisation process, it may be prudent to include a clause whereby, upon notice of such a dispute, the parties agree that the rig will be towed to the required destination. The clause should specify who bears responsibility of the tow in those circumstances, pending determination of the dispute.
It will also be important to ensure that there is a contractual mechanism which will enable the charterer to gain access to relevant and necessary documents in order to verify the rig owner’s position.
Conclusion
Clearly de ned demobilisation and direct continuation provisions do not only provide commercial bene t to a charterer, but also operational and safety bene ts, as mobilisation and demobilisation are generally considered to be high-risk phases in a drilling programme. Contractual disputes as to which party bears certain demobilisation costs can distract the management and operations teams from carefully planning and executing the demobilisation.
It is important to remember that the obligations surrounding demobilisation can be established and modi ed by contract in order to accommodate unique situations applicable to each drilling programme.
Through careful drafting, charterers have the ability to reduce commercial exposure to demobilisation costs by limiting or removing ambiguity surrounding a charterer’s obligations on demobilisation. They can also take steps to ensure that the rig owner has less control over the trigger points that determine whether a rig is in direct continuation.
Obviously, these issues will be a matter for commercial negotiation, but the more fully the parties consider and record their obligations in writing, the less likely it will be that questions about the parties’ obligations on demobilisation will result in a legal dispute.
1 See rigzone.com/data/dayrates.
2 Norwegian Oil and Gas Recommended Guidelines for Joint User Costs for Mobile Rigs/ Drill Ships, Norsk olje & gass, No. 077/02, Rev. No. 1; Rev. date: 01.01.2009, part 4.4, Demobilisation and Oil & Gas UK, Standard Oil Accounting Procedures, Minimum Standards for Well Cost Reviews and Recommended Well Accounting Policies, revision 4, August 2014, SOAP 3.
3 Clause 203 , Termination , of the International Association of Drilling Contractors, International Offshore Daywork Drilling Contract, November 2007.
4 IADC Standard form contract, clauses 203 and 703.
5 Daywork Drilling Contract, techagreements. com.
6 Offshore Drilling Contract between CIE Angola Block 21 Ltd and Universal Energy Resources Inc. for the newbuild semi-submersible drilling rig SSV Catarina, 30 July 2012, sec.gov.
7 Cunliffe-Owen -v- Teather and Greenwood [1967] 1 WLR 1421 at 1438. The test for proving such usage is demanding. See also Nelson -v- Dahl (1879) 12 ChD 568 at 575 Jessel MR.
For further information, please contact:
Peter Voss, Partner, Ashurst
peter.voss@ashurst.com
