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The recently reported disputes involving Venture Global LNG have highlighted the importance of commissioning clauses in Liquefied Natural Gas Sale and Purchase Agreements (“LNG SPAs”). In this Martello View, the expert reviews the features in such commissioning clauses. It is worth noting that although this is prompted by recent events, it provides a general commentary on the subject of commissioning clauses. This does not express an opinion on the specifics of the Venture Global cases.

 

Introduction

Commissioning of an LNG plant occurs after the completion of construction and before the start of commercial operations. This allows the plant to be tested and optimised prior to commercial operation. During the commissioning period, the quantity and quality of LNG produced will be variable but, crucially, cargoes of LNG will be produced and available for sale.

 

These commissioning cargoes must be removed from the plant storage tanks to avoid interrupting the commissioning process. Historically, limited trading in the LNG spot market typically required commissioning cargoes to trade at a price discount as an incentive to a potential buyer. Today, as a result of the growth of the LNG spot market, it is now possible to trade commissioning cargoes without a price discount, and therefore they have become a significant source of income for some LNG producers. However, the variable timing and quality of commissioning cargoes mean both the buyer and the seller assume additional risks when trading them (specifically, both parties assume increased liability should they fail to deliver or lift as scheduled).

 

Commissioning clauses are therefore a feature of LNG SPAs. Commissioning clauses provide for the sale of commissioning cargoes and the liabilities involved in order to manage risk and allocate value before commercial operations begin. They prescribe a specific regime on liability that only applies during the commissioning period. These commissioning clauses have become more common (and more complex) in recent years, driven by the increased liquidity of the LNG spot market and the lessons learned from experience.

 

Commissioning period

The commissioning period is defined as the period between the date of the first LNG delivery and when the LNG plant is ready (the “Start Date”).

 

An LNG SPA for a greenfield project (i.e., built from scratch) is signed prior to construction, and therefore the precise date when the plant will be completed cannot be determined accurately. A key term of the LNG SPA is therefore a mechanism to determine this Start Date, usually a funnelling mechanism where a series of windows are nominated by the seller and used to narrow down the Start Date as the project progresses.

 

Completion of commissioning is sometimes included as a condition to trigger the Start Date, at which point the LNG SPA will apply in its entirety and the reduced liabilities relating to the commissioning period will lapse.

 

Commissioning clause provisions

Commissioning clause provisions (which only apply during the commissioning period) are intricately linked to the specifics of each project and are therefore not standardised. However, key issues covered in commissioning clauses will typically include provisions for:

 

1. Late cargo delivery or lifting: In older LNG SPAs, parties were typically expected to use reasonable endeavours to deliver and take a commissioning cargo, with little consequence for failure to deliver. Recent trends have seen commissioning clauses include a liability regime for failure to deliver or failure to take a commissioning cargo.
2. Cargo quantity: Commissioning clauses give flexibility for the seller to determine the size of the commissioning cargo delivered.
3. Ownership of the commissioning LNG: It is customary to offer the commissioning LNG to the offtakers, but the seller may decide to market it directly.
4. Price: In older LNG SPAs, it was common for commissioning cargoes to be sold at a discount to the contract price. However, it has become more common recently to sell the commissioning LNG without a discount, either at the contract price or at the price of the relevant spot market.
5. Quality: Special provisions regarding off-specification LNG may be included in the LNG SPA for the commissioning period.

 

Conclusions

Recent events may prompt the market to reexamine how commissioning clauses are structured and used in future. A particular area of focus is likely to be the determination of the Start Date (i.e., the end of the commissioning period). If a commissioning period continues indefinitely, this delays the full terms of the LNG SPA coming into force.

 

It is possible to fine tune the LNG SPA commissioning clause by defining objective criteria, such as directly linking the end of the commissioning period (defined within the LNG SPA) with specific milestones in the Engineering, Procurement, Construction and Commissioning or EPCC contract. However, commissioning clauses will need to appropriately balance the requirement for some flexibility in commissioning activities with the commercial interests of all parties.

 

There are risks involved in tightening those clauses, notably the potential adverse effect on the bankability of the LNG project. For example, if buyers insisted on changing the risk allocation in an LNG SPA so that a delay in commissioning would have to be compensated by the seller, this would decrease the bankability of the overall project.