The phrase "If you can rent it, don’t buy it" is commonly attributed to J. Paul Getty, the American petroleum industrialist who founded the Getty Oil Company. Mr. Getty was known for his frugality and financial acumen and this quote reflects his practical approach to managing his business.
"If you can rent it, don’t buy it" was prevalent in parts of the global FPSO market for a long time, but is that changing? Many of our clients ask this question and the short answer is yes, but let’s start with the basics first.
Cost of FPSOs
The cost of a new FPSO varies widely depending on factors such as the size, technical complexity, production capacity, regulatory compliance and specific project requirements. The planned location of an FPSO also has a big impact on costs and FPSO’s designed for deployment in harsh environments such as the North Sea or Arctic regions or on ultra-deepwater fields are much higher because of the advanced mooring and riser systems required to operate in such conditions. While specific project requirements cause significant variations in cost, on average the cost of a new FPSO typically ranges from USD 1 billion to USD 3 billion.
Many large upstream companies have owned a significant number of FPSO’s for decades. Examples include the Brazilian state oil company Petrobras, the China National Offshore Oil Corporation (CNOOC) and French energy company TotalEnergies.
Having said this, numerous FPSO’s are owned by global FPSO contractors such as for example MODEC, BW Offshore, Bumi Armada, MISC, SBM Offshore, Bluewater, Yinson and Altera Infrastructure (formerly known as Teekay Offshore Partners). Many of these contractors typically enter into a lease or bareboat charter with an upstream company, often combined with an operations and maintenance agreement. For the construction and deployment of an FPSO, the FPSO owner typically enters into a contract with a fabrication yard. It also usually enters into a transport and offshore installation contract as well as supply agreements for key components such as cranes, communication systems, helideck, flare systems, offloading arms, the turret and swivel system and the topsides.
The lease model was common in some segments of the FPSO market for many years , but we see a noticeable increase in the use of the EPC (Engineering, Procurement and Construction) model. The shift in preference is based on financing, project requirements, risk management considerations and market conditions.
In the EPC model, a contractor will design and construct and sometimes install the FPSO. The transfer of ownership of the FPSO to the upstream company occurs at completion of a key milestone, such as for example delivery on the field, successful commissioning or start of operations. An EPC contract is sometimes combined with an operations and maintenance agreement, pursuant to which the contractor will operate the FPSO post-delivery, including ongoing maintenance. In an EPC model, the operator thus assumes more financial and operational risks and incurs high capex.
Examples of the usage of the EPC model in the FPSO sector include Woodside Energy’s contract with MODEC for the Sangomar field offshore Senegal and SBM Offshore’s contract with ExxonMobil for the FPSO Jaguar for deployment on the Stabroek block offshore Guyana.
For many FPSO contractors, the EPC model can be a good option, particularly given the challenges they face seeking financing as many banks shun fossil fuels and since their balance sheet may simply not be robust enough to support a new FPSO project on a lease model basis.
Obtaining financing for new oil and gas projects has become increasingly challenging due to several key factors, including pressure from investors and regulators over environmental, social, and governance (ESG) concerns, volatility in global oil prices (making it difficult to project long-term returns on investment), a growing concern that new FPSO’s might become stranded assets as the world shifts toward cleaner energy and in my view most importantly, banks withdrawing from fossil fuel financing. Many major banks (particularly from the United Kingdom and continental Europe) are scaling back or ceasing financing for new oil and gas projects, thus reducing the pool of available capital.
EPC Model
The EPC model provides a solution to these challenges as large upstream companies can use their impressive balance sheets to buy the FPSO outright, rather than lease it. Other advantages can include tax benefits, long-term cost efficiency (as the operator eliminates lease payments), greater operational control, enhanced customization of the FPSO, easier upgrades or modifications, no lease renewal risks and lastly, no uncertainty regarding the return of the FPSO at the end of a lease. Disputes at the end of a lease regarding the condition of an FPSO are unfortunately common and generally involve disagreements between the contractor and the operator over whether the FPSO has been returned in the agreed-upon condition (the lessor and the lessee may have different interpretations of what constitutes normal wear and tear versus damage or substandard maintenance).
While we see a noticeable increase in the use of the EPC model for FPSO’s, the lease model is still widely used and we expect this to continue for decades to come. This is particularly the case for smaller upstream companies as well as for "end of field life" oil projects, when a field approaches the depletion of its economically recoverable reserves.
Editor’s note: Ton van den Bosch is a partner in the Singapore office of global law firm Clyde & Co. Before moving back into private practice many years ago, Ton was the General Counsel of a global FPSO operator. Ton van den Bosch advises upstream companies and contractors on FPSO projects and transactions around the world.
