The oil and gas industry is complex and is divided into three main sector segments: upstream, midstream, and downstream.
Yanal Abul FailatSenior Associate,Corporate Commercial
The oil and gas industry is complex and is divided into three main sector segments: upstream, midstream, and downstream. The midstream segment is crucial because it links the upstream extraction of hydrocarbons to the downstream distribution of petroleum products, playing a vital role in the industry’s overall function.
Midstream companies are key players in the oil and gas industry, offering essential services, including transportation, storage, and wholesale marketing of petroleum products. A significant component of these services is the storage of various petroleum products, such as hydrocarbons in their gaseous state and material extracted from crude oil, including gasoline, kerosene, gas oil (diesel), fuel oil, base oil, and lubricants of various kinds, such as motor oils, industrial oils, and grease, bitumen, liquefied petroleum gas, and biofuel.
The strategic importance of these storage services cannot be overstated, as they provide a buffer that efficiently manages supply and demand fluctuations in the market. Central to this role are petroleum products storage agreements (“PSAs”) – contracts that govern the relationships between storage facility owners (also referred to as operators) and their customers, which can include upstream producers, traders, or end-users.
In PSAs, the contractual framework often comprises a combination of special terms tailored to the specific agreement and the operator’s standard general terms and conditions. These agreements allow for bilateral negotiations, particularly concerning special terms. This flexibility enables both parties to tailor aspects of the agreement to their specific needs and circumstances. However, operators often hesitate to change their general terms and conditions to maintain consistency across agreements, ensuring a uniform operational and legal approach.
This article aims to give a legal overview of PSAs, discussing their structure, key terms, and significant legal and commercial factors. While the issues and themes apply broadly to all PSAs, this article it is primarily drafted with a focus on those governed by English law.
A midstream storage facility, also known as a terminal, is more than just a cluster of storage tanks. It is a complex infrastructure designed to efficiently and safely handle different petroleum products. At the core of this system are extensive pipeline networks that enable the smooth movement of products within the facility. Terminals also have specialised facilities for loading and unloading, accommodating transportation methods like tanker trucks, railcars, barges, and ships.
Additionally, these terminals have state-of-the-art systems to maintain the quality and integrity of petroleum products. These systems ensure that the products meet required standards throughout their storage and handling. Together, these elements form the operational heart of a terminal, where a range of services are performed, underscoring the sophisticated nature of midstream storage facilities.
In PSAs, defining the scope of services the operator provides is crucial. These services are divided into two main categories: basic and additional services.
Basic services cover the initial receipt of petroleum products at the terminal, which can occur via various methods such as rail, truck, pipeline, or vessel in the case of marine terminals. The operator’s responsibility then extends to securing these products at the facility. The process culminates with the redelivery of the products, which is done according to the terminal’s configuration and pre-agreed delivery points. At this stage, it would be the customer's responsibility to ensure they have the appropriate facilities to receive the products.
Additional services offered by operators can include tasks like executing tank-to-tank blending, adding additives during the product pumping process, blending additives for product differentiation, and managing all relevant documentation. In marine terminals, some of these services, especially those related to receiving, handling, and redelivery of products, might be undertaken or facilitated by the port operator.
Effective management of stored petroleum products is a crucial aspect of PSAs. PSAs clearly define the types of petroleum products allowed for storage, as many facilities have specific limitations based on factors like potential co-mingling in tanks and total tank capacity.
Customers are required to provide detailed descriptions of the petroleum products they intend to store. This includes information about the product’s nature, type, quality, composition, and other relevant physical or chemical characteristics. If a product’s description is not sufficiently detailed or verified, the operator may still accept the delivery, but they would not be liable for any issues arising from inaccurate or incomplete descriptions. Operators also typically have the right to inspect products to verify the provided details.
PSAs commonly include a clause mandating that the stored petroleum products meet specific quality standards or specifications. This is vital to prevent contamination with other customers’ products. These standards may cover aspects like emissions, lead additives, sulfur content, and other chemical properties. It’s usually the operator’s responsibility to ensure these standards are met, and they have the right to reject products that do not comply.
When petroleum products are delivered to the terminal, the operator is expected to notify the customer if there are visible signs of damage or defect. However, this does not necessarily mean the customer can hold the operator responsible for failing to provide such notification. Moreover, the operator can refuse to accept or service products that pose a danger or potential environmental harm or breach regulations, sanctions, or laws.
If special handling is required for certain petroleum products beyond the standard terms of the PSA, customers are usually obligated to inform the operator of these requirements. The customer typically bears any additional costs incurred due to this special handling.
In PSAs, the responsibility for selecting and managing storage facilities for petroleum products typically lies with the operators. They have the authority to choose suitable storage facilities for the receipt and storage of these products, including the right to move the products within the facility as operational needs require.
Operators often store petroleum products in shared storage facilities with products of similar quality and grade. Blending or co-mingling these products is common, but it requires a prior written agreement between the operator and the customer. When such an agreement is in place, the customer acknowledges that the identity of the delivered products might change due to co-mingling, and they waive the right to challenge this.
Customers usually can inspect the storage facilities before using them under a PSA. This inspection is important for verifying the facilities' cleanliness, suitability, and condition, especially when the products to be stored differ from those previously housed there. Often, customers hire an independent inspector at their own expense for this purpose. The findings of this independent inspection are typically considered final and binding, barring instances of fraud or clear error.
Where there is a need to use substitute storage facilities within the same terminal or elsewhere, it is the operator’s duty to provide these facilities at no additional cost to the customer. The alternate facilities must adhere to the same contractual terms and conditions as the original ones mentioned in the PSA. This ensures consistent quality of service and compliance with agreed standards, irrespective of the storage location.
A key element of PSAs is the definition of the rental period and its commencement date, which marks the beginning of storage services. Unlike many other aspects of PSAs, there is no established industry standard for these rental periods, allowing for a range of structures to accommodate the needs of both operators and customers.
Rental periods in PSAs can vary. They might be indefinite, providing continuous and flexible storage services. Alternatively, they can be for a fixed term, usually one or two years, or even longer. Another option is to tie the rental period to specific events, like the end of production by an upstream producer. This variability is important as it directly affects customers’ operational planning and revenue forecasts. The flexibility in setting rental periods is especially relevant when PSAs are agreed upon before the construction of the storage facility. In these instances, the start of the rental period often depends on the facility's completion, which can be influenced by factors like obtaining necessary permits, authorisations, land rights, third-party consents, & securing construction financing.
Delays in starting storage services can have substantial financial consequences for both operators and customers. Operators may lose revenue and incur interest on construction loans, while customers might face revenue losses and liabilities to their downstream clients. To manage these risks, PSAs frequently include clauses for liquidated damages, termination rights, or other remedies in case of delays due to breaches, negligence, or force majeure events. Provisions for adjusting storage fees or contracted capacities are also common to account for the effects of such delays.
Storage fees are a central financial aspect of PSAs. These fees are charged based on the total capacity reserved by the customer, referred to as the total shell capacity. Typically, storage fees are payable on a monthly basis and are due regardless of whether the reserved storage capacity is fully used. This arrangement ensures a stable revenue stream for the facility owner.
Generally, storage fees encompass basic services like the receipt and re-delivery of products and standard documentation. However, these fees do not cover additional services billed separately, such as tank recirculation or blending. PSAs usually detail other charges for services beyond standard storage, including fees for extra throughput, tank cleaning, gas freeing, residue disposal, and other specialised operations.
PSAs also often include clauses for payment adjustments under special circumstances. This can be during force majeure events, changes in law, or scheduled maintenance. These provisions offer clear guidance on financial responsibilities during periods when operations might be disrupted.
PSAs usually include explicit provisions regarding the title to the petroleum products stored. During the storage period, the title to the products generally remains with the customer. This means that even though the products are physically in the possession of the storage facility, ownership does not transfer to the operator. This retention of title is a key principle of PSAs, ensuring that while the operator is responsible for the safekeeping of the product, the ownership rights stay with the customer.
If there is a change in the ownership of the petroleum products or rights to the products are transferred to a third party, the customer is typically obligated to inform the operator promptly. This notification is crucial as it impacts the product's legal status and may affect the terms of storage, or the services provided by the operator.
When a customer plans to sell the petroleum products while they are still in storage, the operator may have the right to demand immediate payment for all services related to the stored products upon being informed of the sale. Customers are also generally responsible for ensuring that any third party purchasing the products complies with all the obligations outlined in the existing PSA. This responsibility is important as it maintains the customer’s accountability to the operator, regardless of any change in product ownership.
When the customer fails to remove the petroleum products from the terminal following the termination of a PSA or in case of a breach of the agreement, the operator may have the right to sell the products. Proceeds from such sales are typically used to cover any outstanding amounts the customer owes to the operator.
In some jurisdictions, an important consideration would be whether the provisions concerning retention of title are enforceable. In these cases, such provisions might be treated as a type of security, requiring compliance with certain registration processes to ensure enforceability.
PSAs usually specify that the operator has the right to undertake or delegate maintenance of the storage facilities. These decisions, including alterations or maintenance works, are guided by the standards of what a reasonable and prudent operator would do. The need for such works might arise from necessity, advisability, or to ensure compliance with applicable laws or port regulations, where relevant.
In some instances, such as for maintenance, environmental considerations, or to comply with laws or port regulations, the operator may relocate petroleum products to an alternative storage space within the same terminal or elsewhere. This decision is at the operator’s discretion, but typically, the operator will provide written notice to the customer whenever feasible.
PSAs often include a clause stating that if maintenance becomes necessary due to the customer’s petroleum products, especially in response to laws or port regulations enacted after the PSA’s effective date, the operator can conduct these works at the customer’s expense. While the customer bears the cost, any resulting fixtures or fittings become the operator's property. If there are disputes over these maintenance works, especially if the customer withholds consent for an extended period, the matter may be subject to arbitration.
In situations where facility operations are interrupted, such as maintenance or force majeure events, it becomes crucial to allocate available capacity among customers fairly. The PSA should have a mechanism for this distribution, considering factors like the nature of the disruption, types of products, contractual obligations, and market conditions. PSAs may also provide compensation or adjustments for customers negatively impacted by these events.
PSAs detail specific criteria for delivering and redelivering petroleum products to ensure clarity and prevent disputes. In the case of marine terminals, for example, the delivery point to the terminal is usually defined as the moment the petroleum products pass through the connecting flange of the pipeline at the terminal, which is connected to the vessel manifold. This point signifies the transfer of custody and responsibility from the transporting party to the operator. In contrast, the redelivery of petroleum products to the customer is established when the products pass through the connecting flange of the operator’s pipeline to the vessel manifold. This point marks the shift of custody and responsibility back to the customer or their designated recipient.
After the receipt and volume of the petroleum products are verified by the operator at the terminal, it is common for the operator to issue a store warrant or a delivery order upon the customer’s request. A store warrant acts as a title document, indicating the quantity and description of the petroleum products received and stored. On the other hand, a delivery order is an instruction from the customer to the operator, authorising the release and delivery of specified quantities of product from the storage facility to a designated party.
In PSAs, liability and indemnity clauses are essential for addressing claims, losses, or damages related to the agreement or associated services. The nature of these clauses varies depending on the cause of the claims, such as breach of contract, negligence, and force majeure events, and their enforceability varies from one jurisdiction to another. The role of insurance, dispute resolution mechanisms, and governing law provisions are also key in determining the scope and extent of liability and indemnity. Here are some common examples of risk allocation in PSAs:
3.9.1. Typically, an operator’s liability in PSAs is clearly defined and limited. Operators are generally not liable for claims arising from force majeure events, delivery delays, or other causes unless there is evidence of gross negligence or wilful misconduct. Liability caps are often placed on the amount the operator is responsible for per event or connected series of events. Usually, operators are not responsible for claims before delivery to the terminal or after redelivery.
3.9.2. PSAs often restrict the operator’s liability to a predetermined amount. Claims may be void if not reported within a certain period following the incident or redelivery, and legal action must be initiated within a specified time after such notification.
3.9.3. Customers generally bear the risk related to petroleum products, including losses due to shrinkage or quality deterioration, except when the decline is attributed to the operator’s gross negligence.
3.9.4. Customers are typically required to compensate and indemnify the operator for claims arising from their own or their affiliates', employees', contractors', or agents' faults or negligence, including with respect to sanctions breaches, liabilities from terminal access, and transport activities conducted outside the terminal.
3.9.5. Customers are typically obliged to comply with all applicable laws affecting the products, services, and the PSA and are responsible for obtaining necessary permissions and consents. They often indemnify the operator against any fines or penalties resulting from non-compliance.
3.9.6. PSAs often stipulate that neither party is liable for special, indirect, consequential, punitive, or exemplary damages, including lost profits, service interruptions, lost third-party contracts, or cost of capital.
3.9.7. Customers are usually expected to maintain adequate insurance for their products stored at the terminal. Operators are typically not required to insure the customer’s products.
In PSAs, it is crucial to have well-defined breach protocols and corresponding remedies to protect the interests of both the operator and the customer. These protocols specify the conditions under which either party can terminate the agreement and the actions that can be taken as a result.
For the operators, there are several scenarios where they can terminate a PSA early. These include situations where a customer fails to make timely payments, breaches significant obligations, fails to provide necessary credit support, engages in unauthorised transfer of the PSA, or does not adhere to specific business conduct standards.
On the other hand, customers are also granted protective measures if an operator fails to deliver the agreed-upon services. These measures may include the right to withhold payments and claim damages, depending on the extent and duration of the service shortfall. Furthermore, customers normally have the right to terminate a PSA early under certain circumstances, such as prolonged service failure by the operator (including during force majeure events), unauthorised assignment of the PSA by the operator, or breach of operational standards and business conduct obligations.
PSAs typically outline that in urgent situations, such as potential claims arising from the stored petroleum products, unsuitability of the storage facilities, deterioration of products without customer guidance, directives from authorities not related to the operator’s misconduct, non-fulfilment of agreement obligations by the customer, or customer insolvency, the operator has the right to terminate the agreement immediately. In such cases, customers must promptly remove their products from the terminal. If the customer fails to do so, the operator will be authorised to remove the products at the customer’s expense.
PSAs constitute an intricate matrix of legal, operational, and commercial intricacies, meticulously tailored to cater to diverse needs and scenarios. The delicate balance between the operator's general terms and conditions and the customer's unique demands permeates various facets of these agreements, including service scope, facility management, product handling, rental terms, and fee structures.
In this landscape, a thorough understanding of PSAs is essential for both operators and customers, given their profound influence on operational efficiency and industry adherence. The alignment of these agreements with prevailing regulatory standards and market norms is an inherent necessity, ensuring compliance and effectiveness in a dynamic industry.
For further information,please contact Yanal Abul Failat.
Published in February 2024
