INSIGHTS The Contango Conundrum September 2015 The Contango BOARD DISCUSSION Spotlight on shipowners’ and traders’ liabilities Potential damage to hull and machinery Conundrum following long period of idleness. Contamination, shortage, and other loss or damage to cargo all major concerns. Could oil traders ever be found liable in Marine insurers are becoming increasingly the event of a major oil spill offshore? concerned about the issue of “contango” and its potential to affect bulk carrying vessels, most WHAT IS CONTANGO? notably oil tankers. However, it is a term that many in the maritime industry could be excused People buy futures contracts when the expectation is that the future for never having heard of before, seeing as it is open market, or “spot” price, will be higher at the time of delivery than one that is more readily understood in the the price that was agreed under the commodity futures markets. futures contract, thereby enabling a profit to be made by that investor when the goods are then sold on. (Of course, there is always a risk that market prices at delivery time will be unexpectedly lower than the contractually agreed purchase price. The seller may then be effectively locked into the agreed purchase price, regardless of the actual market or spot price at the time of delivery, unless protected by a “stop loss” or similar clause).
A gradual, long-term increase in prices is the normal way of markets and, in this state, a market is said to be in a state of “backwardation.” However, prices don’t always rise and there is no guarantee that the future spot price will be higher at the time of delivery. When a market has unexpectedly weakened, to the point that the market price for that commodity is lower on delivery than it was when the price was agreed within futures contracts, the market is said to be “in contango.”
1 In January 2015, we saw the price of brent crude oil plummet to below US$50 INSIGHTS The Contango Conundrum September 2015
THE IMPACT ON THE MARITIME WORLD INSURERS ARE INCREASINGLY Price of Brent Crude Oil (US$ Per Barrel) Source: MoneyAM.com CONCERNED WITH THE “CONTANGO 115.00 110.00 MARRIAGE OF 105.00 100.00 (GB @IB.1) CONVENIENCE” 95.00 90.00 BETWEEN OIL 85.00 80.00 TRADERS AND OIL 75.00 70.00 TANKER OWNERS 65.00 60.00 55.00 MARINE CARGO INSURANCE 50.00
May 2013 Sep 2013 Jan 2014 May 2014 Sep 2014 Jan 2015 Crude oil is not a liquid — it is a suspension of numerous hydrocarbon compounds, among Crude oil is a commodity that is One of the attractions of a futures other things. If stored for long widely traded on the global futures contract is that until the delivery periods of time, undisturbed crude markets. In January 2015, we saw the date, the buyer is not in possession oil will begin to settle. The heavier price of brent crude oil plummet to of the commodity, and so does hydrocarbons (such as bitumen) sink below US$50, having been around not have to worry about storing it. and coalesce at the bottom, while US$100 just a few months earlier. However, once that delivery date the lighter hydrocarbons (such as arrives, it becomes their property methane and ethane) rise to the top Investors and/or traders and/or and will remain so until the oil is and, if permitted, escape the crude their financiers who had bought sold on to others. oil altogether as vapor. As such, the “long” suddenly found their market crude oil starts to degrade. This can to be in contango. When the delivery It is no coincidence that, at times lead to both quality claims as well date arrived, they had to accept when crude oil prices fall, maritime as shortage claims due to excessive that, if they then tried to sell the freight prices for the carriage of sediment (or sludge) forming at the oil they had purchased, they would oil also often fall. This is due to bottom of the cargo, which becomes have to realize a substantial loss there being a glut of oil on the unpumpable, leading to residues as the spot price was considerably international markets (as indeed was remaining on board (ROB) issues. lower. Therefore, rather than sell the case in 2014), which depresses it immediately, oil traders opted oil freight rates. Oil tanker operators Oil tankers used as storage units are to keep possession and wait for often find it difficult to obtain good exposed to the climatic conditions the oil price to rise again, before charters for their vessels at exactly where they are anchored. In many then selling the oil on. There are, the time when oil traders are looking locations, there can be considerable however, the following problems for somewhere to keep their newly variations between daytime and with this approach: delivered (or about to be delivered) nighttime temperatures, which may oil. Not for the first time, we have • Problem 1 – Where do traders lead to a loss of cargo due to venting a situation where there are two keep the oil in the meantime? (the release of gases into the atmos- willing partners in what becomes phere). This may well lead to cargo • Problem 2 – If purchasing the oil a maritime contango marriage of “shortages,” as the volume of the under the futures contract requires convenience. Oil traders charter cargo on board is slowly reduced due the trader to obtain financing idle oil tankers to store their oil to this constant temperature change. from banks or other institutions, and shipowners find a cheap way The longer the oil is in storage on the are those financiers aware of the of employing their tankers, simply vessel, the greater the possible loss risks associated with the long-term anchoring the vessels and offering from this cause. storage of crude oil at sea? these otherwise idle ships to be used as floating storage units.
2 INSIGHTS The Contango Conundrum September 2015
Long-term settling of oil cargoes can result in degradation and increased viscosity at the base. MARINE HULL INSURANCE
The lightest alkane, methane, will try The evidence from earlier economic to leave the suspension as vapor. downturns and shipping slumps in the 1970s and 1980s, where large numbers of unemployed tankers Heavier, more viscous were often moored together for alkanes such as bitumen and many months (sometimes years), tar sink to the bottom. is that considerable problems were encountered when those vessels Lighter alkanes such as were finally reactivated. In such methane, ethane, and instances, damage occurred both butane rise to the top. to the hull (due to the excessive fouling and degradation of the hull) and the machinery (never designed Crude oil is a suspension. If the lighter compounds are allowed to escape, then, to maintain the for long periods of idleness) of the balance of the suspension, small quantities of the heaviest compounds will also leave the suspension ships in question. Both main engines to compensate, so that the remaining compounds maintain a suspended balance. The heaviest and auxiliaries often developed compounds can then coat the lining of storage tanks with thick sticky residues that are very similar in nature to the tarmacadam used to make roads. problems that only became apparent when those vessels had started to work again.
The mixing or “blending” of cargoes event at sea would fall on the Cargoes of oil, carried for long at sea is not permitted under the vessel operator (often strictly periods of time, can also cause International Convention for so, as, for example, under the considerable harm to the steel of the the Safety of Life at Sea (SOLAS), Civil Liability Convention [CLC]), tanks they are carried in. Some of the but such mixing may occur under some jurisdictions, it is naturally occurring constituents of accidentally, leading to claims of by no means certain that such crude oil, such as hydrogen sulphide, the cargo being “off-spec” when clear-cut responsibility on the can be particularly harmful, as their it is eventually discharged. vessel operator would always be corrosive effects, over long and applied. This is especially true sustained periods, can additionally With current international concerns in countries like the US, where cause damage to all the pipes and over the origin of oil cargoes, the laws on responsibility for pumps they come into contact with. resulting from international marine oil spillage are somewhat The proportion of hydrogen sulphide sanctions, any blending that occurs different. If a major oil spill were within the stored crude oil varies will make it increasingly difficult to to occur from a vessel engaged in considerably, depending on where it prove that a cargo’s origin remains this oil-storage activity, oil traders was drilled. While in most places it is legal, especially in areas of the world and/or their financiers who are a relatively low percentage (between where sanctioned oil cargoes may be seen to be the owners of the oil 2%-4%), oil and gas extracted from present. If any ship-to-ship transfers might not escape legal action and wells in Kazakhstan, for example, of the cargo occur, this risk of could at least incur defense costs, is known to be considerably more blending and of contamination only maybe even an actual liability in “sour,” with a much higher hydrogen increases each time. some jurisdictions. It is therefore sulphide content (sometimes in not surprising that increasing excess of 10%). numbers of traders and their TRADERS AND financing banks are seeking oil The buildup of cargo “sludge” at THEIR FINANCIERS traders’ liability insurance cover. the bottom of cargo tanks sustained during long periods of offshore oil storage use, can cause issues While it may widely be true that when tankers are then reactivated liability following a pollution for normal use, necessitating
3 INSIGHTS The Contango Conundrum September 2015 considerable and expensive cleaning. of concern, as periodical weather On the face of it, the reduction in Hull underwriters learned during and sea states may expose the vessel voyages might make the P&I risk previous shipping downturns to unusual strains on its anchoring appear reduced. To some extent, this that crude oil washing (COW) systems. Should the vessel go adrift, argument is persuasive but there are operations and inert gas systems then the perils occasioned by long other aspects to consider. (IGS) are vulnerable to failure periods of inactivity of its machinery after long periods of inactivity, may cause additional problems. Liability to cargo interests due and the need for extensive tank Where storage vessels are anchored to shortage would be a major cleaning can actually cause is another important factor, as quiet concern and the exposure would damage to the tanks themselves. locations that might pose reduced only increase with the length of collision risk may also suffer from a the storage period. As well as the As mentioned previously, lack of nearby adequate salvage and potential liability, fines may be temperature changes in and around rescue services. imposed on the vessel operator, the vessel may either lead to under some jurisdictions, for vacuums in the tanks or, conversely, cargo shortage. Possible liability pressure buildup. Unless strict PROTECTION AND for contamination of the cargo adherence to approved venting is another risk that shipowners procedures is undertaken, the risk INDEMNITY (P&I) (and their P&I clubs) might have of explosion will be increased, as to face. Pollution liability poses a external air mixing with the fumes Employing tankers as floating constant threat for laden tankers, from the cargo could result in a storage units would usually and the long-term use of vessels highly explosive cocktail. represent a material change in as oil-storage vehicles can only information and so the P&I Club increase the risk of a pollution One of the more traditionally ought to be promptly advised of event occurring or resulting from understood risks to hull involves the any such plans. other events (such as a collision or ship-to-ship transfer of stored oil breaking adrift in bad weather and between tankers. Such operations, Underwriters could take the view grounding). If ship-to-ship transfers having two or more vessels very that this is a material change are involved, then the pollution close to each other, increase the in information and may, under liability risks increase further. possibility of collision, with a the Rules, seek to impose new consequential increase in the risk of premiums, terms or deductibles. Long-term employment of oil damage to the insured vessel’s hull There may also be risk management tankers as floating storage units and a possible liability to the other concerns and conversations would may also lead to disputes under vessel (assuming primary collision need to be had with the Club along the charterparty such that FD&D liability is insured under the hull these lines. In extremis, the Club cover, if purchased, may also need policy). The mooring arrangements managers could cancel the entry. to be utilized. of a long-term lay-up of a tanker with cargo on board is also another area
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