The cargo diversion in LNG trade refers to the redirection of an LNG cargo on buyer`s request towards a different unloading terminal than the LNG terminal at which such LNG cargo was initially agreed (in spot transactions) or scheduled (in the Annual Delivery Programme agreed by the seller and buyer under a long-term sale contract) to be delivered1.
The cargo diversion may be required by buyers for commercial reasons in order to gain a profit from the price differentials between the buyer`s home market and another market (a highly – priced market) or for operational reasons, in case of insufficient storage capacity or unforeseen events (force majeure events) that prevent the berthing and/or unloading of LNG ships at the LNG terminal  where the diverted cargo was initially agreed or scheduled to be delivered.
The contractual clauses which give the CIF and Ex Ship buyers the right to request the diversion of surplus LNG cargoes to alternative destinations are referred to as "flexible destination clauses".
In CIF and Ex Ship sale contracts, the flexible destination clauses will usually provide a range within which the receiving terminal may be nominated prior to each shipment and give the buyers the option to demand delivery of LNG cargoes at any receiving terminal from the respective range of LNG terminals with the obligation to provide a safe berth at such receiving terminal at which the LNG ship carrying the diverted cargo can safely reach fully laden and where it can safely lie and discharge always afloat and it can safely depart from. Such clauses stipulate also the requirements for diversion of cargoes: i.e.

- the buyer must request the seller`s consent for diversion;

- in case of LNG cargoes sold under fixed – term contracts, the distance and necessary time for transportation of diverted cargo to the alternative receiving terminal should allow the LNG ship to return in time for the next scheduled delivery2;

- the buyer has the obligation to reimburse to seller the additional transportation and insurance costs, including the market value of any additional boil-off gas, arising out of cargo diversion;

- the LNG ship nominated to transport the diverted cargo is compatible with the unloading facilities of the alternative receiving terminal and has been and continues to be approved by the terminal operator. The ship carrying the diverted cargo may be scheduled for unloading at an LNG terminal only if it has been previously vetted and approved by the LNG terminal operator. If the LNG ship nominated to transport the cargo proposed for diversion has not been previously vetted and approved by the operator of the alternative receiving terminal, the seller would be entitled to refuse the diversion request due to the timescales required by the LNG terminal operators for the verification of the ship`s compatibility with the unloading facilities and for the safety inspection and the risk that the LNG ship will not be able to return in time for the next scheduled delivery. The LNG terminal operators do not guarantee the approval of an LNG ship by a particular date.

- the LNG ship nominated to transport the diverted cargo shall be allowed to berth and unload the cargo at the alternative receiving terminal on the ETA date. This would require that the third party to whom the buyer resells the LNG cargo to obtain a slot for ship berthing and unloading of cargo on the ship`s ETA date, unless the LNG terminal operator can reschedule a scheduled slot of the third party buyer.

- the cargo quality characteristics, particularly the Gross Calorific Value and Wobbe Number, are within the quality specifications of the alternative receiving terminal.

The alternative receiving terminal may have different quality specifications than the previously agreed unloading terminal. In such case the possibility of cargo diversion will depend on the capability of LNG suppliers to adjust the quality characteristics in function of the quality specifications of the alternative receiving terminal3. Otherwise, the receiving terminal operators will have to adjust the LNG quality characteristics to bring them within the entry specifications of the national gas grid4 and this will be made at a cost that will make the cargo diversion less profitable.
Furthermore not all LNG terminals have quality adjustment facilities. According to GLE List of Services published by Gas Infrastructure Europe, in Europe the Wobbe Index/ GCV Correction service is currently provided only by eight LNG terminals: Gate LNG terminal from the Port of Rotterdam, Fluxys LNG terminal from the Port of Zeebrugge, Grain LNG terminal from the Isle of Grain, Elengy LNG terminals from Montoir-de-Bretagne, Fos Tonkin and Fos Cavaou, Panigaglia LNG terminal and Livorno LNG terminal5.

The Application Of Profit Sharing Mechanisms For Diverted Cargoes

The profit-sharing mechanisms are contractual clauses which require the buyers to share with the sellers a part of the profit obtained from diversion of LNG cargoes when the buyers re-sell the LNG cargoes ouside their home market designated in the sale contract.
The question whether the profit-sharing mechanisms may be applied in the LNG sale contracts concluded with European buyers depends on the delivery terms agreed in those contracts, specifically on the time when the title (i.e. ownership) and risks for the LNG cargoes pass from the sellers to the European buyers.
The LNG cargoes are purchased by the European buyers under three Incoterms: FOB, CIF and DES6.
In FOB sale transactions, the LNG cargoes become the property of the buyers at the time of delivery at the loading terminal (once the LNG cargo is loaded on board the carrying vessel) when the title (i.e. ownership) to and risks for the LNG pass to the buyers.
In CIF sale transactions, like in FOB sale transactions, the LNG cargoes become the property of the buyers at the time of delivery at the loading terminal (once the LNG cargo is loaded on board the carrying vessel) when the title (i.e. ownership) to and risks for the LNG pass to the buyers.
Unlike the FOB sellers, CIF sellers have the additional obligation to arrange and pay for the transportation of LNG cargoes to destination. But the CIF sellers are responsible only for the costs of transporting the LNG cargoes to the receiving terminal at which the LNG cargoes were initially agreed (in spot transactions) or scheduled (in fixed-term sale contracts) to be delivered. Any other additional costs due to events occurring after the time of delivery, such as the additional costs arising from the cargo diversion to another receiving terminal, shall be borne by the buyers.
In Ex Ship sale transactions, the LNG cargoes remain the property of the sellers until the time when they are delivered to the buyers at the receiving terminal.
The European Commission considers that in FOB sale contracts the buyers should be free to re-sell and deliver the LNG cargoes to any destination they wish. Similarly in CIF sale contracts, the buyers should be free to re-sell the LNG cargoes to any destination they wish provided that they shall reimburse to sellers the additional costs arising from cargo diversion7. The application of profit-sharing mechanisms in FOB and CIF sale contracts is a disincentive for the buyers to divert LNG cargoes from one EU Member State to another EU Member State, thereby potentially distorting the competition within the EU gas market8.
The European Commission considers that the profit-sharing mechanisms can be applied in the LNG sale contracts concluded with the European buyers only where the LNG is delivered on Ex Ship terms (DES Incoterms 2000 or DAP Incoterms 2010 and 2020), because in Ex Ship sale transactions the LNG cargo remains the property of the seller until the time when it is delivered to the buyer at the receiving terminal9.
Similar views were expressed by the Japan Fair Trade Commission in a report published in June 201710. Similar to the European Commission, the Japan Fair Trade Commission considers that the application of profit-sharing mechanisms in FOB sale contracts prevent the buyers from reselling the LNG freely and properly. The insertion of profit-sharing clauses in FOB sale contracts is not considered reasonable and is highly likely to be in violation of the Japan`s Antimonopoly Act.
In Ex Ship sale contracts, the application of profit-sharing mechanisms is reasonable due to the difficulty for the sellers to quantify all the additional costs and risks which a diversion requested by the buyer may cause. The application of profit-sharing mechanisms is justified only where it is used as a compensation for the additional costs and risks taken by the seller that are difficult to quantify. However, when the application of profit-sharing clauses contribute to an unreasonable profit sharing with the seller, by setting a high percentage of the resale profit without properly considering the seller`s actual contribution to resale or by using a gross profit as a resale profit or when the profit-sharing clauses have some effects to prevent a buyer from reselling due to a seller`s request of information in respect of the company to which the buyer resells the cargo or a request for the disclosure of the profit or costs structure, these are likely to be in violation of the Japan`s Antimonopoly Act.
In October 2018 the Professor Kim Talus from Helsinki University published a model of cargo diversion clause which provides two options for the buyers to compensate the sellers in Ex Ship sale transactions for the additional costs and risks incurred by the sellers due to the cargo diversion:
- either to compensate the seller for all actual documented net costs and risks incurred by the seller to complete the diversion of cargo to the alternative unloading terminal; or
- by sharing with the seller the net profit realized from resale.
The resale profit should be calculated as the difference between the net proceeds obtained by the buyer from the resale of diverted cargo to the third-party purchaser based on the market price in the country where the alternative receiving terminal is located and the net value of diverted cargo on the scheduled unloading date at the originally agreed receiving terminal, less the difference between the amount of transportation and insurance costs incurred by the seller for the delivery of the diverted cargo to the third-party purchaser and the amount of costs which would have been incurred by the seller in delivering the cargo to the buyer at the receiving terminal at which the cargo was scheduled to be delivered in the Annual Delivery Programme and which were eventually avoided by the seller as a result of the fact that the cargo was not delivered to the contractual buyer.

by Vlad Cioarec, International Trade Consultant

This article has been published in Commoditylaw`s Gas Trade Review Edition No. 2.

Endnotes:

1. See the definition of cargo diversion in the Japan Fair Trade Commission report "Survey on LNG Trades" (Chapter 4 – Ensuring of fair competition in LNG Trades).
2. In fixed – term sale contracts the seller`s refusal of a diversion request can be considered reasonable where the distance and necessary time for transportation to the alternative receiving terminal would prevent the carrying ship to return in time for the next scheduled delivery. See the Japan Fair Trade Commission report "Survey on LNG Trades" (Chapter 4 – Ensuring of fair competition in LNG Trades).
3. The LNG cargoes are described either as "rich LNG" or as "lean LNG" in function of their Gross Calorific Value and Wobbe Number. The rich LNG cargoes contain a higher proportion of hydrocarbons heavier than methane (i.e. ethane, propane, butane and pentane) than lean LNG cargoes which means that the rich LNG cargoes have a higher Gross Calorific Value and Wobbe Number than lean LNG cargoes. The LNG suppliers can adjust the quality characteristics of the rich LNG by extracting the heavier hydrocarbons from the feed gas before liquefaction to reduce the Gross Calorific Value and Wobbe Number. In the case of lean LNG, the quality characteristics can be adjusted by injecting propane to increase the Gross Calorific Value and Wobbe Number. The seller`s refusal of diversion request can be considered reasonable when this would require a change of the quality characteristics, i.e. a different Gross Calorific Value and Wobbe Number, of the LNG cargo proposed to be diverted. See the Japan Fair Trade Commission report "Survey on LNG Trades" (Chapter 4 – Ensuring of fair competition in LNG Trades).
4. The LNG terminal operators can adjust the quality characteristics of the rich LNG by extracting the heavier hydrocarbons, particularly propane and butane, from LNG and/or by diluting the LNG with liquid Nitrogen to reduce the concentration of heavy hydrocarbons and thereby the calorific value and Wobbe Number. In case of lean LNG, the quality characteristics can be adjusted by injecting propane and/or by blending the lean LNG with rich LNG to increase the calorific value and Wobbe Number.
5. FSRU Toscana is equipped with a Wobbe Index correction system installed onboard. See the information provided on the operator web site: https://www.oltoffshore.it/en/terminal/terminal-plus/
6. DES in Incoterms 2000 was replaced in Incoterms 2010 with DAP terms.
7. See the European Commission Policy Newsletter No. 3/2007, the article "Territorial restrictions and profit sharing mechanisms in the gas sector: the Algerian case" by Eleonora Wäktare. "As soon as the buyer takes title to and bears the risks for the gas, he should be entitled to take the gas to another destination, i.e. divert the ship."
8. In the year 2000, the European Commission had started to investigate the profit-sharing clauses in the long-term LNG sale contracts concluded by Sonatrach with the European LNG importers from the perspective of EU`s competition policy. In July 2007 the European Commission had reached an agreement with the Algerian government and Sonatrach over the application of profit-sharing mechanisms in the LNG sale contracts concluded by Sonatrach with the European importers whereby Sonatrach had agreed to remove the profit-sharing clauses from the FOB and CIF sale contracts concluded with the European buyers. See the European Commission Policy Newsletter No. 3/2007, the article "Territorial restrictions and profit sharing mechanisms in the gas sector: the Algerian case" by Eleonora Wäktare.
9. See the European Commission Policy Newsletter No. 3/2007, the article "Territorial restrictions and profit sharing mechanisms in the gas sector: the Algerian case" by Eleonora Wäktare.
10. See the Japan Fair Trade Commission report "Survey on LNG Trades" (Chapter 4 – Ensuring of fair competition in LNG Trades).