Oil Traders` Potential Liability In Sale Transactions With Fuel Oil Cargoes Blended On Board The Vessels
The fuel oil blends (i.e. the blend components and their ratio in the blend product) are designed by the oil traders by mathematical calculation with the cooperation of chemists who test them in their laboratories. However, the mathematical calculations and laboratory tests of hand-blended samples cannot always be relied on to predict the characteristics of a hypothetically blended cargo. It may happen that the blend components are not compatible making the blended cargo unstable and that the blended cargo does not comply with the contract quality specifications or does not even correspond with the cargo description in the sale contract.
Then the blend components must be properly mixed so that the final blend product is homogenous. In case of blending different oil products on board a vessel it is difficult to obtain a homogenous cargo. Blending on board the carrying vessel the product components has the risk the cargo may not be fully homogenized by the time of the vessel`s arrival at the port of discharge, with the product components forming strata in the vessel`s tanks. That`s why the blending of oil products should preferably take place only in shore tanks in order to ensure that the final blend product is homogenous prior to the delivery to the carrying vessel.
The oil traders require blending of oil products on board the carrying vessels due to the geographical distance between the locations of blend components and lack of storage facilities for blends at loading ports. The blending of liquid bulk cargoes on board a ship is permissible by IMO regulations only if it is carried out while the ship is moored at berth or while the ship is at anchor within the port limits1.
The blend components are delivered to the carrying vessel from different shore tanks and/or barges. Samples of blend components are taken from the shore tanks and barges prior to the delivery of these components to the vessel. The samples of components are proportionally blended in a composite sample which is then analysed at a loading port laboratory2.
Then the shippers expect that the mixing of the blend components on board the carrying vessel will result in a cargo conforming with the cargo description and quality specifications in the sale contract. However, thorough mixing of the blend components on board the carrying vessel does not always occur as intended and when the vessel reaches the port of discharge, the cargo samples taken from the vessel`s tanks do not yield the same test results that were obtained at the loading port based on the proportionally hand-blended samples3.
An example of such case was the English law case Mena Energy DMCC v. Hascol Petroleum Ltd.4. The case was a dispute under a contract for the sale of a cargo of “HSFO 125 cSt” (high viscosity fuel oil with a maximum viscosity of 125 centistokes) to be delivered in Pakistan on CFR Karachi terms and outturn quality basis within a date range of 5 – 10 November 2014.
The seller Mena Energy shipped separately on board the carrying vessel three oil parcels: a parcel of fuel oil with a viscosity of 280 cSt, a parcel of gas oil and a parcel of cutter stock and instructed the Master to blend them on board the vessel after the completion of loading.
Before loading, samples drawn in correct proportions from each of the three parcels were blended by hand and the analysis of the hand-blend sample indicated that the cargo had a viscosity of 101.6 cSt, that was below the contractual specification of 125 cSt. No other sample was drawn from the cargo for further analysis after the blending of the three oil parcels on board the vessel.
The sale contract provided that the cargo`s compliance with the contract quality specifications was to be determined by the laboratory analysis of the composite sample obtained from the samples to be drawn from the vessel`s cargo tanks at the port of discharge prior to the commencement of discharge. The results of the laboratory analysis performed by the discharge port authority, the Hydrocarbon Development Institute of Pakistan (HDIP), on the composite sample drawn from the vessel`s tanks at the discharge port were to be final and binding on the contracting parties with regard to the quality of cargo. If the sample analysis results did not conform with the contract quality specifications, the sale contract provided that the seller had the right to request the buyer to re-sample the cargo from the vessel`s tanks and ask the Hydrocarbon Development Institute of Pakistan to test again the sample in order to determine the cargo quality.
When the vessel carrying the blended cargo arrived at the port of Karachi on 15 November 2014, spot samples5 were drawn from the vessel`s cargo tanks through the vessel`s closed sampling system in the presence of SGS and HDIP representatives. The laboratory analysis of the cargo sample showed that the cargo had a viscosity of 192.92 cSt and therefore, did not comply with the contract viscosity specification. On receipt of these results, the buyer Hascol Petroleum Ltd. rejected the cargo.
The cargo could not be discharged in Pakistan unless its viscosity was certified by HDIP as complying with the contract specification.
On the following day, that is, on 16 November 2014, the seller instructed SGS to take running samples from each of the vessel`s cargo tanks. The running samples are taken by lowering a sample container to the bottom of the cargo tank and then by drawing the container through the full height of the cargo in the tank. The analysis of the running samples indicated an overall viscosity of 113.6 cSt, below the contractual specification of 125 cSt.
On 17 November 2014, the seller instructed the Master to re-blend the cargo on board the vessel and then asked SGS to take further samples, this time both running and spot samples. The analysis of the running samples showed an average viscosity of 108.9 cSt, while the analysis of the spot samples showed an average viscosity of 118.1 cSt. The analysis of the spot samples also showed that in all but three tanks the cargo was stratified, with viscosity ranged between 230 cSt and 286 cSt at the upper levels of the tanks. Therefore, the cargo was not fully homogenized not even after re-blending.
Then the seller asked the buyer to arrange re-sampling of cargo, pursuant to the contract provisions entitling it to do so, but the discharge port authority, the Hydrocarbon Development Institute of Pakistan refused to re-sample the cargo on the ground that re-sampling was prohibited under Pakistani law.
On 21/22 November 2014, the contracting parties agreed for the vessel to return to the port of Fujairah to discharge there the cargo for further blending in the shore tanks and then reload the blended cargo and sail back to Karachi for a new analysis.
When the vessel arrived at Fujairah on 25 November 2014, new samples, both spot and running samples, were drawn from the vessel`s cargo tanks prior to the discharge of cargo in the shore tanks for blending. The analysis of the composite sample obtained from the spot samples indicated a viscosity of 159.1 cSt, while the analysis of the running samples showed a viscosity of 159.3 cSt.
After the blending of cargo in the shore tanks, the analysis of cargo sample indicated a viscosity of 95.25 cSt. After the reloading of cargo on board the vessel, a new sample was taken from the cargo. The analysis of the sample showed a viscosity of 92.8 cSt.
On 26 November 2014, the vessel sailed back to Karachi.
In the meantime, unbeknown to the buyer, the seller demanded the payment under the letter of credit presenting to the confirming bank a letter of indemnity instead of Bills of Lading and a commercial invoice with a price calculated based on the original Bills of Lading date, 12 November 2014. The sale contract and letter of credit provided that the unit price of the cargo was to be determined based on Platts price quotation on the Bills of Lading date. However, in late November 2014 the oil price in Pakistani market had fallen and by 1 December 2014 a lower price was due to take effect. On 21/22 November 2014, the buyer agreed for the delivery of cargo following re-blending in shore tanks at Fujairah provided that the carrying vessel would have returned to Karachi by 26 November 2014 so that the buyer to be able to deliver the cargo to its customers in Pakistan by 30 November 2014. If the vessel could not arrive by 26 November 2014, the buyer was not willing to pay a price based on the original Bills of Lading date (12 November 2014), but a lower price based on the date of Bill of Lading to be issued following the re-blending operation at Fujairah. However, no new Bills of Lading were issued following the re-blending operation at Fujairah on 26 November 2014.
On 29 November 2014, after finding about the seller`s demand for payment under letter of credit, the buyer obtained an injunction order from a Pakistani Court to prevent the issuing bank (a Pakistani bank) to pay under letter of credit (in fact, to reimburse the confirming bank which paid to the seller) in an attempt to settle the dispute over the contract price with the seller.
Caught in the middle of the commercial dispute, the Pakistani bank that issued the letter of credit had to reimburse the confirming bank which paid to the seller. On 2 December 2014, the bank officials convinced the buyer to withdraw the injunction order.
The vessel carrying the cargo arrived back at Karachi on 30 November 2014. Not surprisingly, this time the cargo was found to be on specification. The laboratory analysis of the new cargo sample showed that the cargo had a viscosity of 82.47 cSt.
Following Mena Energy`s misconduct for the delivery of that fuel oil cargo and misuse of the letter of credit, Hascol Petroleum did not want to be involved in any other deals with that oil trader notwithstanding that it had previously approved two vessels nominated by Mena Energy for the supply of two cargoes, one of fuel oil and one of gas oil. The seller Mena Energy brought a claim in the English High Court for damages for the financial loss incurred due to the buyer`s failure to open confirmed letters of credit for the fuel oil and gas oil cargoes. In turn, Hascol Petroleum claimed damages for the late delivery of the fuel oil cargo that had to be re-blended in shore tanks at Fujairah.
As regards the buyer`s claim for the late delivery of the fuel oil cargo, the English High Court was asked to decide over the questions:
- whether the seller, Mena Energy had the obligation to deliver a homogenous cargo; and
- whether the cargo was in fact in accordance with the contractual specification as to viscosity when the carrying vessel arrived first time at Karachi on 15 November 2014.
The buyer, Hascol Petroleum Ltd., contended that:
- the viscosity specification formed part of the description of the commodity in the sale contract;
- the cargo was required to comply with the commodity description in the sale contract “HSFO 125 cSt”; and
- a cargo which was non-homogenous and stratified as shown by the samples drawn on 17 November 2014 could not properly be described as “HSFO 125 cSt”.
The English High Court held that the viscosity specification was not only a quality specification but also part of the description of the commodity in the sale contract and the fuel oil cargo was required to comply with the commodity description in the sale contract.
As regards the buyer`s contention that the fuel oil cargo had to be homogenous at the time of delivery to comply with the commodity description in the sale contract, the Court held that there was no such provision in the sale contract. The Judge held that although the analysis of the cargo sample taken on 15 November 2014 showed that the cargo did not comply with the viscosity specification of the sale contract, once the seller exercised its contractual right to request re-sampling of cargo, the buyer`s failure to arrange re-sampling of cargo meant that the analysis certificate issued by the Hydrocarbon Development Institute of Pakistan based on the sample drawn on 15 November 2014 was no longer final and binding as between the seller and buyer.
The fact that the sale contract did not specifically stipulate any sampling method allowed the seller Mena Energy to argue that the samples drawn on 15 November 2014 were not reliable and had not to be taken in consideration.
Mr. David Edwards, the expert brought by Mena Energy to support its case during the proceedings in the English High Court, was able to convince the judge, Mr. Justice Males, that the running samples are more reliable than the spot samples to determine the quality of a non-homogenous cargo such as fuel oil. On the basis of his testimony, the judge held that:
- the most reliable samples to show the composition of the cargo on board the vessel at the time of the vessel`s arrival at the port of discharge were the running samples drawn by SGS surveyor on 16 November 2014;
- what really mattered to buyer was the overall composition of the cargo, i.e. that the blend components had been loaded on board in the correct proportions, and not whether it was stratified, because the cargo would have been thoroughly blended in the course of discharge and thereby meet the viscosity requirement. “There is therefore no need to read the contract as imposing any requirement as to the homogeneity of the cargo or to imply any term to that effect”.
- the cargo was in accordance with the contract description and quality specifications at the time of the vessel`s arrival at the port of discharge on 15 November 2014 and the seller was entitled to recover the costs for the vessel`s return to Fujairah for the re-blending of the cargo components in the shore tanks.
Reliability of the running samples
The sad thing about this case was that the judge was too easily convinced by the expert brought by Mena Energy on the reliability of the running samples taken on 16 November 2014. In the CFR Outturn Quality and DAP oil sale transactions the sampling method used by surveyors is in function of the discharge port authority regulations and not in function of the sale contract provisions. The CFR and DAP sale contracts usually provide that the cargo samples will be taken in accordance with the discharge port authority regulations6. Even if a sale contract is silent on this matter, this should be an implied term of the contract. Therefore, in Mena Energy DMCC v. Hascol Petroleum Ltd. it was for the discharge port authority, the Hydrocarbon Development Institute of Pakistan (HDIP), to decide what sampling method was more suitable to analyse the quality of the cargo on board the vessel and not for the seller.
The running samples are not so representative for non-homogenous cargoes as Mr. David Edwards, Mena Energy`s expert claimed during the Court proceedings7. It is difficult, not to say impossible, to obtain representative samples from a non-homogenous cargo8. That`s why the SGS analysis report from 17 November 2014 stated that the cargo needed to be properly/fully homogenized in order to obtain a representative sample.
The judge seems to have overlooked the fact that when the vessel arrived at Fujairah on 25 November 2014, the analysis of the running samples drawn from the vessel`s tanks had shown a viscosity of 159.3 cSt, not very different from the test results for the composite sample obtained from the spot samples which had indicated a viscosity of 159.1 cSt. If the running samples were so reliable on 16 November 2014, how come the running samples drawn on 25 November 2014 showed that the cargo had such a high viscosity?
The judge did not seem to be bothered by the fact that the analysis of the cargo sample drawn on the very same day, 25 November 2014, after the blending of the cargo components in the shore tanks at Fujairah indicated a viscosity of 95.25 cSt. Nor he was troubled by the fact that when the vessel returned to Karachi on 30 November 2014, the analysis of the cargo sample showed that the cargo had a viscosity of 82.47 cSt. This time the sampling method was no longer an issue. It was only when it showed that the cargo was off-specification on 15 November 2014.
Cargo Homogeneity
All the trouble could have been avoided if the seller would have blended the three oil parcels in shore tanks from the very beginning in the early days of November 2014. The fact that the blend components had been loaded in the correct proportions did not necessarily mean that the cargo would have certainly complied with the commodity description and quality specifications from the sale contract.
If the CFR and DAP sellers choose to blend different oil grades on board the carrying vessels rather than in shore tanks before loading, they are the ones who should bear the risks and costs arising therefrom until the blended cargo is certified as meeting the contract quality specifications9, and not the buyers as in Mena Energy DMCC v. Hascol Petroleum Ltd..
Contrary to what the judge understood about the oil traders` requirements in respect of fuel oil cargoes, the fuel oil cargoes must be homogenous at the time of the vessels` arrival at the discharge port to allow the discharge port authorities to determine whether they comply with the sale contract quality specifications. That`s why in the contracts for procurement of fuel oil cargoes on CFR and DAP terms the cargo homogeneity is usually an express requirement10.
In Mena Energy DMCC v. Hascol Petroleum Ltd., the sale contract was drafted by the seller with no such provision, but it does not mean that it was not necessary for the cargo to be homogenous at the time of the vessel`s arrival at the discharge port. As stated in SGS analysis report, the cargo had to be homogenous in order to obtain a representative sample.
The seller`s failure to deliver a homogenous cargo within the date range of 5 – 10 November 2014 caused a financial loss to the buyer which had to deliver the fuel oil cargo to its customers in Pakistan by 30 November 2014 to avoid a financial loss. Therefore, the buyer`s claim for late delivery was justified and should have been upheld.
Mena Energy DMCC v. Hascol Petroleum Ltd. should be a reminder for oil traders who are required to deliver fuel oil cargoes on CFR Outturn Quality or on DAP terms and are considering the option of blending different oil grades on board the carrying vessels in order to obtain fuel oil blends complying with the buyers` specifications that there is a risk that such cargoes may not be fully homogenized by the time of the vessels` arrival at the discharge ports and thereby fail to meet the contractual quality specifications. The expenses subsequently incurred by the oil traders to bring such fuel oil blends on-specification will be borne by them alone and not by the buyers nor by the carriers.
If a fuel oil blend will be rejected by the buyers at the discharge port, the oil trader who asked the carrier to blend different oil grades on board the carrying vessel cannot blame the carrier, unless there is evidence of water ingression in the cargo or contamination due to a technical malfunction of the vessel11.
Blending of different oil grades on board the carrying vessel is not an activity specified among the carrier`s obligations under the International Conventions for the sea carriage, i.e. to properly load, stow, carry, keep, care for and discharge the goods. The carriers would normally have to keep the parcels of different grades fully segregated.
The carriers who agree to blend different oil grades on board their vessels do this on the basis of the contractual indemnity provided by the oil traders who charter the vessels12 and charterers` contractual warranty that the blend components are compatible and stable and that no precipitation of solid deposits will occur in the vessel`s cargo tanks, pipes and pumps13.
by Vlad Cioarec, International Trade Consultant
This article has been published in Commoditylaw`s Oil Trade Review Edition No. 1.
Endnotes:
1. The physical blending of MARPOL regulated cargoes (i.e. petroleum oil, vegetable oils and biodiesel) on board the vessels during the sea voyage for the purpose of creating new product blends was prohibited by IMO in August 2009 due to concerns over the safety of the vessels. See the IMO`s Maritime Safety Committe and Marine Environment Protection Committee Circular No. 8/ 3 August 2009 and the Regulation 5-2 in the Chapter VI of the SOLAS Convention.
2. See IFIA (TIC Council) Petroleum and Petrochemical Bulletin 99-02 Rev.1/September 2015 and the English law case Mena Energy DMCC v. Hascol Petroleum Ltd., [2017] EWHC 262 (Comm).
3. See IFIA (TIC Council) Petroleum and Petrochemical Bulletin 99-02 Rev.1/September 2015.
4. [2017] EWHC 262 (Comm).
5. The spot samples are taken from specified heights in each cargo tank – upper, middle and lower spots.
6. See Sub-Section 5.4.3 of Qatar International Petroleum Marketing Company Ltd. (TASWEEQ) QJSC General Terms and Conditions For CFR/CIF Sales and Purchases of Bulk Oils.
7. See IFIA (TIC Council) Petroleum and Petrochemical Bulletin 99-02 Rev.1/September 2015.
8. See IFIA (TIC Council) Petroleum and Petrochemical Bulletin 99-02 Rev.1/September 2015.
9. See Qatar International Petroleum Marketing Company Ltd. (TASWEEQ) QJSC General Terms and Conditions For CFR/CIF Sales and Purchases of Bulk Oils.
10. In the US law case Westport Petroleum Inc. v. M/V OSHIMA SPIRIT, 111 F. Supp. 2d 427 (S.D.N.Y., Sept. 5, 2000), a contract for the procurement of a fuel oil cargo on CFR terms stipulated that it was permissible for the cargo to be a blend of different oil products provided that at the time of delivery at the discharge port the cargo was a homogenous mixture conforming to the contract quality specifications.
11. See the US law case Armada Supply, Inc. v. S/T Agios Nikolas, 613 F. Supp. 1459 – US District Court, S.D. New York (1985), the English law case Fal Oil Co. Ltd. v. Petronas Trading Corporation Sdn Bhd, [2004] EWCA Civ 822; [2004] 2 Lloyd`s Rep 282, the US law case Westport Petroleum Inc. v. M/V OSHIMA SPIRIT, 111 F. Supp. 2d 427 (S.D.N.Y., Sept. 5, 2000).
12. See INTERTANKO Blending Clause.
13. See BP Blending Clause.