How to future-proof your newbuilding project

Despite favourable earnings trends across ­various shipping and offshore segments, there are no clear trends in newbuild orders. The ongoing debate regarding which fuel standard will dominate the future and whether to scrap old ships or upgrade them to reduce emissions remains intense. As regulatory requirements tighten, ensuring that your investments are secure for the future is more relevant than ever. 

Flexibility in the newbuilding contract 

Construction contracts are complex instruments for risk allocation between shipowners and yards, and the number of factors a shipowner must consider has grown significantly. From the shipowner’s perspective, ­flexibility in newbuilding contracts is crucial to cater for an uncertain future. Incorporating as much flexibility as possible at the lowest cost and with minimal delays should be the ultimate goal.
Shipping companies increasingly need to make ­contract modifications during construction. For ­example, an owner of an ammonia-ready LNG tanker may need to install the ammonia system before ­delivery at the request of the charterer. The need for these modifications emphasises the importance of ­including performance obligation clauses to ensure such ­modifications can be carried out efficiently.

Regulatory issues

Regulatory changes pose significant challenges for ­shipping companies as the IMO and the EU rapidly introduce new emission reduction rules. Because of this uncertainty relating to future regulations, it is crucial to ensure that ships can adapt quickly to necessary changes.

Flexibility through variation orders and options

To meet new regulations or shifting market ­requirements, shipowners may need to implement contractual modifications during construction. Owners should seek to include performance obligations on the yard to cater for the possibility of having to make such ­modifications, and to ensure that modifications are implemented if and when required. 

Shipbuilding contracts should include mechanisms for flexibility. Such flexibility may be implemented through agreed options, such as options for ­different ­engines or hydrogen suppliers and timeframes for ­upgrades. Further, so called ”sleeping beauty” clauses which allow for delivery delays until necessary ­infrastructure is available, are becoming increasingly relevant. It is also important to ensure that these ­contractual ­flexibilities are passed on to charter party agreements, where the end customer ultimately bears the cost.

Pricing and warranties

As with any project, increased flexibility must be ­balanced against costs. Thus, a cost-benefit analysis is ­essential when considering pricing, weighing the ­tolerance for delays. Longer delays generally result in lower costs compared to shorter delays requiring ­extensive per­formance obligations from the yard, ­leading to higher costs.

Owners should secure warranties that oblige the yard to make necessary adjustments if systems do not ­perform as expected and obtain warranties from ­subcontractors providing these solutions.

Back-to-back in charterparties

Charterparties in a newbuild project have two aspects: their relation to the construction contract and their role as standalone risk allocation instruments between the shipowner/operator and the charterer.

In relation to the shipbuilding contract, a shipowner/operator will want to ensure that, so far as possible, the charterparty terms relevant to the ship’s construction are ”back to back” with the shipbuilding contract – ­subject to limitations on commercial feasibility.

As a standalone, and usually long term contract the charterparty also needs to try and foresee and ­address future regulatory, technological, and commercial changes. 

Allocating costs according to the polluter pays principle

Ultimately, the charterer utilising the vessel’s tonnage should bear the operational costs, aligning with classic risk allocation in time charter parties. This approach should also apply to regulatory changes.

Technological uncertainty, options and pricing

New technology involves uncertainties related to, among other things, functionality and repairs. Commercial risks resulting from non-conventional technology implemented at the request of the charterer should be governed in the charterparty. Typically, ­delays or loss of time resulting from such non-­conventional technology should be the charterer’s risk.

Where charterers are given options for upgrading or modifying the vessel, careful commercial considerations also have to be made. For instance, if a charterer implements upgrading or modification which is only of limited value to the owner or the subsequent charterer, it is important to include pricing terms or hire adjustment mechanisms reflecting the limited value to the owner.

Consider options for financing

Banks and financial institutions meticulously scrutinise new technology in credit approval processes. While they are commercially willing to finance new, especially green, technology, this depends heavily on their assessment of the technology. Detailed due diligence of the technical aspects ensures viability.
Loan agreements for construction projects also ­contain provisions closely tied to the project’s risk ­profile. These include termination clauses for delays and conditions that prevent loan drawdowns until equity injections are made, as well as terms relevant to guarantees or deposit commitments.

Sometimes, shipowners may seek to finance ­specific equipment in addition to the main loan for refits or newbuilds. However, banks and lenders are often ­reluctant to provide such loans due to the difficulty in securing collateral, as equipment like cranes are ­considered part of the ship and are therefore included in the ship mortgage for the main lender.

Alternative financing

Leasing is becoming increasingly integrated into financing models, not just for individual equipment but also for larger systems. Equipment suppliers and financial leasing companies buy equipment packages that are then leased to shipowners, offering flexible financing solutions that facilitate necessary technological upgrades without overburdening the main loan.

Green loans

Green loans enable shipping companies to finance environmentally friendly projects under specific conditions. To draw on a green loan, the loan must be confirmed as intended for an environmentally friendly purpose.

One key advantage of green loans is their potential for lower interest rates if the shipowner maintains greener operations, providing incentives for sustained environmentally friendly practices.

Green loans also come with reporting requirements. Shipowners must regularly document and report on measures taken to ensure continued green operations. This includes fuel efficiency and emission ­reductions, thereby maintaining standards for green loans and ­contributing to shifting the industry in a more ­sustainable direction.

Navigating the complexities of newbuilding ­projects requires careful consideration of many ­factors to ­ensure future-proof investments. Key strategies include ­incorporating flexibility into newbuilding ­contracts, pushing obligations down to customer ­contracts, and exploring alternative financing ­options such as green loans and leasing. Our team is well-­prepared to ­assist you with these critical aspects, ­helping you make ­informed decisions to safeguard your projects amidst evolving regulatory and technological landscapes.