How The Iran War Has Snarled Global Oil & Gas Shipping

Types : In the News

The Iran war has effectively closed a key global shipping lane for oil and gas, and the resulting logjam is causing major headaches for companies responsible for transporting oil and gas from the Middle East to global markets.

Vessel traffic in the Strait of Hormuz, through which 20% of the world’s crude oil is transported, has largely ceased since the war began earlier this month, as Iran has vowed to attack ships that try to cross the strait. Thousands of ships that transport oil, liquefied natural gas and other commodities and goods are now stuck either inside the Persian Gulf or outside the strait and unable to enter the gulf.

Energy, maritime and insurance attorneys told Law360 that the blockade is forcing oil and LNG shippers to confront uncomfortable questions about whether they can fulfill their contractual obligations — or adequately insulate themselves from business losses.

“No vessel owner wants to risk its personnel or vessel to an attack at the same time that insurance rates, when available for war risks, are just prohibitively expensive,” said Mayer Brown LLP energy partner Jose Valera, who frequently works on international oil and gas development. “So this is creating a lot of disruption on the commercial chains for LNG and oil … but other products as well that are produced in various facilities throughout the Persian Gulf, and imports into countries that border the Persian Gulf.”

Here, attorneys outline several legal and compliance challenges facing oil and gas shippers as the conflict scrambles global supply lines.

Contract Performance: The Devil Is in the Details

Global marine transportation of oil and LNG relies on a complex web of contractual agreements, including between producers and customers, producers and vessel charterers, and charterers and vessel owners.

Some LNG suppliers, such as QatarEnergy, have already declared force majeure in contracts with buyers. But not all contracts contain force majeure or similar provisions, and not all such provisions may cover the war, attorneys say.

“By all accounts it would probably fit, but depends on how that language is drafted, and if you could have an argument that, well, the U.S. hasn’t formally declared war,” said Holland & Knight LLP maritime partner Sean Pribyl. “So is it just purely a … potential dispute on what the contracts say about delayed delivery … how that time is calculated from a damages viewpoint, whether the contract allows for that.”

Those contractual uncertainties can reverberate down the chain to agreements between suppliers and vessel charterers, or charterers and vessel owners, attorneys say.

William Cecil, who heads Haynes Boone’s dispute resolution team in London and frequently works on oil and gas shipping matters, said charterers and vessel owners, especially ones that are stuck outside the Persian Gulf, may have to examine whether their contracts allow them to temporarily take on other business, or even terminate their existing cargo deliveries.

“They’ll have booked, or pre-booked … their next voyage, so all of that will be disrupted,” Cecil said. “The reality is, all charter contracts have a period of time, because obviously, these [vessels] are sailing around the world.”

Long-term crude oil and LNG supply contracts frequently contain some wiggle room for missed cargo shipments, attorneys say. But the longer the war drags on and Strait of Hormuz traffic remains at a standstill, the more contract termination becomes a possibility.

“It would not be unusual to see a contract that says that due to an extended force majeure that is extended beyond the time as stipulated, a party may terminate,” Valera said.

Are Existing Insurance Policies Good Enough?

For shipping companies hoping to tap their insurance policies to cover any war-related losses, the first step is to file a notice of claim, which can also start the clock on calculating losses. Bracewell LLP insurance partner Carlton Wilde, who represents policyholders, said most policies have 30- or 60-day deadlines to file claim notices.

“If right now I was in-house counsel [of a company] that had a bunch of ships floating around, I would want to go pull my notice provisions of every single policy,” Wilde said. “If your clock’s already running, you know you don’t want to be missing that deadline. Whether you can forfeit coverage or not, it’s going to depend on a lot of different jurisdictions and how missing that notice time is interpreted.”

Another threshold item for companies is determining is how broadly their insurance policies cover business interruptions, as opposed to actual physical damages or loss of life. Wilde said most policies generally require some direct event to trigger business interruption coverage, and vessels simply being stuck in the Persian Gulf or unable or unwilling to cross the Strait of Hormuz may not qualify.

“The odd thing that this leads to is today, a charterer could probably stand on its rights and order these tankers to transit, even under the current situation,” said Jon Werner, a member of the maritime and transportation industry group at Montgomery McCracken Walker & Rhoads LLP. “It’s really the market policing itself that’s prevented that from happening.”

War Risk Insurance: Is It Worth It?

One major insurance problem for shipowners is that their policies generally exclude damages caused during war. That’s where purchasing additional war risk insurance becomes a possibility — but even if it’s available, the price tag is likely too high for most shipowners, attorneys say.

“War risk insurance is very expensive, but it’s a bespoke type of insurance, because not every vessel is traveling through a war zone,” Pribyl of Holland & Knight said. “The premiums are set based on risk, and when you look at Strait of Hormuz, it’s an international strait and a choke point. This is a clear risk, as far as the danger to naval vessels and to the shipping community, which are usually civilian in nature.”

Cecil of Haynes Boone said that if vessel charterers are committed to ordering ships through the strait, they may have to agree to cover war risk insurance costs.

The U.S. International Development Finance Corp., as directed by President Donald Trump, has said it will provide $20 billion in reinsurance, including war risk, for eligible vessels in the Gulf region. The DFC, an international investment arm of the U.S. government, said Wednesday that insurance giant Chubb would be the lead underwriter.

But attorneys say that even with Chubb’s involvement, the DFC doesn’t have any insurance regulatory or underwriting experience, and any legal framework governing claims is essentially being written in real time.

“I haven’t seen any interest really … in picking up that insurance, so it remains to be seen whether that is successful,” Werner said. “There’s no bureaucracy yet in place to handle claims, and they could be complicated claims.”