The inherent volatility of the global oil market creates opportunities for traders to optimise market conditions to obtain the best price. Efficient and strategic oil storage facilitates such opportunities. With growing production of crude oil, expansion of the refining sector and high trading levels, the demand for oil storage has been robust in various jurisdictions, and traders are seeking to diversify storage options by venturing into further jurisdictions. The legal risks around oil storage are however not straightforward and due consideration needs to be given to the structure and documentation necessary to allow a lender/trader to enforce its rights and take possession of oil, considering the tripartite relationship between the seller, the storage operator and the buyer/lender. Key issues for consideration include:
Ownership: What is needed to recognise ownership of commingled oil under local laws?
Security: Can you take a pledge of commingled oil in tanks, when parcels of oil are moving in and out?
Enforcement: In the event of enforcement, is a local court order needed to enforce security over the oil? How along will such an order take, especially if there are competing claims for the oil?
Visibility: What visibility do you need over the tank operator’s actions of receiving and releasing parcels of oil in the tank, particularly when it is stored with a third party’s oil that has been commingled?
Commingled oil
An oil tank may simultaneously contain a trader’s unfinanced oil, oil financed by different financiers and/or another trader’s oil. Considerations of costs efficiency, and optimisation of the storage space lead to such commingling arrangements. However, title to commingled oil is not always straightforward leading to challenges with selling the oil, or taking security over commingled oil.
Questions of ownership in relation to commingled oil are governed by the law of the jurisdiction where the oil is stored. In Singapore and England, the Sale of Goods Acts of the respective jurisdictions provide that if certain conditions are met (eg, a buyer who has paid the purchase price), a buyer can become an ‘owner in common’ of the bulk, with the result that the buyer acquires an undivided share in the bulk in proportion to its share of the total. Other laws might not recognise this concept.
Whilst contracts can be governed by English or Singapore law, the question of ownership will be governed by the local laws where the oil is stored and ultimately where a local court order might be needed to enforce any security over the oil. If ownership of a portion of commingled oil is not recognised under local laws, a trader’s/financier’s ability to sell it or take security over it, will be in jeopardy. The robustness of the trader’s title to the oil is particularly relevant in the insolvency of the terminal operator whose liquidators may make competing claims to the oil or when a financier seeks to exercise its security interests over the financed oil which compete with other claims from the unfinanced portion.
Pledge over stored oil
Apart from ascertaining title to the stored oil, there are a number of further factors to consider when giving or taking security over stored oil. A common form of security taken over stored commodities is a pledge. Singapore and English law provide for a common law pledge, which entails a transfer of possession of the relevant commodities from the pledgor to the pledgee, with the pledgee getting the right to sell the goods in the event of default. Often, what is transferred is constructive possession by way of an “attornment”, i.e., an acknowledgement from the person holding the goods (i.e, the tank operator) that the goods are being held on behalf of the pledgee. Tank certificates should be carefully examined that they go further than just acknowledging receipt of a certain volume of oil and expressly attorn that such oil is being held for the benefit of the pledgee. The attornment must be directly from the operator physically holding the oil rather than the trader who has deposited the oil in the tanks.
While Singapore and England do not have statutory pledges or require registration of pledges, a number of jurisdictions allow for creation of statutory pledges with varying requirements as to possession, control and registration of the pledged assets. The form of security that can be taken in the jurisdiction where the oil is stored should be carefully considered along with the requirements they prescribe as to the level of possession or control required. Some questions to be considered in deciding the appropriate form of security, apart from the key question of whether a pledge can be taken over commingled oil include:
- must the tank operator take instructions from the pledgee in relation to all the in/outflows from the storage tanks (regardless of whether the flows concern the pledged oil or not),
- must the tank operator attorn to the financier in relation to the pledged oil and/or every time there is any inflow or outflow of any oil at all (or of the pledged oil) from the tanks,
- does the pledge need to be updated, notarised and/or registered every time there is any inflow or outflow of any new parcel of oil at all (or of the pledged oil) from the tanks?
These issues should be discussed with local counsel to minimize risk and ensure smooth enforcement.
Dealings with tank operators
Since stored oil is physically in the control of the operator, due diligence on the operator (including in particular on its storage practices, reporting and updating customers on the inflows / outflows / quantity of stored oil at a given time, any prior litigation or disputes, risk of contamination, theft or fraud, insolvency risk) is critical. Real time reports on the status of stored oil would be ideal from the perspective of a trader or its financier, but not many storage facilities offer such services as yet. Among the few storage facilities offering such services is the Jurong Port in Singapore, which has terminal facilities operated and controlled by an integrated Supervisory Control and Data Acquisition (SCADA) system to closely monitor all tanks and systems around the clock. The SCADA system can access real-time data and efficiently keep track of (among other things) product transfers and tank levels. Real time data on the quantity of oil in tanks at any given time can be a very useful tool for traders and financiers seeking transparency over the status of their stored oil and prevent minimize the scenario of competing claims on the same oil.
The terms of any storage agreement between the operator and the trader must be reviewed closely. It is important for financiers to review the storage agreement as well in particular for any rights it may purport to give to the operator in relation to the stored oil, which may undermine the financer’s security interest, e.g., the right to apply to sell the oil if the storage fees remain unpaid. Such questions of the operator’s rights over the stored oil can become acute in the case of its insolvency, with its liquidator seeking recovery from its assets. To the extent possible, a financier should also negotiate an obligation for the operator to follow its exclusive instructions in relation to the financed goods, and to inspect the financed stocks from time to time, and to receive notice if any amounts under the storage agreement are unpaid.
