In most offshore drilling contracts, the contractor has a far-reaching obligation to comply with the oil company’s
variation orders. The obligation is however not without limitations. The oil company’s right to issue variation orders was considered in a recent judgment by Stavanger city court in a dispute between Mærsk and Statoil.

As discussed below, the recent case of Mærsk vs. Statoil is however an example of the opposite, i.e. that the oil company or operator’s right to give instructions and issue variation orders was not exceeded.

THE NEED FOR FLEXIBILITY

The right to vary the scope of work is well-established in the offshore sector, and there are good reasons why the opera-tor’s rights must be wide. Drilling (and production) contracts are often entered into well in advance of the commencement date under the contract, and the contract periods are often long. It will generally be difficult for the operator to foresee all aspects of the employment and use of a drilling unit when a drilling contract is entered into, and full information about the reservoir and other geographical conditions may not yet be available. There is therefore a genuine need for flexibility to vary the scope of work during the contract period, including by modifying the drilling unit, to fulfil the contract’s intended purpose.

This need for flexibility is the backdrop for variation clauses, such as the clause in the Statoil contract in the Mærsk v. Statoil case, which reads:

“Company has the right to order such Variations to the Work, which in Company’s opinion are desirable and which are not held to be unreasonable”

This clause is in line with the clauses commonly found in drilling contracts on the Norwegian continental shelf, including the Norwegian standard contract, Norsk Fabrikasjonskontrakt 2005 (the “NF 05”). NF05 does not contain the “unreasonable” limitation, but a similar limitation follows from general Norwegian contract law principles.

If the contractor receives a variation order that falls within the contract’s variation order regime, the contractor will normally be obliged to carry out the variation, regardless of whether the time and cost consequences of the variation have been agreed. This is often referred to as the
contractor’s “jump duty”. More sophisticated contracts may provide for specific dispute resolution mechanisms in the event of disputes regarding variation orders. However, under some contracts, the contractor’s only option may be to initiate legal proceedings against the operator if the parties disagree on whether the variation order is justified, or whether the compensation offered is adequate. This can, for obvious reasons, be very difficult.

LIMITATIONS ON THE RIGHT TO ISSUE VARIATION ORDERS

As evident from the above, variation clauses are generally widely drafted. The question then arises whether limitations can be construed into the contract pursuant to the background law, to restrict the operator’s right to make changes.  Under Norwegian law, there are in principle two main limitations on the operator’s right to make changes. The first limitation is that the operator is not entitled to change contract terms as such. The operator cannot, by using the variation order regime, shift the risk and liability allocation of the contract. Secondly, a general limitation must be interpreted into the contract to the effect that variations cannot extend beyond what was reasonably anticipated by the parties when entering into the contract, which principle was invoked in the Mærsk vs. Statoil case. There is how-ever, a very high threshold for arguing that a contract provision or variation order is “unreasonable” between commercial parties.

THE MÆRSK VS. STATOIL CASE

The facts of the aforementioned case are as follows. In 2005, after years of negotiations, the drilling and production unit “Mærsk Inspirer” was contracted by Statoil for operations on the “Volve” field on the Norwegian continental shelf. The contract was for a period of ten years, and payment rates were set out for the various types of work to be performed during the contract
period. The scope of work had a brief description of a base case that included eight wells, but the contract also stated that Mærsk had to prepare the unit for tie-in of five additional wells. The contract was silent with respect to whether the original eight wells were to be drilled in one or several drilling campaigns.

After completing the original eight wells during the period between 2007 and 2009, the unit went into a production phase and most of the drilling crew were demobilised. In 2012, Statoil instructed Mærsk to drill additional wells (under the contract’s original scope of work, and not pursuant to a variation order) and also issued a variation order to carry out top-side modifications to enable the unit to perform the requested drilling services.

Mærsk contested Statoil’s right to make the instruction, arguing that the drilling of additional wells fell outside the scope of work and that a variation order was required. Mærsk further argued that such variation order, together with the variation order for the topside, would extend the duration of the con-tract period and cause Mærsk to suffer losses, and consequently that these variations should be considered “unreasonable”.  Statoil on the other hand argued that the instruction to drill the additional wells was within the original scope of work, and did not require a variation order. As for the topside modifications, this work required a variation order, but the variation order could not be considered unreasonable.

The Stavanger city court ruled in favour of Statoil. In the court’s opinion, the drilling of the additional wells fell within the original scope of work, taking into consideration inter alia that the contract explicitly included preparations for tie-in of an additional five wells. This obligation
would be without real content if these additional wells were not included in the contract. The court also took into consideration that the purpose of the contract was to exploit all of the resources on the “Volve” field, and that the “Mærsk Inspirer” was the only unit that could drill the wells as long as the unit was stationed and producing on the field. It was also acknowledged by the court that these changes are common in drilling operations, and that on many North Sea fields, the production phase has turned out to last longer than originally envisaged.

With regards to the topside modifications, the court did not agree with Mærsk that this variation order was unreasonable. When determining this issue, the court considered the scope of the modification work and its close connection to other work that was included in the scope of work. The purpose of the modifications, to allow the rig to produce oil from the new wells, was also
a factor that made it hard to say that the variation order was unreasonable.

SUMMARY

As recognised by the court, the only factor that supported an argument that the variation order was unreasonable, was the negative financial consequences for Mærsk. By 2012, the contract had turned out to be commercially disadvantageous to Mærsk due to inter alia market changes, and even before the new instructions and the variation order, Mærsk reportedly lost money on the contract. With the modifications and the increased scope of work, the losses would be even greater. However, between large, commercial parties the threshold for considering a variation order unreasonable due to its adverse financial consequences is very high.

This judgment is only from the court of first instance, and thus has limited weight. However as we rarely see drilling contract disputes in Norwegian courts, the case has attracted lots of interest. Mærsk has appealed the judgment to Gulating Court of Appeal.