Another new era? The Progressing Partnership Working Group reports

The two final reports of the Progressing Partnership Working Group (set up under the auspices of PILOT to address commercial barriers to United Kingdom Continental Shelf (UKCS) development) were presented to a great fanfare last week by UKOOA. The Energy Minister himself, Brian Wilson, was there to give his support. If accepted whole-heartedly by the industry, the recommendations of the Operators' Group and the Contractors' Group could mean some radical changes to legal and commercial practices in the sector.

What do the PPWG proposals mean for the future of the industry?

Among the topics addressed by the Operators' Group were:

• Licence holding
• Licensees' Code of Practice on Improving Commercial Effectiveness
• Pre-Emption Rights
• Decommissioning Provisions
• Availability of Technical Data
• Standardisation of Agreements
• Access to Infrastructure

Licence holding

A major issue for the UKCS is the number of fallow fields and discoveries where no work has been carried out for a number of years. In order to end this stagnation, the recommendations from the Operators include:

• Changes to standard licence terms – under the most recently granted licences terms are 3-6-15 years. Coupled with limited work obligations beyond the initial term, low licence rentals and limited requirements to relinquish after the first two terms this provides little incentive to explore and develop. The group recommended that future licences should (except in frontier areas) take the form of 4-4-18 years with 50 percent relinquishment after the first term and relinquishment of all areas without a firm development plan at the end of the second term.
• Fallow blocks – A detailed voluntary process to encourage activity on fallow blocks is proposed. If there has been inactivity for 4 years, a 15 month "activity or drop" scheme will be invoked under which, if no commitment is made to activity, the licence will be relinquished and the block re-licensed by the DTI. This voluntary scheme will be underpinned by the ultimate sanction of the DTI invoking its statutory powers to require activity.
• Fallow discoveries – A similar scheme but with a longer time frame of 27 months has been recommended for fallow discoveries.

Likely consequences:

• Although "use it or lose it" provisions exist under the current regime they are not as immediate as the new proposals. Companies may therefore in future think twice about applying for licences unless they are committed to early exploration in those areas – otherwise they will be obliged to relinquish without knowing what it is they are giving up;
• The fallow fields and fallow discoveries proposals are likely to lead to a flurry of exploration/development activity or increased trading of licence interests.

Licensees' Code of Practice on Improving Commercial Effectiveness

The Operators' Group felt that the commercial culture of the industry had developed in a time of a small number of major projects and that more flexible and less formal procedures were needed to cope with the variety and volume of transactions likely to occur in the UKCS of the future. Specific problems identified include an adversarial approach designed to extract maximum value, complex commercial agreements and misalignment of values within partner groups.

The proposed solution is a voluntary Code of Practice, to be endorsed by the DTI and senior management of UKCS operators, under which operators will be encouraged to adopt best practice with a view to achieving "win-win" solutions.

The full code has yet to be launched but the short form version recommends adoption of the following best practice approaches:

• establish an agreed timetable to completion
• adopt flexible methods and "fit for purpose" solutions
• maximise the use of standard form agreements
• comply with codes of conduct
• ensure personal issues do not become a barrier to progress
• conduct post-activity audit and analysis.

Many operators would no doubt claim that they already apply these processes in their commercial operations – but most of us will have experienced exceptions. In particular, the commitments required from senior management will strike a chord with many at the "sharp end" of deal making: senior management are required to commit to:

• continuous process monitoring
• the allocation of appropriate resources
• empowerment of staff to commit the company to commercial terms at appropriate levels of materiality;
• ensuring materiality differences do not become a barrier – e.g. where one company regards the transaction as too small to devote resource to;
• ensuring that commercial tactics such as use of blocking votes, linking unrelated deals and allowing approval periods to expire are not used as a negotiating tactic;
• adopting a stand-aside approach to allow other parties to conduct activities rather than blocking and delaying.

Inclusion of the Code of Practice in initial documentation may perhaps make it more difficult for the exceptions to persist.

Technical Data

The UKCS is rather slower in its release of technical data than other sectors and the PPWG is seeking to accelerate this process. This will however require further work by the Stimulating Exploration Work Group.

Pre-emption

The exercise of pre-emption rights in JOAs was identified as a barrier to new entry into the market for licence interests. Although it was recognised that pre-emption is not inherently bad and can arise from valid commercial considerations, the factors which caused particular difficulty for new entrants were:

• parties with pre-emption rights often do not make their intentions clear until late in the process, creating uncertainty;
• some existing provisions require a fully termed sale and purchase agreement before the rights come into play, which means that new entrants must incur considerable time and expense before knowing if pre-emption will occur;
• some provisions provide extended periods for exercise of rights, prolonging the whole process.

The conclusions of the Operators' Group were:

• the DTI's original proposal concerning future JOAs was accepted. Pre-emption provisions would not be accepted other than in special and justified circumstances and preference may be given to applicants without such provisions – this proposal was discussed in LawNow at [http://www.law-now.com/Law-Now/press.cfm?id=3987];
• so far as existing JOAs are concerned, the Operators Group propose a cross-industry agreement which will effectively remove existing pre-emption provisions from all existing JOAs and replace them with a standard clause which provides for the following process:
  • a licensee wishing to sell will notify co-licensees, who will then have 7 working days to reserve pre-emption rights;
  • the licensee may negotiate simultaneously with any third party and any co-licensees who have reserved rights;
  • if negotiations with any party are successful, the licensee will notify all co-licensees of the key terms and the identity of the proposed purchaser. Co-licensees who reserved rights will have 30 days to notify the licensee that they intend to exercise those rights;
  • pre-emption rights will apply only to transactions for cash or where the cash value can be clearly determined.

The cross-industry agreement will also introduce a standard procedure for notification and assignment to avoid time spent in obtaining consent to assignment. An ambitious timetable of having the cross-industry agreement signed by 31st March 2002 has been set out.

Likely consequences:

• It is has been suggested that some oil companies might find that the requirement for new JOAs to exclude pre-emption might put them off entering into new JOAs, because they will be unable to control or influence who buys into the licence. On balance this is unlikely to be the determining factor in such decisions;
• The market in the sale of licence interests may become more liquid over time;
• Pre-emption will continue in existing JOAs and this legacy may mean that it will take some time for new entrants to make any inroads into the market. On the other hand companies are likely to test the process to establish how easily pre-emption rights can be disapplied and the industry may experience a period of uncertainty until the process has become established;
• The impact on the timetable for assignment of interests under these legacy JOAs may be shortened but perhaps not significantly. The proposal for standard terms states that pre-emption rights may be exercised only once "negotiations with any party are successful" and that the licensee must notify all co-licensees of the "key terms". In order to reach this stage, the potential purchaser is likely to have conducted full due diligence so this stage of the process will not be shortened. The conditional period will not now be extended by the need to allow partners up to 90 (sometimes more) days to exercise their rights – they will have only 30 days – but other conditions will still need to be satisfied, for instance the obtaining of DTI consent.
• There are likely to be more new entrants who are likely to be looked at closely by the DTI and it may be that financial security arrangements for decommissioning may be required more often in the future.

Decommissioning

The requirement for present and prospective licensees to provide financial security for future decommissioning obligations in certain circumstances proved a particularly difficult obstacle for the Operators' Group. The DTI is empowered to require such security when concerned that the participants in a licence may not have the financial strength to carry out their joint and several liabilities in relation to decommissioning. So far the DTI has required security in 7 cases and a number of other arrangements have been made by co-venturers themselves under JOAs.

An industry steering group which met during 1999/2000 considered a number of options (including reducing the credit rating of the security provider, finding alternative security providers, a mutual guarantee fund for companies with stakes in a wide range of joint ventures, a self-guarantee scheme or a sinking fund) and these options were taken up and pursued under the PPWG. However, no ideal solution has yet emerged and a working group has been established to consider the matter further.

Infrastructure Access

This issue is being pursued in the context of the ongoing consultation exercise around the DTI's Infrastructure Code of Practice and related guidance. The PPWG intends to continue to meet to consider the way forward in this area.

Standardisation of Agreements

A number of standard agreements already exist within the industry, developed by a Working Group under the OGITF and these appear to be used routinely or occasionally by most companies. A subgroup of the PPWG is continuing to work on standard templates for a Sale and Purchase Agreement and for a JOA for possible use during the 20th Licensing Round.

The Contractors' Recommendations

The Contractors' Report focussed on a Code of Practice for Supply Chain Partnership although it intends to continue work and provide further recommendations in relation to encouraging the take up of new technology and promoting the UK as a regional hub for supply chain activities.

The Contractors' Report identifies the need, faced with smaller, more marginal fields, high development costs and competition for investment from other parts of the world, for the UKCS industry to streamline commercial relationships. Its recommendation is for a Code of Practice endorsed by senior management and the DTI and backed up by internal incentives and penalties and an external monitoring system.

The Code of Practice would require:

• more transparency in planning of commercial activity by operators including systematic publication of aggregated and individual data on plans for activity;
• use of FPAL as the only generic pre-qualification required in order to reduce costs;
• commitment to shorter tender turn-around times with completion timetable in all tenders;
• specifying award criteria up front in all tenders, including identification of project drivers to enable contractors to identify scope for adding value;
• commitment to providing detailed feedback on all unsuccessful bids;
• use of standard contracts (company's own standards or LOGIC (formerly CRINE) standards) and additional clauses kept to a minimum;
• prompt payment terms of 30 days and compliance with these terms;
• inclusion of KPI's and regular review mechanism in all material contracts;
• provision of robust feedback on completed contracts including use of the FPAL feedback process;
• internal monitoring by Supply Chain Champions of performance against the Code, DTI publication of aggregated industry performance and pan-industry sharing of best practice.

Conclusion

It still remains to be seen whether these recommendations signal a major shift in the commercial culture of the UKCS.

For further information please contact Bob Palmer at [email protected] or on +44 (0)20 7367 3656, Penelope Warne at [email protected] or on +44 (0) 1224 622002 or Judith Aldersey-Williams at [email protected] or on +44 (0)1224 622002.