Liability generally for decommissioning offshore infrastructure
One of the conditions on which offshore petroleum production licences are granted in the UK is a requirement that, once production comes to an end, all infrastructure that has been installed to produce oil and gas from the licence area must be fully decommissioned. Subject to a few exceptions, that requires its complete removal. That can be a very costly exercise and due to the legislative regime in the UK, various parties are potentially liable for the costs of that decommissioning – this includes the owners of the infrastructure, historic owners and may even extend to their respective affiliates. Subject to any special arrangements which may have been put in place between the parties concerned, the current owners of the infrastructure at the time of decommissioning will usually pay the costs of such decommissioning in line with their normal joint venture billings – in the same way they will have met the operational costs throughout the life of the asset – and historic owners will not be required to contribute to those costs. However, since the most significant decommissioning costs will arise only after production has ceased, those decommissioning costs will fall due to be paid when there is no (or limited) cash flow from the asset and therefore the risk of a particular owner being able to meet its share of those decommissioning costs is, at least in theory, increased. If that happens, then the liability to meet those costs will fall on the other current owners and potentially also on the historic owners, whose interest in the particular asset may have come to an end many years previously, and who may have only benefited to a very limited extent from the production phase.
Decommissioning Security Agreements
As a result, it is now industry practice for all of the parties with potential liability to seek security for those costs of decommissioning from the current owners, by means of entering into a decommissioning security agreements (DSA) – that agreement provides for security for future decommissioning costs to be paid by current owners during the production phase of the asset in respect of the anticipated future decommissioning of offshore installations and infrastructure that will be necessary at the end of their productive life.
OEUK DSA templates
In order to provide for a standardised approach to the provision of security, Offshore Energies UK (OEUK) has published two template DSAs; one for use in relation to PRT (Petroleum Revenue Tax) paying fields (the PRT DSA) and another one for all other circumstances (the non-PRT DSA) - collectively referred to as the OEUK DSA for ease of reference. A combination of the publication of the Decommissioning Relief Deeds in 2013 (see our Law-Now article here) and the introduction of the Oil & Gas Authority (now North Sea Transition Authority) in 2016 (which has sought to encourage the agreement of decommissioning security arrangements for all existing offshore installations) has resulted in wide-spread use of these agreements across the industry.
All current owners and historic owners (who have been served with section 29 notices) will usually be party to the OEUK DSA, which means that the security posted can then be drawn on by those who may be required to step in in the event that one of the current owners fails to pay its share. Current owners are generally referred to as “Licensees”; historic owners are “Second Tier Participants” and each group has slightly different rights and obligations in terms of the OEUK DSA – broadly speaking the Licensees have a more active role in the arrangements, with the Second Tier Participants afforded a “watching brief” along with certain rights so that they can take steps to ensure that the security in place is sufficient to protect their potential exposure. The OEUK DSA also provides an option for others with potential liability for decommissioning “at-law” to be listed as “Third Tier Participants”. If included in the relevant agreement, Third Tier Participants will not be a direct party and therefore have no monitoring rights or involvement in the processes set out in the DSA but will be a beneficiary of the security provided thereunder.
Over the coming months we will be taking a detailed look at certain aspects of the OEUK DSA in line with the process timeline that it sets out for calculating, agreeing or determining, and providing the appropriate level of security for a particular asset.
In this article we consider the first step envisaged by the OEUK DSA, namely the preparation of a proposed plan estimating the future costs of decommissioning, the steps for its approval and other relevant points. Capitalised terms used in this article which are not otherwise defined have the meaning as given in the OEUK DSA, and clause references are to clauses of the OEUK DSA.
The OEUK DSA provides in Clause 4 the obligation for the Operator to prepare a plan (the “Proposed Plan”) setting out certain information regarding anticipated decommissioning arrangements and costs, and provide this to the other parties to the DSA by a specific date each year. The ‘default’ date in the OEUK DSA template is 30 June but parties may elect to move the timing. The obligation on the Operator to prepare a Proposed Plan begins with the year (or prior to the year) in which the Operator estimates the Run-Down Period is likely to commence. The Run-Down Period commences, broadly speaking, when the net cost of expected decommissioning exceeds the likely remaining value in the field.
The Proposed Plan shall include a proposed decommissioning schedule and budget, which must include the following information:
- geological or reservoir review of the relevant field;
- estimate of the dates on which decommissioning will begin and finish;
- estimate of the highest Net Cost during the immediately following year (such immediately following year being the "Relevant Year");
- estimate of the lowest Net Value during the Relevant Year;
- estimate of the date on which the Trigger Date will be reached;
- all other matters relevant to the proper preparation for and management of decommissioning, including but not limited to:
- decommissioning options;
- alternative uses for the relevant field property;
- an assessment of eligibility for derogation from removal obligations; and
- the salvage value of relevant field property where it cannot be reused.
In order to prepare the Proposed Plan, the Operator is required to apply a set of assumptions in its assessment of the constituent elements of the calculation of Decommissioning Costs which in turn determines the amount of security that is to be posted by the current owners. The key constituent elements in this regard are the Net Cost, Net Value and “TR” - the amount of tax relief for each relevant licensee for the purpose of the security calculation. In the absence of bespoke agreement on particular assumptions by the Parties, the assumptions provided in Appendix 5 of the OEUK DSA are used by the Operator, to determine (for example) the rate of inflation, the appropriate currency conversion rates and the future market prices of crude oil and natural gas that will require to be included in the Operator’s calculations.
The assumptions set out in Appendix 5 of the OEUK DSA cover the following:
- Cash flows
- No double counting
- Tax assumptions
- Calculation of TR
- Operating assumptions (this includes crude oil and natural gas prices, among others)
As a result of the impact of increased rates of inflation on these calculations, leading to significant increases in the amount of security that required to be posted across the basin, in April 2023, OEUK released a Guidance Note on Inflation and Discounting, suggesting some amendments to DSAs (including Article 3 of Appendix 5 in relation to inflation) to align the basis of revenue and cost inflation and discounting. As stated in the Guidance Note, the revisions are advisory in nature and it is left for each group of DSA parties to consider the merits and risks of adopting the suggested changes.
From Proposed Plan to Decommissioning Plan
Under the OEUK DSA template, the Proposed Plan requires unanimous approval although the template provides optionality as to whether the Proposed Plan should be approved by Licensees only, or by all Parties (and as to whether that approval right includes Second Tier Participants, or whether they are permitted alternatively to provide written recommendations in response to the Proposed Plan).
The approving parties have an initial 60-day period from the date the Proposed Plan is submitted by the Operator to raise any objections. If no objections are received within that period, the Proposed Plan is deemed approved and becomes the Decommissioning Plan for the Relevant Year (e.g., by the 29th of August).
If the Parties have any objections, they shall meet promptly to discuss them and attempt to reach an amicable resolution. If no amicable resolution has been reached within ninety (90) days of submission of the Proposed Plan by the Operator, an Objecting Party shall be entitled to refer the matter for Expert determination (e.g., by the 29th of September).
Calculation of Security – the “Provision Amount”
The purpose of reaching an agreed Decommissioning Plan is to enable the Operator to calculate each Licensee’s share of the cost of Decommissioning in accordance with the formulae included in Clause 6 of the OEUK DSA on a pre-tax and post-tax basis in order to determining the amount of security to be provided by each Licensee (the “Provision Amount”).
If by 1 October, the Decommissioning Plan for the Relevant Year has yet to be approved or deemed approved under Clause 4, the Operator shall issue a Provision Invoice to each Licensee based on its Proposed Plan for the Relevant Year.
The output of the calculations must be provided to each Licensee and a “Provision Invoice” shall be issued by 1 October prior to the Relevant Year.
Payment of Provision Amount
Under the OEUK DSA, by 1 November in the year prior to the Relevant Year, each Licensee is required to make payment of the Provision Invoice to an independent trustee (usually The Law Debenture Trust Corporation plc.) to be held under a Trust Deed that the DSA requires is entered into by each Licensee. In practice the security is often not provided by way of a cash payment, but where it is, the calculation of the Provision Amount will take account of any cash already held by the Trustee.
As an alternative to paying the Provision Amount in cash, Licensees are entitled to make Alternative Provision to the relevant trustee in an amount equal to the Provision Amount in any of the following ways:
- letter of credit from single issuing bank;
- letter of credit from consortium of banks;
- parent company or affiliate guarantee;
- on-demand payment bond from a bank or a parent company or affiliate;
- a combination of the above.
An indicative timeline based on the dates set out in the OEUK DSA identifying the points set out above is as follows:
Future Law-Now articles in this series will consider key aspects of the OEUK DSA arrangements in more detail, such as the expert referral process, notice requirements and forms of security. We will also consider broader potential implications of these arrangements, such as events of default, interaction with the relevant field operating agreements with respect to default and payment of decommissioning costs, as well as looking more widely at how other jurisdictions are addressing the question of how the costs of decommissioning are met.