OEUK DSA – Calculation and Payment of Licensee’s share of Decommissioning Costs

Parties to decommissioning security agreements are likely to be entering into an important phase of the typical process contained in these agreements. This year in particular, due to high inflation (and even with recent guidance released by Offshore Energies UK relating to inflation and discounting in relation to Net Value and Net Cost calculations), the calculations run are likely to have resulted in increased amounts needed to be secured. This Law-Now article focuses on the payment of these amounts and the alternative to paying these amounts in cash, all under the OEUK template PRT and Non-PRT Decommissioning Security Agreements (the “OEUK DSA”^[1]).

Licensees’ obligations to pay their respective shares of the estimated costs of decommissioning (i.e. the relevant Licensee’s Provision Amount) or make alternative provision (i.e. place a letter of credit, bond, guarantee or other agreed form of quasi-security into trust) for those amounts are triggered by the Operator advising the Licensees of the Provision Amounts and issuing a Provision Invoice to each Licensee whose Provision Amount is a positive number. These obligations are generally contained in clauses 6 and 7 of the OEUK DSA and the timeline that is suggested by the OEUK DSA requires the Provision Invoices to be issued by no later than 1 October in any Year prior to a Relevant Year (i.e. the calendar year during which the Licensees will incur costs in respect of Decommissioning).

Small changes in approach can have significant consequences to the total estimate that is produced.  Since a failure to pay a Provision Invoice is a default under the DSA and a cross-default under the relevant Joint Operating Agreement, it is important that these amounts are calculated properly and in accordance with the terms of the parties’ agreement. 

Calculation of the Provision Amount

Clause 6 of the OEUK DSA provides that the Operator calculates the Provision Amounts on the Pre-Tax Basis and the Post-Tax Basis. The Post-Tax Basis is used because Licensees are, under current legislation and as a result of the Decommissioning Relief Deed, expected to benefit from tax relief on decommissioning spending (and are therefore generally comfortable with each other providing cash or security on a post-tax basis). However the Pre-Tax Basis is used also because there is the potential for this tax position to change (see clause 2 on adverse tax events).

• X is the Licensee’s share of the decommissioning costs as provided in the Decommissioning Plan or Proposed Plan for the Relevant Year (see our Law Now regarding the preparation and issuance of the Proposed Plan by the Operator).
• Y is the risk (i.e. contingency) factor. This factor is agreed in the DSA itself and is usually a number greater than one. The OEUK DSA includes optional language allowing two risk factors to be agreed, with one applying until approval of the Statutory Decommissioning Programme for the relevant field (the Initial Run-Down Period) and the other applying from approval of that programme until 12 months after its completion (the Later Run-Down Period). Parties will tend to agree a lower risk factor for the Later Run-Down Period on the basis that once there is an approved Statutory Decommissioning Programme there will be more certainty over the decommissioning work that will have to be performed and the costs of doing so.
• Z is the Licensee’s share of the estimated Net Value as provided in the Decommissioning Plan or Proposed Plan for the Relevant Year. As provided in the OEUK DSA formulae above, the question of whether to deduct “Z” from the calculation will have been considered by the parties at the time that the DSA is entered into, and is one of whether the value of a party’s interest in the relevant field can be taken into account as (effectively) part of their security.
• F is the amount of any existing provision already provided by the Licensee. The calculation therefore takes account of any cash or alternative security already held by the Trustee from that Licensee which will not expire at the end of the current Relevant Year and so will continue to apply throughout the next Relevant Year, such as evergreen guarantees.  Where there is such continuing security, a Licensee will only be required to post a ‘top up’ amount of additional security.
• TR is the amount of tax relief for each Licensee. TR is calculated only in relation to that part of the estimated costs for which there is (i) any reduction in Tax liability or any Tax repayment which results (or is expected to result) from incurring Decommissioning Expenditure, or (ii) a payment pursuant to a Decommissioning Relief Deed (in the model form published by the Government Counterparty in November 2013).  It will be bespoke for each Licensee, rather than calculated at a joint venture level.
• TR_RFCT&SC / TR_PRT is the allowed Ring Fence Corporation Tax and Supplementary Charge Relief or PRT Relief calculated in accordance with paragraph 6 of Appendix 5.  There are two options provided in paragraph 6 of Appendix 5 for calculating PRT Relief: Option A1 is a precise calculation based on the PRT Certificates issued by HMRC and Option A2 is a calculation which assumes a standard rate for all licensees, Option A1 is the ‘default’ option and so will be used unless the parties unanimously agree to use Option A2. Each of TR_RFCT&SC / TR_PRT are multiplied by a factor intended to reflect the average period which is expected to accrue between the expenditure being incurred and the receipt of the relief payment from Government, which in the case of TR_RFCT&SC is nine months and in the case of TR_PRT is eight months.
• RBridge is an annual rate of bridging finance equal to SONIA Compounded in Arrears plus an agreed percentage points figure. The use of SONIA Compounded in Arrears was adopted by the OEUK DSA in November 2021, prior to which LIBOR was used. DSAs entered into prior to November 2021 therefore tended to use LIBOR and may not have been updated to SONIA Compounded in Arrears.

Payment of Provision Amount

Each Licensee whose Provision Amount is a positive number is required to pay its Provision Invoice in full by no later than the due date for that invoice - under the OEUK DSA template, the suggested date of issue of the Provision Invoice is 1 October in the year prior to the Relevant Year, so that payment of the Provision Amount (or Alternative Provision) is due by 1 November in that Year.

The cash payment is held by the Trustee under the Trust Deed executed by the relevant Licensee. The Operator is responsible for, among other things, notifying all Parties when payment of any Provision Invoice is due (or overdue).

If, however, the Provision Amount is a smaller positive amount than the immediately previous Provision Amount, no further cash is required to be paid and there is a mechanism for surplus cash to be returned to the relevant Licensee.

Alternative Provision

As an alternative to making cash payment of the Provision Amount, Licensees are entitled to make an Alternative Provision to the relevant Trustee.

The OEUK DSA suggests the following ways (whether alone or as a combination):

1. Irrevocable letter(s) of credit issued by the UK branch or lending office of a Bank (or consortium of banks) which are Qualifying Sureties. Parts 1 and 2 of Appendix 3 of the OEUK DSA contain suggested forms of letters of credit. Their key features are:
   1. the Bank agreeing to pay, up to a maximum amount of the relevant Provision Amount, the amount demanded in any demand notice;
   2. the demand notice should not require the Trustee to prove any failure by the Licensee to pay under the DSA; and
   3. incorporation of appropriate industry rules relating to letters of credit (such as the ICC Uniform Customs and Practice for Documentary Credits).
2. Irrevocable, unconditional on demand payment bond from the UK branch of a Qualifying Surety (other than the Licensee or an Affiliate) accompanied by Counsel’s Opinion (i.e.  a legal opinion from an independent law firm or legal practitioner in the form set out in Appendix 6). The OEUK DSA does not include a suggested form of bond (whether issued by the Licensee itself or an Affiliate (see 3 below) or the UK branch of a third party Qualifying Surety). Common key features of a DSA bond include:
   1. the issuer irrevocably and unconditionally agreeing to pay on receipt of a valid demand notice the amount demanded in the demand notice up to a maximum amount of the relevant Provision Amount;
   2. the demand notice should not require the Trustee to prove any failure by the Licensee to pay under the DSA; and
   3. incorporation of appropriate industry rules relating to bonds (such as the ICC Uniform Rules for Demand Guarantees).
3. Irrevocable, unconditional on demand payment bond from an affiliate of the Licensee or by the Licensee itself which is a Qualifying Surety and accompanied by Counsel’s Opinion. The common key features of a bond are the same as those summarised at 2 above; and
4. Guarantee from the ultimate holding company / an Affiliate of the Licensee which is a Qualifying Surety and accompanied by Counsel’s Opinion. The form of guarantee should be agreed between the parties – the OEUK DSA does not contain a suggested form. Common key features of a DSA guarantee include:
   1. the guarantor guaranteeing for the benefit of the Trustee the payment obligations of the Licensee under the DSA;
   2. a form of demand that does not require the Trustee to prove any failure by the Licensee to pay under the DSA; and
   3. a robust list of events that will not discharge the liability of the guarantor.

In our experience, all of these forms of Alternative Provision are routinely included as options in a DSA used in respect of the UK Continental Shelf, and most Licensee’s choose to make Alternative Provision in respect of their Provision Amount, as it means that it is not necessary to tie up potentially significant amounts of funds as security.  It is sometimes convenient for other reasons to pay a particular Provision Invoice in cash. For example, parties acquiring an interest in the field (whether as part of an asset acquisition or a corporate acquisition) to which an existing DSA relates sometimes choose to pay the then current Provision Invoice in cash to simplify completion of the acquisition (and to avoid paying cash for cash as part of the acquisition). The acquiring party may then choose to make Alternative Provision for future Relevant Years and have returned to it the cash previously paid to the Trustee.

The OEUK DSA also allows other such other forms of provision as may be agreed between the parties from time to time. An insurance bond is one such other form of provision which parties are often willing to agree to.  

A “Qualifying Surety” is a Bank (or, if the parties choose to include optional wording, a company or corporation) which has a minimum corporate credit rating agreed between the parties. The OEUK DSA includes as optional wording, a corporate credit rating of at least AA- from Standard & Poor’s or Aa3 from Moody’s. These ratings are no longer widely used and are generally viewed by the market as being unnecessarily high following the general downward trend of credit ratings over the past ten to fifteen years. However, these are only suggestions and parties often have their own ‘corporate policy’ minimum acceptable ratings.  We more commonly see A- (Standard & Poor’s) and A3 (Moody’s).

If the parties agree to an insurance bond being an acceptable form of Alternative Provision, it is usually necessary to amend this definition to allow insurance companies to be Qualifying Sureties. The insurance industry adopts specific ratings (rather than corporate credit ratings) that also need to be reflected in the Qualifying Surety definition.

Parties sometimes agree to add flexibility to the Alternative Provision clauses by, for example:

• only requiring Counsel’s Opinion where the issuer of the relevant Alternative Provision is not incorporated in the United Kingdom; and
• allowing any Licensee at any point during a Relevant Year to change the method of Alternative Provision by which it provides the Provision Amount, or to pay the Provision Amount in cash.

Provision Invoice / Provision Amount when Decommissioning Plan is not approved

The Proposed Plan approval and objections process timeline (see our Law-Now regarding the approval / submission of objections to it by the parties) and the fixed date for issuing and paying (or providing Alternative Provision for) the Provision Invoices creates a risk that the Decommissioning Plan is not approved by the time the Operator is obliged to issue Provision Invoices.

The OEUK DSA caters for this situation by providing that where the Decommissioning Plan has yet to be approved or deemed approved the Provision Invoice is issued by the Operator based on its Proposed Plan for the Relevant Year. Where the Provision Invoice has been issued based on the Operator’s Proposed Plan and the Provision Amount as calculated under the Decommissioning Plan is greater than that calculated under the Proposed Plan, the Operator issues a supplemental Provision Invoice for the balance at the point where the Decommissioning Plan for the Relevant Year is determined (usually by expert if the parties have been unable to agree). The Licensee then either: (i) makes payment to the Trustee of the balance to be held under the Trust Deed, or (ii) provides Alternative Provision. Such supplemental Provision Invoices are to be paid within 15 Business Days.

Where the Provision Invoice has been issued based on the Operator’s Proposed Plan and the Provision Amount as calculated under the Decommissioning Plan is less than that calculated under the Proposed Plan, the Operator must serve a Type VI Notice on the Trustee requiring the Trustee to refund the difference to each Licensee (if the relevant Provision Invoice was paid in cash), or return the previous Alternative Provision to such Licensee (or such other nominated person) for cancellation on receipt of the reduced Alternative Provision (if Alternative Provision was made in respect of the relevant Provision Invoice and reduced Alternative Provision is provided).

Current common issues

We mentioned above that OEUK has recently (in April 2023) issued guidance relating to inflation and discounting methodologies in Net Value and Net Cost calculations. This guidance was issued in response to significant levels of inflation and higher interest rates in the UK since 2021 and in recognition that the assumptions applied in the OEUK DSA regarding inflation and discounting were backward-looking and “unlikely to be representative of credible long-run trends”. In other words, there was a feeling within at least some parts of the industry that the OEUK DSA inflation and discounting assumptions would result in potentially volatile Provision Amounts that could, at times, over- or under-estimate the likely actual costs of decommissioning, resulting in fields being ‘over-secured’ as a result of high inflation around the relevant time of calculation or ‘under-secured’ as a result of low inflation around the relevant time of calculation. The guidance therefore includes recommended revisions to the OEUK DSA that aligns the basis of revenue and cost inflation, and discounting, to be based on a forward-looking Monetary Policy Committee forecast / Bank of England target basis. We are seeing widespread uptake of this revision, in the form of parties including the OEUK’s recommended revisions in both new DSAs and amendments to existing DSAs.

Next steps

Future Law-Now articles in this series will consider other key aspects of the OEUK DSA arrangements in more detail. We will also consider broader potential implications of these arrangements, as well as looking more widely at how other jurisdictions are addressing the question of how the costs of decommissioning are met.

^[1] Unless otherwise specified, capitalised terms used in this article have the meanings given to them in the OEUK DSA.