Decommissioning offshore oil and gas
facilities: Industry contracts and security
arrangements
Contact
Marc Hammerson
Direct line
+44 (0)20 7809 2148
Email
[email protected]
One, St Paul’s Churchyard
London EC4M 8SH
Telephone + 44 (0)20 7329 4422
Fax + 44 (0)20 7329 7100
www.shlegal.com
Decommissioning offshore oil and gas facilities: Industry contracts and security arrangements
Speaker's notes1
1
Introduction
One of the disadvantages of speaking on the last day of a conference – and particularly immediately
after another lawyer! – is that many of my planned topics have already been covered. We heard
2
yesterday from Hanne-Grete Nilsen about the OSPAR Convention. Leon has just spoken about UK and
international law in this area.
I therefore plan to limit my talk to two contractual agreements that oil companies typically enter into in
relation to decommissioning in the UK Continental Shelf (UKCS):
(a)
Firstly, I will discuss abandonment or decommissioning agreements contained in, or entered into
pursuant to, a joint operating agreement (JOA). In this presentation, the use of the term
"decommissioning agreement" is a reference to provisions relating to decommissioning whether
contained in a JOA or as a standalone agreement.
(b)
Secondly, I will discuss the different options for companies to provide security for costs for
abandonment or decommissioning. Security is often dealt with in a separate decommissioning
security agreement (DSA).
There are a couple of points to note at the start of this presentation:
(c)
You may have already noticed duplication in terminology between "abandonment" and
"decommissioning". I will try (other than where the applicable legislation uses a different term)
to refer to "decommissioning", which reflects the modern usage. In legal, as well as every day
language, "abandonment" has the implication of discarding property with an implied
renouncement of title and any on-going legal liability. As we have heard, the law provides for,
and policymakers are at pains to emphasise, the opposite.
(d)
There is no clear boundary between the contents of a decommissioning agreement and a DSA.
One set of JOA parties may include security-related provisions in a decommissioning agreement.
Another group of parties (under similar circumstances) might prefer to have the same provisions
in a DSA. A third group may split security-related provisions between both a decommissioning
agreement and a DSA. The name of the agreement will not make any material difference, other
3
than the timing of when the security obligations are entered into.
1
This is the text of a talk given by Marc Hammerson, partner at international law firm Stephenson Harwood
([email protected]), to IBC's conference on Counting the Costs of Decommissioning in Oil & Gas, Aberdeen 18
and 19 June 2008.
2
Convention for the Protection of the Marine Environment of the North-East Atlantic (the convention that came into force on
25 March 1998, replacing the Oslo and Paris Conventions).
3
To avoid potential conflicts, contractual drafting should attempt to avoid duplication of similar provisions. Notwithstanding
this, for safety, a suite of project documents (such as a JOA, decommissioning agreement and DSA) should state which
agreement will govern in the event of conflicting or inconsistent provisions.
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2
Overview of policy and commercial considerations
Before I start discussing those two agreement, it may be useful to note the competing interests of
different participants.
2.1
Government
Firstly, the Department for Business, Enterprise and Regulatory Reform (BERR) (formerly the Department
of Trade and Industry) is concerned that if companies do not take liability for decommissioning the
government will breach its international treaty obligations (for example, the UN Convention on the Law
of the Sea (1982), which is enforceable against the United Kingdom in the International Court of
Justice or the OSPAR Convention, which was the subject of a presentation yesterday).
Current estimates are that the costs of decommissioning the UKCS over the next thirty years will be
4
between £15-19 billion , therefore the government may (if it is not able to ensure that oil companies
fulfil international law obligations) indirectly take some of the cost and risk.
The government's objective is, therefore, to impose responsibility for decommissioning on oil companies
and, furthermore, to ensure that those companies have the financial means to meet their obligations.
An example of the risk to the public purse was given in 2005 when two companies involved in the
Ardmore block (initially developed in 1971 and therefore the UKCS's oldest producing oil field) went
into liquidation (thought to be the first insolvency of a company producing in the UKCS). At around £5
million, decommissioning costs were relatively small. The government was, however, faced with the
possibility of assuming some of the field's decommissioning liabilities (although, ultimately, a
5
commercial solution was found).
As the UKCS becomes a mature hydrocarbons province, increasing numbers of fields are approaching
the end of their production lives and therefore about to be decommissioned. At this point in the UKCS's
life cycle, the government is concerned that the potential for default will increase. Three factors are
relevant:
(a)
fields licensed in the 1970s and 1980s will soon be reaching the end of their production lives
and therefore the decommissioning of these existing installations is approaching (although we
heard yesterday how, with the current high oil price and improvements in enhanced oil recovery
technology, the production life of these fields is being extended);
(b)
because many of these fields are now in a marginal phase of production, the oil majors are
selling their UKCS assets and being replaced by smaller – and, by implication, less creditworthy –
independent E&P companies; and
4
Source: BERR (September 2007). The estimate is made up of £10 billion for oil and gas installations, £3 billion for subsea
structures and £2-6 billion for pipelines.
5
Contractors accepted decommissioning liability for their facilities. Liability for the remaining equipment was met by an
associated company.
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Decommissioning offshore oil and gas facilities: Industry contracts and security arrangements
(c)
6
in recent licence rounds, there has been a government policy of encouraging diversified
ownership of blocks by smaller (and, again, less creditworthy) companies (as recently
7
implemented in the recent 25th UKCS licensing round).
On the other hand, particularly with the current high oil price and its political consequences, the
government wishes to ease supply-side burdens and does not want to create any disincentives to the
development of further fields. Despite the UKCS being a mature hydrocarbons province there are an
8
estimated 25 billion barrels of oil equivalent yet to be discovered. Continued success in maximising
recovery of UKCS reserves relies on attracting new investment, which in turn depends (in part) on the
nature and stability of decommissioning regulations and the fiscal regime related to it.
The challenge for the government is, therefore, to balance the need for future investment with a
regulatory system that ensures that decommissioning is satisfactorily completed. BERR states that it will
endeavour to strike this balance: "Government will seek to achieve effective and balanced
decommissioning solutions, which are consistent with international obligations and have a proper regard
for safety, the environment, other legitimate uses of the sea, economic considerations and social
9
considerations".
2.2
Taxpayer
Despite the primary obligation for decommissioning being placed on oil companies, even if the
government is able to absolve itself of liability, the costs of decommissioning are tax deductible
expenses. You may be glad to hear that petroleum tax is not an area that I am qualified to speak about
in any detail. Suffice it to say, for some UKCS fields that are subject to Petroleum Revenue Tax as much
as 66% of the costs of decommissioning are (indirectly) paid by the taxpayer through companies setting
off decommissioning expenses against revenue and thereby reducing their charge to tax.
2.3
Oil Companies and Associated Companies
Oil companies, faced with the collective costs of decommissioning, want to ensure that their JOA
10
partners have the financial resources to meet their obligations. The Petroleum Act 1998 imposes joint
and several liability on JOA parties for decommissioning obligations:
6
The government's policy of promoting a wider range of entrants to the UKCS started in the 21st licensing round with the
introduction of the "Promote" licence designed to attract smaller companies.
7
A list of the 131 companies that applied for the 25th licensing round, contained at
www.og.berr.gov.uk/press/25th_round_applications.doc, includes many small companies that are new entrants to the UKCS.
8
This is the current estimate of UK Oil & Gas (the offshore industry trade association). With the current high oil price and
improvements in enhanced oil recovery technology, some geologists claim that the eventual figure could be double that
amount.
9
Paragraph 1.1 of Guidance Notes for Industry: Decommissioning of Offshore Installations and Pipelines under the Petroleum
Act 1998 (produced by BERR's Offshore Decommissioning Unit) ("BERR's Guidance Notes").
10
Unless otherwise stated, all references in this presentation to section numbers are to sections of the Petroleum Act 1998.
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Decommissioning offshore oil and gas facilities: Industry contracts and security arrangements
"… it shall be the duty of each of the persons who submitted [an abandonment programme] to
secure that it is carried out and that any conditions to which the approval is subject are complied
11
with" (emphasis added) (section 36).
12
BERR also has the power under section 30(1)(d) to issue a section 29 notice on any company
associated with a JOA party or operator.
2.4
Transferee licensee
On disposing of an interest in a licence, a seller may apply to BERR to be released from its section 29
notice. Section 31(5) gives the Secretary of State discretion whether or not to release. According to
BERR's Guidance Notes, a section 29 notice should be rescinded if (among other factors) the financial
strength of the remaining licence group is strong. A seller that is not released will be concerned about
its continuing joint and several liability to perform decommissioning and (as a result of this continuing
liability) may require security from its buyer under the terms of the sale and purchase agreement. This
position can lead to "double security", in other words the buyer providing security to both the seller (for
its unreleased liability) and the JOA parties for on-going decommissioning costs – an economically
13
inefficient outcome.
Furthermore, even if there has been a section 29 release, section 34 allows BERR to recall any previous
owner of an installation to be responsible for the costs of a decommissioning programme. Therefore,
even historic licensees will have an on-going interest in ensuring that the current owners have posted
sufficient security to guarantee their decommissioning obligations. Despite the fact that BERR has
described section 34 as "a measure of last resort which we endeavour to avoid by use of appropriate
14
security arrangements" , this is a draconian power which does not allow a seller ever fully to absolve
itself of decommissioning liability. For this reason, the power of recall is, understandably, disliked by
industry.
11
Also note in section 29 (footnote 12, below) that when the notice is given to more than one person, those persons must
jointly submit an abandonment agreement.
12
Section 29 is the provision which was formerly section 1 of the Petroleum Act 1987. It states:
"(1) The Secretary of State may by written notice require –
(a)
the person to whom the notice is given; or
(b)
where notices are given to more than one person, those persons jointly,
to submit to the Secretary of State a programme settling out the measures proposed to be taken in connection with the
abandonment of an offshore installation or submarine pipeline (an "abandonment programme")" (emphasis added).
13
The risk of double security has been addressed in the decommissioning cost provision deed (see section V of this paper)
which allows a seller (despite no longer having any interest in the licence) to remain a party to the security arrangements for
the purpose of relying on security provided by others.
14
Paragraph 3.9 of BERR's Guidance Notes.
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Decommissioning offshore oil and gas facilities: Industry contracts and security arrangements
2.5
Contractors
It should be noted that under section 30:
15
(a)
any "person [and their associated companies ] having the management of the installation or its
main structure" (section 30(1)(a)); and
(b)
any "person [and their associated companies] … who owns any interest in the installation
otherwise than as security for a loan" (section 30(1)(d)),
can be subject to a section 29 notice. The section could be applied, for example, to a total facilities
contractor.
More generally, it should be noted that the classes of person on whom a notice can be served is wide.
In addition to the categories referred to above any person, or its associated company, who is or may be
the recipient of a section 29 notice will have an interest in how decommissioning is performed.
2.6
Interest groups
16
Lastly, the environmental and maritime lobbies are active pressure groups that ensure that
governments and companies comply with their international, domestic and contractual
decommissioning obligations. Brent Spar is, to date, the most high profile example of the power of the
17
environmental lobby in relation to this topic.
15
This term is defined widely in section 30(8).
16
For example, the fishing industry has set up the Fisheries Legacy Trust Company, a charity funded by the oil industry to
safeguard against and compensate for damage caused by partial decommissioning of oil and gas installations.
17
Much has been written elsewhere about Brent Spar, which was an oil storage and tanker loading buoy that Shell planned
to dispose of in deep Atlantic Sea waters. Greenpeace occupied the Brent Spar in protest for three weeks, forcing Shell to
abandon its plans and adopt an onshore disposal option.
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3
Decommissioning agreements and JOA provisions
3.1
Historic practice
Contractual documents previously paid little attention to decommissioning. This was an unsatisfactory
position which resulted from a lack of importance being paid by oil companies to the subject. As seen
from the following clause taken from the model JOA contained in Taylor and Winsor on Joint Operating
Agreements (second edition, 1992) JOA parties were typically more concerned about recovering the
maximum amount possible in the event that Joint Property was no longer needed for Joint Operations:
"1.
If the Operator shall consider that any Joint Property is no longer needed or suitable for the Joint
Operations the Operator shall … dispose of the same. The Operator shall notify the Non-Operators
of such disposal as soon as practicable thereafter.
2.
If the Parties shall decide to abandon the Joint Operations, or any part thereof, the Operator shall
recover and endeavour to dispose of as much of the Joint Property as the Operating Committee
directs can economically and reasonably be recovered under the Acts, the Licence or any other
applicable law, and the net costs or net proceeds therefrom shall be charged or credited to the
Joint Account for eventual allocation in proportion to the Percentage Interests of the Parties."
Note that clause 2 is about making money out of decommissioning, rather than the associated costs.
Sometimes a JOA would go on to provide that, following a development programme for a discovery, the
JOA parties will agree the terms of a decommissioning agreement which would cover the sharing of
liabilities between the parties and the provision of security. If unanimity on a decommissioning
agreement cannot be reached then the relevant passmark will be required. The following clause is also
taken from Taylor and Winsor on Joint Operating Agreements:
"3.
Without prejudice to clause [2, above], following any proposal made to the Operating Committee
for the Operator to prepare a development Programme and Budget for a particular Discovery, the
Parties shall, before submission to the Secretary of State of a programme … in good faith
negotiate, agree and execute an agreement (the "Abandonment Agreement") relating to the
abandonment (which expression shall include demolition and removal together with any
necessary site reinstatement) of any offshore installations and pipelines used in connection with
the Joint Operations. The Abandonment Agreement shall be prepared in all respects with due
regard to and in accordance with the requirements of the Acts, and shall provide inter alia for:
(i)
an equitable sharing between the Parties of their liability to meet the costs of and other
obligations relating to the abandonment of such offshore installations and pipelines;
(ii)
the preparation and periodic review by the Operator for submission to the Parties of
estimates of the likely costs to the Parties of such abandonment and of the amount and
value of the net recoverable reserves of the field in question, provided that any Party shall
have the right reasonably to require the preparation of further reports and studies in
relation thereto …" (emphasis added).
Note the underlined words. After a discovery has been made, but before a development programme has
been submitted to the Secretary of State, is the logical point at which to negotiate a decommissioning
agreement. However, the drafting above would be considered by English law to be an "agreement to
agree" (in other words, an agreement to agree, at a future point in time, a further contract) and
unenforceable under English law due to vagueness and uncertainty. This clause therefore runs the risk
that it will not be legally binding – an unhappy position for co-venturers to find themselves in with
respect to such a major liability.
One possible solution to this legal problem is to include a provision that deems a party refusing to enter
into a decommissioning agreement to have made a non-consent election in relation to that discovery.
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Decommissioning offshore oil and gas facilities: Industry contracts and security arrangements
Non-consent is, of course, traditionally used when one JOA party does not want to participate in the
exploitation of a discovery (typically because it takes a different view on the commercial success of
developing reserves). However, in this context, non-consent will give the majority JOA parties a stick
with which to force an unwilling co-venturer to fall in line with the majority's wishes on
decommissioning.
The lack of decommissioning detail typically contained in historic JOAs was re-evaluated with the
enactment of the Petroleum Act 1987. The 1987 Act introduced a regime that allowed the government
to demand a decommissioning programme setting out the measures proposed to be taken.
Furthermore, it imposed joint and several liability on each JOA party.
When companies form joint ventures (of which JOAs are an unincorporated example) it raises the issue
of allocating liability among the co-venturers. In the same way that joint and several liability of
licensees under a UKCS oil and gas licence provides a powerful motivation for parties to set out their
respective rights and obligations in a JOA, the joint and several liability for decommissioning provides a
similar incentive. Despite the difficulties in drafting decommissioning provisions before a discovery has
been made, modern practice is moving towards parties agreeing more detailed decommissioning
provisions at an earlier stage.
3.2
Modern practice
Modern practice is moving towards an earlier fully-termed decommissioning agreement which is
contained as an annex to the JOA or even appended to the joint bidding agreement. However, despite
this trend, the amount of detail on decommissioning contained in JOAs still varies. This is because, at
the time of entering into the JOA, it is not known whether there will be commercially-recoverable
reserves and, if so, whether the block will produce oil or natural gas or both and in what quantities.
Because these factors are unknown it is impossible to contemplate the infrastructure required and
eventually decommissioned. Due to these uncertainties it is difficult, prior to a discovery being made, to
negotiate a fully-termed decommissioning agreement.
On the other hand, notwithstanding these difficulties in concluding a decommissioning agreement, for
such a large expense it is important (at the earliest possible point) to establish contractual certainty
among the JOA parties.
Furthermore, regulatory certainty between the JOA parties and the government is important. Since
18
every JOA has to be approved by BERR , a JOA's decommissioning provisions are capable of forming
19
part of an approved abandonment programme under section 29. Including detailed decommissioning
provisions in the JOA may therefore provide certainty vis-à-vis the government.
18
Model Clause 41(5), The Petroleum (Current Model Clauses) Order 1999, S.I. 1999 No. 160.
19
Despite government policy against using the term "abandonment", the Petroleum Act 1998 still refers to "abandonment
programme".
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3.3
Conclusion
There are, therefore, many variables surrounding contractual arrangements relating to decommissioning:
(a)
decommissioning provisions may be included in a section of the JOA or they may be contained in
a standalone agreement;
(b)
the documentation may use the terminology "decommissioning" or "abandonment";
(c)
if the decommissioning provisions are contained in a separate document, it can be entered into
at the same time as the JOA or at a later date (for example, after a commercial discovery has
been made); and
(d)
decommissioning programmes (which are an important product of the abandonment agreement)
can be voluntarily submitted by the JOA parties to government or it can be demanded by the
20
government at a time of its choosing.
Whatever form it takes, there are some common provisions that need to be addressed in the
decommissioning agreements. These issues are discussed next.
20
Typically, section 29 notices are issued to the licensees around the time of development approval and require the
submission of a decommissioning programme at a date to be notified later (usually three years before cessation of
production). However, the government will be particularly keen to see expedited abandonment agreements and
decommissioning programmes put in place for high risk, high cost projects.
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4
Typical contractual decommissioning provisions
4.1
Sharing of liabilities
Companies should be liable for decommissioning costs in proportion to their participating interests in
the JOA.
Furthermore, to deal with the situation where there has been a partial decommissioning of an
21
installation , JOA parties should allocate liability arising from any materials left at sea. JOA parties
have a theoretical liability in tort (the English law term) or delict (the Scots law term) for a claim in
negligence for any failure in a duty to take care to notify sea-users of the location of the partiallyremoved or sunk installation. There may also be on-going environmental liabilities resulting from a
partially-decommissioned structure.
4.2
Decommissioning programme and budget
Decommissioning programmes and budgets are the formal procedure for determining what
decommissioning operations are required and for costs to be budgeted. A section on decommissioning
programmes and budgets needs to provide for procedures authorising the JOA operator to prepare these
and for subsequent approval by the JOA operating committee (OpCom).
(a)
Timing of Decommissioning Programme
Normally decommissioning is considered in the annual budget after developmental approval. Each year
the operator will submit an update to the programme and budget with details of new costs. The annual
programme and budget would need to be approved by the OpCom each year. Once agreed, the
operator should be authorised to submit the decommissioning programme to the Secretary of State as
required under the Petroleum Act 1998.
Alternatively, to avoid the problems of procuring that all (or, at least, a passmark majority) of JOA
parties agree a programme and budget, some companies might prefer to provide for decommissioning
programmes and budgets to be prepared prior to first commercial production.
Note, however, whatever the JOA says about timing of the programme and budget this may be
overruled by section 29. If the Secretary of State requires a programme and budget prior to the OpCom
reaching agreement, the operator will need the power to prepare the programme and budget and
submit it to the Secretary of State without prior OpCom approval. In this case, revisions would need to
be proposed by the JOA parties after submission of the decommissioning programme.
21
United Kingdom and international law have moved a long way from the 1958 Geneva Convention on the Continental Shelf
which (at Article 5(5)) required complete decommissioning of offshore facilities. The inflexible rule has been ignored in
subsequent international conventions and in domestic law and practice. For example, the OSPAR Convention allows
derogations for partial decommissioning. According to Daintith & Willoughby, because of the failure of most states to
implement the entire removal rule, Article 5(5)'s requirement for complete decommissioning is no longer considered good law
even in countries (such as the United Kingdom) which are signatories to the 1958 Convention.
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The decommissioning agreement should state that all the JOA parties must pay their participating
interest share of the decommissioning programme whether it is an approved programme or one
22
imposed by the Secretary of State.
(b)
Contents of a Decommissioning Programme
A decommissioning programme should contain:

An estimate of the cost of the measures proposed

The timeframe within which those measures will be taken

Where an installation or pipeline is to remain in position or to be only partially removed, include
provision for maintenance

Where appropriate, a decommissioning programme will deal with both removal and disposal of
an installation or pipeline.
The precise contents of a decommissioning programme will vary according to circumstances. However,
the following are likely to be necessary in most cases:

Introduction

Executive summary

Background information

Description of items to be decommissioned

Inventory of materials

Removal and disposal options

Selected removal and disposal options

Wells

Drill cuttings

Environmental impact assessment (EIA)

Interested party consultations

Costs

Schedule

Project management and verification

Debris clearance

Pre- and post-decommissioning monitoring and maintenance

Supporting studies.
23
22
BERR's ultimate sanction is to prepare its own decommissioning programme (section 33(1)). BERR may carry out its own
decommissioning programme and recover expenditure from the section 29 parties.
23
According to BERR (at paragraph 6.7 of BERR's Guidance Notes) the foregoing headings are likely to be necessary in most
cases. The details of what should be contained in each category is expanded upon in Annex C of BERR's Guidance Notes.
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4.3
Security for decommissioning
The concept of joint and several liability under the Petroleum Act 1998 means that the JOA parties
must be sure that if one their co-venturers defaults there will be adequate security to fund the
defaulter's liabilities.
Oil companies do not ordinarily provide security for their other JOA obligations. Why is it important
that they put up security for decommissioning costs? The ultimate remedy for failure to comply with
JOA obligations is forfeiture (i.e. losing a participating interest in the JOA). However, in the case of
decommissioning, by the time these costs are due the field will be in production decline and the
defaulter's participating interest in the JOA may be worth less than its share of decommissioning costs.
Forfeiture is, therefore, at this point in the field's life, an inadequate remedy.
There is no general requirement to enter into, or provide BERR with, a DSA. However, the following
provisions encourage parties to do so:
(a)
Section 38 allows the Secretary of State to investigate a company's financial resources to carry
out decommissioning and to request security if he feels that the resources are inadequate.
(b)
BERR has stated that where an acceptable DSA has been entered into they will look favourably
on releasing a transferee from its section 29 notice.
(c)
Lastly, section 30 allows the Secretary of State to imposed decommissioning liabilities on parent
companies. Although, according to the government "the option of securing more widely will be
pursued only in cases where it is judged that satisfactory arrangements, including financial, have
not or will not be made to ensure that a satisfactory decommissioning programme is carried
24
out" , it is important to note that decommissioning liability is not an issue that can be ringfenced at subsidiary company level. Parent companies will be keen to see that adequate security
has been put in place.
For these reasons it is very common (although not compulsory) to enter into security agreements.
24
Paragraph 3.2 of BERR's Guidance Notes.
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5
Decommissioning security agreements
Again, these agreements are labelled with different names and are sometimes called decommissioning
25
cost provision deeds. However, in this presentation I will refer to them as decommissioning security
agreements or DSAs.
The basic function of a DSA is that the parties provide security for their share of decommissioning
liabilities. There is no obligation for parties to enter into a DSA, but (for the reasons already given) it is
often in their interests to do so.
Furthermore, pursuant to section 36, BERR can require a party to enter into a DSA after a
decommissioning programme has been agreed if it has justifiable concerns about its financial capability.
5.1
Who will be party to a DSA?
(a)
Existing Licensees
Current licensees will be (or prior to a development programme likely to become) subject to a section 29
notice. We have seen that it is important for both the co-licensees and the government to ensure that
existing licensees have provided adequate security.
(b)
Historic Licensees
We have seen that, with BERR's section 34 powers of recall, it is important for historic licensees to
ensure that adequate security has been provided by the current licensees. This should prevent
(although not guarantee) that the section 34 powers are not exercised. A DSA can therefore provide an
option for former licensees to remain parties to the DSA with no obligation to provide security but solely
to enable it to enforce the DSA security.
(c)
BERR
The Secretary of State may want to be a party to control any amendments to the DSA.
(d)
Other Ex-Section 29 Parties and Section 34 Parties
Other companies, although not a party to the DSA, may be given third party rights (pursuant to the
Contracts (Rights of Third Parties) Act 1999) to enforce security if they are ever required to carry out any
decommissioning.
25
The decommissioning cost provision deed is the industry standard security agreement developed by the Brownfields Work
Group.
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5.2
Forms of security
(a)
Trust Fund
The following issues are relevant in deciding whether the JOA parties provide security by way of cash
into a trust fund:

JOA parties will not want to tie up cash flow by paying into a trust fund.

Whilst tax relief is available for the costs of payment of guarantees and letters of credit, such
relief is not available for cash payments into a decommissioning fund to provide for future costs.

A typical decommissioning agreement will therefore commit the parties to maintain adequate
security and provide that if the security becomes inadequate or is not renewed, cash payments
will only then be made into a decommissioning trust fund.

Because (as we have seen) forfeiture is an inadequate remedy by the time decommissioning
liabilities are due, a trust fund with the requirement to make cash payments is considered the
most effective way of dealing with security defaults.

The trustee of the fund is normally a trust corporation (i.e. an independent third party) and not
the operator.

There should be a provision about the permitted investments, which will normally be
conservative, that the trust fund can invest in. There is likely, therefore, to be a low rate of return
on any investments.
(b)
Guarantee
The following issues are relevant in deciding whether the JOA parties provide security by way of
guarantee:

A guarantee could be from a party's parent company (if the parent has a good credit rating) or
from its bank. The only difference is the credit rating of the guarantor. A bank will charge for
issuing a guarantee, a parent company normally wont.

A guarantee imposes a secondary liability to pay on the default of the primary obligor. The
evidence required to prove an entitlement to payment under a guarantee varies according to the
manner in which the guarantee is drafted.

Most decommissioning agreements will define what Standard & Poor's or Moody's rating the
guarantor must have and keep during the life of the guarantee. This is designed to ensure the
creditworthiness of the guarantor.

Notionally under English law companies are separate legal entities and a company's directors
have duties to consider the interests of that company alone. The directors of XYZ Plc should not
consider the interests of XYZ (United Kingdom) Limited, and vice versa, or the interests of any
other member of the XYZ corporate group. There is no direct benefit in one company agreeing to
guarantee the liabilities of the other company. However, often a wider group benefit can often
be found. This needs to be recorded in the corporate minutes approving the guarantee.

Because of these difficulties, it is important to obtain a legal opinion (as to competency of the
guarantor and corporate approvals), particularly for parent company guarantees.

A guarantee is a contingent liability on the balance sheet of the guarantor. If guarantees are
given they should, to limit contingent liability and for commercial good sense, contain a cap on
liability.
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A guarantee should be drafted to allow changes to the underlying contract. A guarantee should
be expressed to be irrevocable.
Generally, parent company guarantees are not liked by BERR and are not regarded as acceptable
security. The reasons given are difficulty of enforcement, particularly in foreign courts and issues about
the creditworthiness of the parent (see Annex G of BERR's Guidance Notes). Therefore, parent company
guarantees tend to be used when parties want to provide security to each other (and do not feel that
the government will want to see security in place).
(c)
Letter of Credit
A letter of credit is a promise to pay by an issuing bank against the presentation of documents. The
presentation of documents within a specified time limit should be the only condition of payment by the
issuing bank. The cost of the letter of credit will be about 0.2% to 2% of the security amount per
annum (depending on the credit rating of the issuing bank's client). It is normally issued for a 12month period and renewed each year.
A letter of credit differs from a guarantee in that it is not contingent on the default of the primary
obligor and is usually conditional only on the presentation of a written demand by the beneficiary – i.e.
it is independent of the underlying obligation contained in the decommissioning agreement.
Traditionally, the letter of credit was physically held by the operator (although, if drawn upon, the
proceeds were paid to a trustee). Under the new industry decommissioning cost provision deed, all
security is expressed to be in favour of a trustee.
26
For the reasons given by BERR for refusing to accept guarantees , an irrevocable letter of credit is
generally stronger for a beneficiary than a guarantee.
(d)
Conclusion
Trust funds tie up cash without the benefit of tax relief. This is why, despite the expense, parties often
prefer security provided by banks or parent companies. In practice there may be little difference
between bond, letter of credit or guarantee. All are undertakings to pay; it is the degree of
conditionality to the undertakings that varies between them.
5.3
Timing of security
To avoid tying up cash or paying a third party provider, companies are reluctant to provide security to a
decommissioning fund too early. On the other hand, companies want to act prudently to ensure that
security is in place in adequate time to meet decommissioning costs. Therefore, a practice has
developed of providing security at a "trigger point" in the field’s life.
The United Kingdom Offshore Operators' Association (UKOOA) believes that the trigger point should
come into play when the "discounted cost of abandonment exceeds a pre-determined proportion of the
discounted value of the remaining reserves (typically 50% - 75%)".
In most decommissioning agreements the security requirements is triggered when the remaining value
of the field is equal to or below 135% - 150% of the projected cost of decommissioning.
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At Annex G of BERR's Guidance Notes.
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Determining when this trigger is met requires constant monitoring. It also requires recourse to expert
determination if values cannot be agreed. Once the trigger is reached the field will have entered its
"run down" period and each year the parties will need to determine the value of security required from
each other.
5.4
Amount of security
Typically, to provide a buffer, JOA parties will provide security equal to 150% of the estimated
discounted costs of decommissioning less estimated discounted revenues. This is recalculated by the
operator on a yearly basis with any disputes being referred to an expert. Because the parties' tax
positions will differ considerably (and also because uncertainties about the future of tax relief under the
Petroleum Revenue Tax), decommissioning costs are always estimated on a pre-tax basis (compared to
revenue which, for similar reasons, is calculated on an after-tax basis).
The calculation of the security amount requires the parties to make several cost assumptions.
Sometimes these are agreed in the DSAs but (with no industry consensus on what the assumptions
should be) often they are not. On the question of whether any income from the salvage of installations
can be assumed, BERR takes the view that, except for floating production and storage and operating
systems (FPSOs), assuming any revenue is too speculative. Another contentious assumption is whether
the parties will be granted an OSPAR Convention derogation allowing them partially (rather than fully)
to decommission an installation. Some argue that, with the support of an independent environmental
impact assessment, an assumption that this will be allowed should be factored into the estimate of
decommissioning costs.
In order to ascertain the timing and amount of decommissioning, the parties will also be required to
make other (non-decommissioning-specific) assumptions such as a reserves estimate and an assumption
of the likely oil or gas price. The latter can be based on a public index.
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