UK: Gulf Of Mexico Oil Spill:Likely Impact On UK Regulation And Contractual Arrangements

Last Updated: 20 October 2010
Article by Humphrey Douglas

The Gulf of Mexico oil spill resulted in a temporary moratorium on deepwater drilling and implementation of new regulation in the USA. Consequential organic changes to UK regulations are unlikely but more importance on the interpretation of existing regulations through continued and improved technical guidance is evident combined with greater enforcement of existing regulations. There is perhaps unlikely to be a fundamental change to the "no gain, no loss" principle of operatorship, but rather, increased scrutiny of contractual allocation of risk and rising insurance premia.

Background of US litigation

As Scott Pegau of the Oil Spill Recovery Institute in Cordova, Alaska apparently said of the Exxon Valdez incident:

"Without a doubt this litigation did more harm to the region than the oil did. It dragged out for 20 years... In Alaska, it was about impacts on fishing, while in the Gulf the business impacts go beyond fishing to a large tourism industry... Legislation coming out of the Gulf is likely to have a much broader effect on the oil and gas industry."1

No doubt the US faces a protracted period of public litigation of third party claims in addition to which BP and its co-venturers will likely conduct much of their own dispute resolution behind closed doors in accordance with the arbitration provision of the relevant joint operating agreement. BP's Deepwater Horizon Accident Investigation Report of 8 September 2010 sets the scene and points to:

"well integrity failure, followed by a loss of hydrostatic control of the well... followed by a failure to control the flow from the well with the BOP equipment... Eight key findings related to the causes of the accident emerged."

Whatever the liability motivations of the parties involved, it was perhaps never likely that any single smoking gun would be deemed responsible. Lawyers will now likely expend much energy in trying to establish probable cause, effect and mitigation.

Background of international regulation

Following various shipping accidents over the years, significant European and international regulation has been aimed at preventing and, to a certain extent, dealing with, oil spill response, health and safety, and environmental pollution from oil tankers rather than from oil and gas installations specifically. Indeed, the United States' ("US") Oil Pollution Act 1990 was in significant part a reaction to what was regarded as insufficient international regulation protecting the Alaskan coast from the Exxon Valdez disaster in 1989.

In light of the above, it remains national and not international or European regulation which is likely to provide the most effective regulation for oil and gas installations in the UK.

The US legislative impact

Following the Gulf of Mexico oil spill, regulation is increasing in the US. A number of current bills (over 50) suggest amendments or additions to US legislation ranging from the removal of the current Oil Pollution Act 1990 offshore facilities liability cap of "removal costs plus $75,000,000" to the inclusion of non-pecuniary losses in the Death on the High Seas Act and the Jones Act.

Although there wasn't a knee-jerk regulatory response in the UK, there is precedent to suggest that some US regulation could indirectly find its way to Europe and the UK. Again taking the Exxon Valdez example, the Oil Pollution Act 1990 rapidly outlawed single-hulled tankers in the US, which concerned European regulators who already had a more gradual period for the phasing out of single-hulled oil tankers in European waters. The concern was that single-hulled tankers would migrate from US to European routes as double-hulled tankers would be diverted to the US, thus increasing the risk of an oil spill in the EU, near to the vulnerable Brittany coast for example, which is particularly susceptible due to prevailing winds and the high volume of EU oil imports through the English Channel. As a result, single hulls were phased out more quickly in Europe than was originally planned, to be inline with US legislation2. Although the above example perhaps demonstrates how US legislation can find its way indirectly into EU regulation, there is clearly not the same risk of "flag of convenience" oil rigs (even floating ones) migrating around the world.

UK regulatory regime "fit for purpose"?

The UK has around 300 offshore platforms of which 22 may be considered "deep water". As there are no deep water wells currently being drilled (although Chevron recently received consent to drill an exploration well to evaluate a deep-water prospect at Lagavulin, 160 miles north of the Shetland Islands) there is presently perhaps little need for any deep drilling moratorium even if there were concerns as to UK safety.

It was suggested that the US is simply playing regulatory catch up with the UK which put its house in order following the Piper Alpha disaster of 1988 (which resulted in the loss of 167 lives, a total insured loss of around Ł1.7 billion and the shutting down of approximately ten per cent of total UK gas production). Following Piper Alpha, the UK established:

  • the Health and Safety Executive ("HSE") as the regulatory body (independent of the licensing body) for health and safety;
  • a "goal-setting" regime (whereby operators have to meet regulatory goals but are given pragmatic freedom as to how they are attained, rather than "box ticking" which could compromise safety);
  • a "safety case" regime (whereby operators have to submit and have a safety case approved before they can start operations3;
  • "duty holder" obligations generally on operators and owners; and
  • the requirement for oil pollution emergency plans.

The Health and Safety at Work Act 1974 is now the principle UK statute governing health and safety on offshore rigs. Duty holders are required to do all that is "reasonably practicable" to ensure compliance with health and safety obligations. A breach of the regulations is a criminal offence, with many being offences of "strict liability" and limitless fines for indicted matters.

Unlike the US (where health and safety regulation and revenue raising were carried out by the same body prior to the Gulf of Mexico oil spill), the UK offshore oil and gas industry has had split regulatory functions for some time and is regulated principally by the Department for Energy and Climate Change ("DECC") (the licensing authority under the Petroleum Act 1998) and the Health and Safety Executive, with the Marine and Coastguard Agency being responsible for oil spill response.

Given this legislative framework, Chris Huhne, the Secretary of State for Energy and Climate Change, and others have reiterated the view that the UK's regulatory regime is essentially "fit for purpose".

UK regulatory lessons from the Gulf of Mexico Oil Spill

Notwithstanding the contention that the UK regulatory regime is more effective than the US, UK regulators do not appear complacent. In reaction to the Gulf of Mexico oil spill, the number of HSE inspectors has apparently increased4, resulting in a doubling of environmental inspections. Anecdotal evidence also suggests that DECC is already putting increasing emphasis on oil spill planning for new wells.

In addition, certain technical circulars have been issued by the HSE, which give additional guidance but do not change the legislative framework. For example, the HSE Offshore Safety Division circular dated 28.07.10 describes how to assess the acceptability of riser Emergency Shut Down Value ("ESDV") leakage rates. Duty holders are not required to meet fixed criteria for maximum riser ESDV leakage rates, rather, the rate of leakage should be based on an installation's ability to control the hazards presented by such a leak5. DECC is also reviewing indemnity and insurance provisions.

In addition, the UK industry and Government's reaction to the Gulf of Mexico oil spill has included:

  • the launch of a recent joint industry and Government group called the Oil Spill Prevention and Response Advisory Group ("OSPRAG") to review the UK's ability to prevent and respond to oil spills;
  • the award, by OSPRAG, of a contract to Wood Group Kenny for the design of new oil spill mitigation technology for the UK continental shelf;
  • a study, set up by OSPRAG, in the light of the Gulf of Mexico incident, to look at estimates of the cost of oil spill clean up in the UK area; and
  • the bringing forward of the planned testing of the National Contingency Plan, and its interaction with other major incident plans, including the oil pollution emergency plans submitted by operators of offshore installations, with a major oil pollution exercise involving the offshore industry in 2011.

The role of the oil and gas industry on UK regulation

Oil and Gas UK ("OGUK") is the industry body which represents the UK oil and gas industry. OGUK was proactive in setting up OSPRAG to learn lessons from the Gulf of Mexico oil spill and the UK's ability to prevent and respond to oil spills in the North Sea.

As such, it is involved in suggesting self regulation. Its seemingly transparent and interactive relationship with DECC perhaps acknowledges the understanding that it is in the taxpayer and fuel bill payers' interests that as much of the UK Continental Shelf's remaining resources are recovered as safely and cost-effectively as possible.

OGUK was seemingly quick to model likely spill scenarios and recommend that the Offshore Pollution Liability Association ("OPOL") coverage limit be increased from $120 to $250 million per incident. OPOL is an oil pollution compensation scheme (to which all North Sea operators are voluntary signatories) which makes provision on a strict liability basis for pollution damage and the cost of remedial measures. By entering into OPOL voluntarily, licensees are also able to meet their obligations to demonstrate to DECC, under the relevant licence, that they have sufficient funds available to discharge any liability for damage caused by pollution. Parties have to establish financial responsibility to meet claims arising under OPOL by producing evidence of insurance, self-insurance or other satisfactory means. They also jointly agree that in the event of a default by one of the parties, each will contribute proportionally to meet claims. The responsibility for meeting claims underOPOL rests solely with the operator, who in turn may reallocate certain responsibilities amongst co-venturers.

The contractual relationships of parties

To carry out UK offshore exploration and development a party must acquire a licence which is awarded over a particular area or "block" pursuant to the Petroleum Act 1998. Where there is more than one licensee, joint and several liability is owed under model clauses6 incorporated into each licence to the UK Government. In addition, pursuant to the model clauses, relevant licensees are required to conduct operations in accordance with certain minimum standards such as good oilfield practice. If they fail to do so, they face potentially unlimited liability to third parties for environmental and certain other damage. They may also face criminal, civil and other sanctions including potentially losing their licence.

Co-venturers will typically enter into a contractual unincorporated joint venture arrangement under a joint operating agreement ("JoA") in which they agree (as amongst themselves) to be severally (or individually) liable only to the extent of their percentage interest under the relevant licence and to indemnify other co-venturers to the extent of their percentage interest. Thus in the Gulf of Mexico oil spill example, BP agreed (in its capacity as a non-operator) to be individually liable up to its 65 per cent share of all costs and liabilities.

As a practical matter under a JoA, the coventurers typically agree to appoint one party to act as operator on a "no gain, no loss" principle. That means that the operator should neither make additional profit nor take additional risk by acting as operator. This principle means that the operator's liability is typically very limited with no liability except for (i) "wilful misconduct" ("gross negligence" not being a settled term under English law); and (ii) failure to place insurance. The term "wilful misconduct" is often defined to refer to "an intentional or reckless disregard by senior managerial personnel of good oilfield practice". The JoA will typically also state that there will be no liability, in any case, for consequential loss.

Impact of the Gulf of Mexico oil spill on contractual relationships

The "no gain, no loss" principle is likely to come under renewed pressure following the Gulf of Mexico oil spill. The disaster has made parties reconsider the potential imposition of not only heavy civil liabilities, but also criminal liabilities under health and safety and environmental regulations. As criminal liability cannot be indemnified against (amongst other things for reasons of public policy) it is likely that the burden of any significant criminal fines will remain with operators.

Conclusion

UK oil and gas regulation is still widely regarded as "fit for purpose" although there has been some acknowledgement that enforcement and technical guidance can be improved.

As increasingly it is not the oil majors acting as operators but smaller North Sea entrants, who increasingly may sub-contract operation to larger service companies, the liability negotiation balance of power is shifting. However, given stabilising oil prices and the intricate web of cross-indemnities and insurance underpinning the industry, we are unlikely to see a fundamental change to the "no gain, no loss" principle of operation for the time being. What we are likely to see, is more time spent negotiating indemnities and liabilities and there will be even fewer instances of commercial arrangements being left unpapered.

Insurance premia are also likely to increase – not least to meet the higher, albeit relatively modest, increase in the OPOL limit. However, as unlimited or multi-billion dollar limit insurance is already not generally economically available, risks above OPOL limits are perhaps not likely to be reallocated significantly other than amongst the insurance and reinsurance industry in rare instances where such cover is provided.

Whilst it is likely that deep water drilling will remain the preserve of those with deep pockets, it may also be an impetus for greater pooling of resources and know-how on a practical level.

Regulators and industry alike will continue torecognise that an arguably more pressing issue in developing the North Sea's remaining reserves is the disincentive to late entrants and ongoing development, resulting from decommissioning security requirements. It will take a brave regulator to further threaten the exchequer's already declining take from the North Sea, no matter how independent that regulator is from revenue raising

Footnotes

1 As quoted by Skip Kaltenheuser in his article "Spills and Bills" which appeared in the August 2010 edition of International Bar News.

2 See Regulation (EC) No 417/2002 of the European Parliament and of the EU Council of 18 February 2002.

3 See the Offshore Installation (Safety Case) Regulations 2005

4 It is understood that the increase is from six to nine inspectors.

5 As per the Pipeline Safety Regulations 1996.

6 See the Petroleum (Production) Regulations 1988 as re-enacted in Schedule 9 of the Petroleum (Current Model Clauses) Order 199

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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