UK: Impact Of The Budget On Decommissioning Security Agreements

The Government's announcement of the 2011 Budget contained an unexpected rise in the Supplementary Charge which has resulted in much comment and concern in the industry.  As well as affecting the viability of future projects, the rise in tax is also likely to affect Decommissioning Security Agreement (DSA) obligations, whether the obligation to provide security has been triggered or not.  The Oil and Gas UK Industry Standard DSA (March 2009) ("OGUK Standard") which is widely used in the UK offshore oil and gas industry requires the Operator to provide each year (usually by the 30th of June) an assessment of the "Net Value" of the oil or gas remaining in the field and the "Net Cost" of decommissioning (including a contingency factor).  When Net Cost exceeds Net Value, security must be provided to the value of the excess (this is referred to as the "Trigger Date").  This year, when producing decommissioning plans, operators will need to factor in the adjustments made by the increase in the Supplementary Charge.

The form of the DSA is structured around a particular formula which is used to calculate how much a party is required to provide by way of security for decommissioning. The formula seeks to establish the Net Cost and Net Value of any particular field. The rise in the Supplementary Charge; by increasing the tax burden associated with a particular field will decrease the Net Value. Although tax relief has been restricted so that it will not be available in relation to the increase of Supplementary Charge, this is not likely to increase Net Cost as it is usual for Net Cost to be calculated without taking account of tax reliefs in any event (precisely because they cannot be relied upon to remain available). 

This law-now will focus on the provisions of the OGUK Standard and will cover three key impacts, which should be considered by operators and other parties to a DSA. 

Trigger Date has not taken place

  • It is common for Trigger Dates to be forecasted by reference to a calculation including the Net Value and Net Cost. The reduction of the Net Value, by virtue of the rise in the Supplementary Charge, will bring the Trigger Date to an earlier point in time than may have been anticipated by the parties to a particular DSA. Such acceleration of the Trigger Date could require parties to provide security earlier than they had been anticipating and this may have a significant impact on their finances.  Security is most often provided by means of a Letter of Credit from a bank. Depending on the creditworthiness of the party requesting the Letter of Credit, a bank may require cash collateral in order to provide a Letter of Credit or may deduct the value of the Letter of Credit from a borrower's credit facility – this in turn will impact the financial position of the party concerned and may restrict its ability to invest in other projects.  The need to provide security may also affect any divestment strategies in place, as it may narrow the pool of potential purchasers in a position to fund such security in the near term.
  • In practical terms, operators will have to ensure that all of the parties to a DSA are informed of the anticipated Trigger Date, in line with the revisions caused by the Budget.

Effect post Trigger Date  (Share of Decommissioning Costs)

  • The decrease in the Net Value of any field will inevitably lead to an increase in the amount of security to be provided, as the OGUK Standard formula (used to calculate this amount) makes reference to the Net Value of the field.  It follows that the reduction of the Net Value will directly affect the amount of security to be provided by a Licensee.  The rise in the amount of security to be provided, compared to the previous year, has a very real impact as noted above – it potentially diminishes the ability of the party concerned to invest in other projects, particularly where cash collateral is required or a party relies on debt funding.
  • The effect is also likely to impact the costs of provision of certain types of security under a DSA. A party to a DSA which provides security by means of a Letter of Credit (the most common form of security) is likely to face higher bank fees associated with the larger value of a letter of credit.

Effect post Trigger Date (Decommissioning Plan and Budget)

  • One particular and unexpected effect that may be caused by the uplift in the Supplementary Charge is a requirement for field operators to submit their decommissioning plans to an expert for review.  The OGUK Standard provides for a referral to an Expert, to asses the accuracy of the estimated Net Cost and Net Value, if "the Operator estimates that either Net Cost or Net Value has altered by more than [10/20%] from the Decommissioning Plan most recently approved".
  • Depending on the particular percentage increase and whether this provision of the OGUK Standard is incorporated in a particular DSA, the increase of the Supplementary Charge may trigger the operator's obligation. If an Expert referral is required, this will result in increased costs and delays to the parties in finalising the decommissioning plan for the year.
  • It is also advisable for operators to focus on the timing of meeting the obligations under a DSA. Under the OGUK Standard, the Operator is required to provide a decommissioning plan by 30th June of each Year, which leaves the Operator with a relatively short period of time to complete its estimates for the following Year and for the parties to review the financial impact of the changes. This relative lack of time may also be compounded by the fact that a decommissioning plan is likely to require unanimous approval from the partners in a field and possibly some former partners.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 14/04/2011.

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