The fall in the world price of crude has been at the centre of a number of obstacles that are currently stifling many North Sea M&A transactions. This factor, along with a lack of acquisition finance and the persistent gap between the price sellers want for assets and the one buyers are prepared to pay, is making valuations hard to land. Where late life assets are concerned, decommissioning liabilities, which can often erode any value in what might otherwise be a viable transaction, are proving another major issue, preventing many deals from getting over the line.
Decommissioning is a particular issue for buyers unwilling to take on considerable uncertain future liabilities or unable to provide an acceptable security to sellers. As we head towards this week’s Autumn Statement, many within the sector will be looking for Treasury support on transferring tax capacity from sellers to buyer to partially alleviate this issue and reduce costs for buyers in decommissioning. However, there are also some innovative solutions available to help address the significant issue of decommissioning liabilities, principally involving a retention of those liabilities by the seller. Here part of the seller’s upside in addition to price received is the time value of money saving enjoyed a result of a buyer hopefully prolonging field life and the seller therefore paying for decommissioning at a much later date than it would have otherwise intended.
The starting point is for both parties to have a clear understanding of what liability is being retained by the seller. For example, does this include all liabilities arising from decommissioning operations including environmental ones? It’s important to clarify if the liabilities only apply to existing assets or ones which may change in future if, for example, additional wells or facilities are added to the asset. A buyer must understand whether a liability is fixed, capped or un-capped or whether or not there is room for increase of any cap.
When a liability will accrue and be paid for by the seller is another key consideration – will this come after cessation of production (COP) or is there potential for an interim plugging and abandonment of wells or is any replacement (and decommissioning) of facilities necessary before COP?
Other key points which require clarification include the level of control a seller requires over the decommissioning of an asset; whether there is a decommissioning security agreement (DSA) in place for it and what form of security is being provided (and will be provided) in respect of any retained liabilities. Once these details are determined, there are various options for both buyers and sellers to consider in structuring the decommissioning element of any deal.
The first of these is a transfer and re-transfer of the liability, involving a sale and purchase agreement which can be triggered at the time of COP. An intervening or interim period agreement, which often involves a high level of accompanying administration, will also be required within this structure to regulate a buyer’s activity within a lease period. This approach enables the seller to take back the asset for decommissioning where they can control timing, work and costs. Getting approval and buy-in from any co-venturers involved in a deal can, however, be an issue and it can increase the risk of greater decommissioning and other licence-related liabilities.
A seller can also consider retaining only the monetary liability for decommissioning an asset. They would agree an obligation to pay a share of the costs and to cease to be party to a joint operating agreement when the decommissioning liability is fulfilled. This approach tends to reduce the seller’s exposure and involves less administration although they will have no direct control over decommissioning activities unless there is an agreement to cap these.
A further option is for the seller to retain the decommissioning security but not all of the associated liability. This usually benefits the buyer and can help expedite M&A transactions as few changes are required to the DSA. The seller, however, bears the credit risk of a buyer defaulting and, in such an event, the access to any remaining reserves would be accrued by co-venturers that were involved in the deal.
The seller could also consider paying an agreed amount into a field’s DSA trust, an option which would benefit the buyer at the time of COP. This provides a clean break with the seller facing no further liability in most cases. It can prove an uneconomic use of capital, however, as the seller effectively pays for the decommissioning at an earlier date than it would like. It is also not a tax efficient option as no reliefs are available until the decommissioning costs are incurred.
A final option is for the buyer to take on the liabilities and pay a percentage of their field revenues into a trust fund so as to slowly generate funds to pay for decommissioning. This has found favour among infrastructure fund buyers in particular. While this approach maintains a seller’s exposure for a period, they are able to make a clean break once the trust fund value is suitable to cover the liability costs. It also allows an asset sale to proceed with a buyer which is unable to provide security but happy to take on the decommissioning liability. Potential amendments to the DSA may also be required.
Utilising one or a combination of these innovative decommissioning structures could be key in making more North Sea M&A deals viable. The Chancellor can also help by providing some further tax incentives to reduce the impact of decommissioning liabilities when he delivers his Autumn Statement this week. This is an important issue to address if we are to continue to see significant recovery within the sector.
Norman Wisely, Partner at law firm CMS