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CMS: New models for old oil platforms?

Offshore construction platform

Decommissioning is now a significant part of the landscape of activity in the UKCS – annual decommissioning expenditure has topped £1 billion since 2015 and may come close to £2bn when Oil and Gas UK reports its estimate for 2018 later this month.

From only two or three decommissioning programmes a year at the start of this decade, last year BEIS approved eight programmes, a figure already equalled in 2018 and there are 15 others under formal consideration with many more in the wings. With this significant workstream, allied with the pressure from both shareholders, partners and the OGA to reduce decommissioning costs, it is not surprising operators are looking for innovative contracting models to produce efficiencies and synergies.

Some of those models are already available, such as the development of contracting consortia to provide bundles of decommissioning services – examples include those between Axis/Costain/BMT Cordah/DNV GL and LR/WorleyParsons/Ardent. There have also been steps towards the development of well plugging and abandonment (P&A) clubs, by Wellsafe, for example. We also have the prospect of a fully turnkey decommissioning solution which covers both well P&A and platform decommissioning services from the likes of Decom Energy.

All of these models are structured in the traditional manner, with the operator engaging a contractor to provide services to it. The operator remains in ultimate control of the process. Until now, what has not been feasible is for an operator to transfer to a contractor ownership of assets to be decommissioned along with a fixed amount of money expected to be sufficient for the decommissioning.

The aim of this approach would be for the contractor to have full discretion over how they carry out decommissioning, and to bear the risk of costs exceeding the transferred amount, but also to be able to make increased profit by reducing the expected cost. For instance, rather than each decommissioning programme being planned and run on a bespoke basis by an operator who may only have a decommissioning project once or twice a decade, such a contractor could develop significant continuing expertise in managing decommissioning projects. It could also assemble a collection of platforms in an area to decommission on a campaign basis, engaging a rig to carry out P&A on each field in turn, or a heavy lift vessel to spend the summer going from platform to platform removing topsides in whatever order made most sense without needing to refer back to the various operators to agree the schedule.

The primary obstacle to this approach has been decommissioning tax relief. Owners who have paid significant tax on their production during the life of a field are able to set off against that tax the expenses of operating the field. Where decommissioning is concerned, this will result in an offset against tax liabilities for other ongoing oil and gas operations or, if there are none, a tax rebate from HMRC.

Since oil and gas field owners pay tax at a much higher rate than typical corporation tax, their tax relief is correspondingly higher. It makes no commercial sense to transfer the assets to a contractor who is only able to set off the costs of decommissioning against tax paid at standard corporation tax rates. Even if the contractor is able to decommission the assets more efficiently and cheaply than the operator, such savings could not outweigh the tax advantage available to the owners. Instead, owners have sought to transfer late life assets to other operators, with different strengths, who can operate those fields in their later life, build up some oil and gas tax capacity and set the cost of decommissioning off against that tax history (although with some assets, the remaining value of the field is such that insufficient tax capacity can be generated and the seller has to retain some decommissioning liability for the deal to be economic for the buyer).

With the expected advent of transferable tax history (TTH) in November’s budget however, such an arrangement becomes at least a possibility, since the operator could transfer to the contractor part of its own tax history along with the asset. Is this therefore a model we are likely to see anytime soon? There are a number of reasons why such arrangements are likely to continue to be challenging. First, under the Petroleum Act 1998, the operator and its partners at the time of the transfer, and indeed their predecessors as owners of the field, will retain either actual or contingent liability for its decommissioning. The owners will of course need to pay the contractor to take the asset off their hands but, quite rightly, cannot wash their hands completely of responsibility for it. If the contractor were to become insolvent before completing the decommissioning, BEIS could require the owners to come and complete the job. Even if the contractor is required to place the funds it receives from the owners into some form of security structure so they remain available for the costs of decommissioning the platform, the owners will still need to be certain the contractor is financially robust enough to take the risk of cost overruns on this and all of the other projects it takes on.

Few contractors have this level of financial muscle. The owners will also be concerned with the potential reputational risk to them if the contractor cuts corners on the job to increase its profit, and causes nuisance or environmental harm. They are therefore likely to wish to have considerable control over the process of decommissioning, which may negate some of the original advantage of the model by limiting the contractor’s freedom of action. In short, while the development of UKCS Decommissioning PLC might offer significant efficiencies and cost savings, it’s not something we are likely to see anytime soon.

Penelope Warne, the senior partner, CMS

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