We have discussed in our earlier note that the Central Obligation is a broad obligation imposed on the OGA and MER Parties and that this is limited by a number of Safeguards.
The concept of 'Economically Recoverable Petroleum' (ERP), which is embodied within the Central Obligation, is a purely objective test and is defined in Annex 1 of the Strategy as:
"Economically recoverable" in relation to petroleum means those resources which could be recovered at an expected (pre-tax) market value greater than the expected (pre-tax) resource cost of their extraction, where costs include both capital and operating costs but exclude sunk costs and costs (such as interest charges) which do not reflect current use of resources. In bringing costs and revenues to a common point for comparative purposes a 10% real discount rate will be used."
The standard is the maximum value that is economically recoverable by any party, irrespective of individual corporate circumstance.
The 'Satisfactory Expected Commercial Return' (SECR) Safeguard, whilst on one hand objective, does permit a subjective assessment to be made. No MER Party is required to comply with the Central Obligation if doing so would result in a lack of SECR. SECR is defined in Annex 1 of the Strategy as:
"an expected post-tax return that is reasonable having regard to all the circumstances including the risk and nature of the investment (or other funding as the case may be) and the particular circumstances affecting the relevant person."
The apparent (and necessary) mismatch between benchmarks which are wholly-objective (ERP) and those that are not (SECR) could, it would seem, give rise to some interesting issues within a joint venture (JV) which, on the basis of the Oil and Gas UK JOA, are not currently catered for but perhaps should be.
Whilst not expressly set out in Section 9C of the Petroleum Act 1988 (as amended), the generally held position is that the Strategy only governs the relationship between the OGA and each of the MER Parties, and not the relationship between the parties involved in a JV.
We set out below a couple of issues which could arise as a result of a JV seeking to adhere to and implement the terms of the Strategy, and the way in which a JOA could be drafted such that the Strategy and the JOA dovetail neatly.
An 'SECR impasse'
As noted, a MER Party will not be required to comply with the Central Obligation "where they will not make a satisfactory expected commercial return". The test as to whether there is a "satisfactory expected commercial return" takes account of "the particular circumstances affecting the relevant person". This subjectivity therefore means that it is highly unlikely that any two or more JV parties are treated in the same way for the purposes of SECR, thereby with the potential that misalignment amongst the JV is created and/or exacerbated.
In this scenario, such misalignment or impasse would give rise to a delay to potential exploration or development, or even simply delay material JV decisions such as approval of a work programme and budget. Such delay would arguably not be compliant with the spirit of the Strategy in that the overarching rationale is to keep assets moving forward with a view to the recovery of ERP.
In this scenario, and to the extent permitted by the Strategy and/or the licence, a JV could consider incorporating mechanisms into a JOA which, for example:
- provide that in relation to issues requiring unanimity, a passmark vote will suffice irrespective of the terms of the JOA. The risk here is that this cuts across the protections afforded in a JOA and exposes a JV party to an increased cost burden beyond that modelled when entering the JV; or
- provide that a JV party is permitted to exercise some form of non-consent right, whether this be the traditional (and optional) non-consent right included in some JOAs or something new in order not to participate in a particular action. As with the point above, this cuts across the usual JOA protection mechanisms and importantly has the potential to vary the participation by each JV party in the JV matter, thereby varying the participating entities' economic exposure; or
- accelerate some form of withdrawal (whether for market value, a discounted sum or for zero value) from the JOA (and licence) pursuant to its terms, or more radically invoke an accelerated version of the divestment aspects of the Strategy (covered in a later note).
The Energy Act 2016 permits the OGA to sanction the MER Parties. One such sanction is licence revocation, both in terms of the licence as a whole and also in respect of a single licensee only. Such a sanction could be used where there is a failure by a MER Party to comply with the Strategy. The right to revoke a licence is not new, and the law was previously updated as a result of the Energy Act 2008 which permits the partial revocation of a licence (i.e. in respect of one licensee only). The right to revoke under the Energy Act 2016, however, is a right linked to Strategy non-compliance, whereas the longer-standing right to revoke is far narrower and linked to insolvency-type events as well as a non-permitted change of control.
A full licence revocation would appear to be a straightforward case of the licence being revoked and (presumably) re-licensed. However, it is not clear how the right of partial revocation would work in practice at a JV level. Would it simply be a case of that licensee's JOA percentage interest being assigned to any other parties in the JV proportionately or as otherwise agreed, as in the case of a withdrawal? Or would it be the case that the licensee's JOA percentage interest would essentially attach to the licence and a new licensee (assuming one can be found) would enter into the JV after having been added to the licence?
In this scenario, and to the extent permitted by the Strategy and/or the licence, a JV could consider incorporating mechanisms into a JOA which, for example, provide that in cases where the licence is revoked in respect of a single licensee only (where it is part of a multi-party JV), that party's JOA percentage interest is transferred to the existing JV parties (in proportion or as agreed), whether for market value, a discounted sum or for zero value (note, however, that the intention is that licence revocation is punitive and that a non-compliant party should not take any benefit as a result of its non-compliance). If the other JV parties did not wish to acquire such additional percentage interest then provision would need to be made as to the process by which a new licensee (assuming one can be found) is brought into the JV.
Given the radical nature of the Strategy and the potential impact this could have on JV arrangements, we expect there to be a significant amount of debate within unincorporated JVs as to how the Strategy is complied with by the participants. This, ultimately, may lead to the need to review key documentation already in place, and could also warrant a review of model form documentation by Oil and Gas UK.