The UK Government has a formidable array of statutory weapons at its disposal to ensure that the cost of decommissioning offshore installations and pipelines does not default to the tax payer. The regime has proved so effective that it has adversely effected new investments as well as the liquidity of existing UK offshore oil and gas interests.
These unintended consequences have compelled the Government to re-consider its approach. There is a lot at stake. Projected expenditure on decommissioning of oil and gas infrastructure in the United Kingdom Continental Shelf (UKCS) through to 2040 is around £35 billion. At the same time, the remaining oil and gas reserves are estimated at over 20 billion BOE. Accordingly the Government faces a delicate balancing act. Decommissioning security is a pressing concern but so is the need to attract fresh capital to maximise the recovery of the remaining reserves.
This article provides an overview of the statutory decommissioning liability regime for off-shore installations in the UKCS and outlines recent novel proposals from the UK Government to increase capital available for new investment by providing certainty on tax relief for decommissioning expenditure.
UK decommissioning liability regime
The legal framework for decommissioning liability is set out in the Petroleum Act 1998 (Petroleum Act) and is administered by the Department of Energy and Climate Change (DECC). The framework was strengthened considerably through the adoption of a suite of amendments in 2008.
Section 29 of the Petroleum Act empowers DECC to service notices (section 29 notices) on eligible recipients requiring them to submit a decommissioning programme for approval in relation to offshore infrastructure. Current practice is for such notices to be issued by DECC when a field development plan is approved and construction of the infrastructure has commenced -- long before the date for submitting the decommissioning programme is notified.
Key features of the liability regime include:
- Obligations derived from the OSPAR Convention to remove completely off-shore installations (excluding pipelines) unless a specific derogation applies.
- The wide group of entities eligible to receive section 29 notices. This includes certain obvious recipients, e.g. the licensees, the operator, the parties to the joint operating agreement and the owners of the infrastructure. However, DECC also has the power to issue section 29 notices to their parent companies and other associated companies.
- DECC's power to withdraw a section 29 notice following a transfer of the recipient's interest in the relevant infrastructure, although it has no obligation to do so. DECC's policy is to keep the section 29 notice in place if it is not satisfied with the credit of the other section 29 notice holders.
- Even where a section 29 notice is withdrawn, the former holder of the notice remains at risk of being required to carry out a decommissioning programme under section 34 of the Petroleum Act (and so do its parent and other associated parties that could have been issued with a section 29 notice during the period it held its interest). This causes a ‘Hotel California’ problem: you can check out but you can never leave.
- The effective imposition of joint and several liability on entities with responsibility for decommissioning irrespective of their respective participating interests.
- DECC's ability to block asset transfers and to intervene where there is a direct or indirect change of control of an asset owner to require a disposal of the relevant assets to another entity (failing which the relevant licence interests may be terminated)
- Statutory rights to require a person responsible for decommissioning to post security or take other action required by DECC at any time.
Although the government has extensive power to impose decommissioning liability on persons who no longer hold a section 29 notice and have no remaining interest in the relevant infrastructure, DECC's policy is to use such power only has a measure of last resort and has not exercised such power to date. In other words, the section 29 holders are the entities in the firing line and DECC has not yet had occasion to fall back on the reserves.
The regulatory regime has had a significant impact on transactional activity. The negotiation of decommissioning security arrangements has become a major hurdle to deal execution. One reason for this is that major oil and gas companies are selling down their mature UKCS interests and many of the buyers are not as creditworthy as the sellers. Accordingly, fearful of their continuing exposure to decommissioning liability, sellers and co-venturers seek security from buyers (although a seller's desire to offload its assets sometimes tempers its demands for security).
These negotiations have become even more challenging following the deterioration of corporate and bank credit ratings in the wake of the global financial crisis.
Decommissioning security agreements
In recent years the oil and gas industry, in consultation with DECC, has developed model form documentation for decommissioning security. DECC's involvement is significant as DECC has made it clear that such arrangements may be taken into account as part of DECC's own assessment of decommissioning security risk so long as they meet DECC's specific requirements.
These agreements are separate from the underlying joint operating agreements and provide for security to be held by independent professional trustees. Former owners (who may be direct parties) have rights under such agreements in recognition of their continuing exposure. Net cost and net value estimates used to calculate the level of required security pursuant to such agreements are subject to periodic independent evaluation.
Providers of decommissioning security prefer to issue corporate guarantees rather than procure LCs or similar security that tie up capital. Acceptance of guarantees by contractual counterparties turns on whether the guarantor has acceptable credit (usually defined by reference to specified minimum credit rating). Fixing the minimum credit rating is a key point of negotiation.
Decommissioning tax relief
Although significant tax relief is available for decommissioning costs, to date decommissioning security has been calculated on a pre-tax basis without any regard to such relief. The approach reflects the reality that there is no certainty that such relief will continue to be available. As a result the level of security provided covers the Government's ‘share’ of decommissioning costs in case the Government decides to legislate its share out of existence. A foretaste of this scenario occurred in 2011 when the Government shocked the oil and gas industry by increasing the income tax rate on profits from oil and gas production and simultaneously announced that tax relief on decommissioning expenditure would continue to apply at the old rate.
The resulting outcry combined with the growing recognition of the importance of continuing investment in the UKCS has since persuaded the Government to take a number of measures to encourage fresh investment in the UKCS. One of these is the adoption of novel proposals intended to increase tax certainty for decommissioning relief. – Legislation incorporating these proposals is currently before Parliament and is expected to be adopted later this year.
The proposals envisage that the government will enter into agreements with owners of offshore installation. These agreements will be known as ‘decommissioning relief deeds’ and are intended to provide certainty over the rate of tax relief that owners of offshore oil and gas infrastructure will achieve in relation to their own share of decommissioning costs. These agreements will also ensure that relief is also available where current or former owners of such infrastructure incur such costs due to the default of other parties.
In effect, the government is proposing to enter into a form of stabilisation agreement that will provide redress in the event that future changes in law reduce the tax relief available for decommissioning expenditure. The object of the decommissioning relief deeds is to reduce the amount of credit tied up in decommissioning security arrangements and release the associated capital for investment in new upstream ventures.
These novel proposals do not go so far as to offer redress if the rate of income tax imposed on upstream activities is increased in the future. They nevertheless represent a bold attempt to promote investment by addressing political risk in a highly developed jurisdiction.