Our previous article (Evolution of Oil & Gas: The OGA's Net Zero Goals) looked at the general themes of (i) platform electrification, gas-to-wire and offshore wind; (ii) carbon capture and storage (CCS); (iii) the hydrogen industry; and (iv) repurposing of upstream assets referenced in the Oil and Gas Authority (OGA) consultation (dated 6 May 2020 and open until 29 July 2020). Each of these decarbonising options will have differing and varying appeal to individual participants in the UK Continental Shelf (UKCS) depending on their respective circumstances. This article is the first of a series of articles that will provide a more in-depth analysis on each of the general themes considered in the OGA consultation, and what UKCS participants need to know when considering the changes proposed by the consultation. The focus of this article is on CCS as it relates to the upstream oil and gas industry. We have done a great deal of analysis of law and policy regarding the whole value chain of CCS – please get in touch if you would like an in-depth discussion.
What is CCS and why is it important for the offshore oil and gas industry?
CCS (or, as it is sometimes referred to, CCUS – carbon capture, use and storage) is the process of capturing waste carbon dioxide (CO2) that would otherwise be emitted into the atmosphere by fossil-fuelled power generating plants and industrial processes, safely transporting the captured CO2 and either permanently storing it in a geological formation (e.g. a saline aquifer, salt caverns or depleted hydrocarbon reservoir), using it in other industrial processes or to make synthetic fuel. CCS is not a new concept: the upstream industry has long used CCS to optimise revenue returns from depleted upstream assets through enhanced oil recovery (EOR). Large-scale CCS projects are less familiar in the UKCS (particularly when compared with their prevalence in the US associated with EOR for shale oil recovery, and in pockets in Europe, where large projects, such as Norway's government-backed Northern Lights project, are already recruiting potential customers) but the process of storing natural gas in geological formations has long been utilised here (e.g. the Rough gas storage facility offshore, and a number of onshore gas storage facilities in the UK, such as Stublach).
In the UK, the government has made two previous attempts to establish CCS facilities based on individual power station projects. Now, taking advantage of the interest in the technology that has built up among both power generators and other industrial emitters in various "CCUS clusters" around the UK, it aims to establish a UK CCUS industry with a target of having at least two such clusters, and a gas-fired power station with CCS, up and running by 2030. In the March 2020 Budget, the government also announced plans to establish a CCS Infrastructure Fund (of at least £800 million) to support these developments. As well as contributing to the decarbonisation of electricity generation and industrial heat use, CCS is seen as playing a key role in fostering a commercialised hydrogen economy – as a clean burning fuel, hydrogen has a major part to play as a substitute for natural gas in a Net Zero world, provided it is produced without greenhouse gas emissions. Currently, steam methane reforming with CCS is the most cost-effective way to do this (although the resulting "blue" hydrogen is not as low-carbon as hydrogen produced by electrolysing water with renewable power).
The UK has the potential to store more than 78 billion tonnes of CO2 through continued technological advancements to scale up CCS deployment, which would see the UK become a world leader in the process.1 For those involved in the oil and gas industry, in the UK as elsewhere, full exploitation of CCS opportunities offers a double prize. CCS makes it possible for many of its industrial customers to operate without emitting CO2 – this makes it more likely that they will continue to use hydrocarbons and refined hydrocarbon-based products in a carbon-constrained world. Secondly, CCS provides the opportunity to build new businesses out of the industry’s existing assets, which provides an opportunity for new income streams. The OGA consultation and, in particular, the proposal to supplement the existing MER objective with a requirement to assist the government in achieving its Net Zero target demonstrate that oil and gas market participants are seen to have a significant role to play in the development of a CCS industry in the UK – their indispensable expertise in the offshore world, pipeline infrastructure and depleting reservoir bases could accelerate and facilitate the development of an offshore CO2 transportation and storage industry.
Generally, UK CCUS can be divided into four new industries that the government hopes to stimulate (CCUS power, industrial CCUS, low-carbon hydrogen, and transportation and storage (T&S)). Whilst each of these is important to the development of a UK industry, T&S is arguably the keystone, as without it none of the other three would be technically possible. The development of a scalable and commercial T&S industry will take galvanised efforts from existing stakeholders in the onshore T&S industry (given the expected commercial models, onshore T&S may replicate those for onshore regulated networks such as downstream gas and electricity), offshore oil and gas market participants (in respect of offshore T&S) and the UK government (as the nascent industries cannot function without the necessary regulatory support (and some public funding, and may, in part, be assisted with an initial element of public ownership)).
Below, we focus on the prospects for the offshore T&S industry, which we think will have the most bearing on offshore oil and gas market participants, and examine the current regulatory regime and implications of the OGA consultation for UKCS oil and gas participants, as well as the implications and impact the proposed changes will have on the UK's offshore oil and gas industry, particularly relating to the re-use and/or repurposing of late-life oil and gas assets and decommissioning.
Recap: OGA consultation and CCS
The OGA consultation looks to revise the OGA's strategy in order to reconcile, be consistent with and facilitate achieving the UK government's Net Zero 2050 target, whilst continuing to promote its MER strategy, with the view that the change in strategy "will support [the] oil and gas industry to reduce greenhouse gas emissions (GGEs)", and "encourage progress on carbon capture and storage (CCS) and hydrogen projects" (for further details, please see our previous publication here).
There are three main areas of the consultation which relate to CCS:
- first, the overall focus of the consultation and the proposed strategy looks at moving the entire industry towards Net Zero. The strategy notes that there are a number of aspects to achieving this (e.g. reducing flaring, electrifying platforms and hydrogen projects), but CCS is heavily emphasised throughout;
- secondly, the consultation proposes a new Supporting Obligation specifically around CCS projects. This recognises that, where existing infrastructure is or can be re-used for CCS, then the existing offshore oil and gas asset stewardship principles should also apply. This would not only align the approaches for CCS and oil and gas assets (which would provide comfort from familiarity), but would also ensure that operators looking at branching out into CCS would have certainty that the rules of fairness, collaboration and non-discrimination for negotiating access to relevant infrastructure would apply. All of this seeks to foster investment in offshore T&S for CCS; and
- thirdly, in respect of decommissioning, there would be a new requirement that, prior to commencing decommissioning, all "viable" options should be explored and considered, which includes CCS uses. Again, this is seeking to foster investment and collaboration in CCS from the offshore oil and gas industry. This approach is not entirely novel, as the existing decommissioning rules require the OGA to consider alternatives to abandoning or decommissioning offshore installations or pipelines during consultations on abandonment programmes.2 What is new, however, is focusing specifically on CCS uses and placing the onus on the UKCS market participant (rather than the OGA) to consider these issues.3
Existing regulatory regime
CCS has been on the government's radar since 2007 (with the Energy Act 2008 being the first piece of UK legislation on the topic, followed by the CCS Directive in 2009, which was given effect by the Carbon Dioxide (Licensing etc.) Regulations in 2010, further amendments to the Energy Act 2008, and further statutory instruments in 2011), so it is no surprise that a healthy amount of legislation in this area already exists. There are also a number of stakeholders who will be familiar to UKCS market participants: BEIS is responsible for government policy on CCS, whereas the licensing authority for offshore storage in England is the OGA, and the Scottish Ministers in the territorial sea adjacent to Scotland.4 In general, the OGA regulates offshore CO2 storage and the exploration of CO2 storage sites, issues storage permits and maintains the carbon storage public register.5 These are powers that have already been exercised by the Secretary of State (with the Goldeneye field (as part of the now-cancelled Peterhead CCS project) issued a licence in 2012) and, more recently, the OGA (in respect of the Acorn CCS project, which was issued a licence in January 2018).
The existing regulatory regime for CCS has a number of similarities with the regulatory regime for offshore oil and gas:
- storing CO2, operating a storage facility and conducting offshore exploration for appropriate sites requires a licence;6
- developers will also require a grant of rights from the Crown Estate (or Crown Estate Scotland) for seabed leases, pipelines leases and rights relating to wells, platforms and offshore infrastructure;7
- third party access to CCS T&S is aligned with the same third party access rules for oil and gas pipelines and networks, and should be provided on a transparent and non-discriminatory basis;8 and
- decommissioning of offshore CCS facilities is subject to the same decommissioning regime, under s.29, s.30 and s.31 of the Petroleum Act 1998, which will be all too familiar to UKCS participants.9 There are, however, some important differences, most notably that (subject to conditions) the storage site, and with it liability for leakages of CO2, may transfer to the government. One condition of this, however, is that the CO2 storage site owner is required to provide financial security to cover this liability for a minimum of 20 years.10
All of this should provide comfort to existing oil and gas companies that there are similar frameworks in place, should they wish to diversify their experience from the upstream world and look to move into operating CCS projects in the future. However, and as we examine below, not all upstream operators will see this as a viable commercial move, particularly those which do not have the capital to start developing or establishing "non-core" business groups, so there is currently a missing link between the CCS regime and the upstream oil and gas regime as to how these two industries will interact.
Issues and risks
The OGA consultation seeks to place increased onus on the role of developing the UK's CO2 T&S industry on offshore oil and gas companies, given their knowledge of the offshore reservoirs and ownership of existing infrastructure. However, this increased role does not currently have the benefit of a regulatory safety net or safeguards, which is unsurprising given the embryonic stage of the industry and the consultation. Any changes to the OGA's Principal Objective will likely require further regulation to provide offshore oil and gas companies with sufficient comfort to make moves into and/or assist the development of the CCS industry.
As mentioned above, CCS will only be truly viable as a commercial industry with T&S deployment. Offshore operators can take some comfort that the existing regulatory regime for CCS bears similarities to the existing offshore oil and gas regulatory regime in a number of respects, but further regulation, particularly around offshore T&S, will be required. Whilst BEIS launched two CCUS consultations in 2019, the outcomes of these have not yet been published, so the regulatory outlook is still unclear.
What is clear, however, is that significant investment will be required to deploy T&S systems that are capable of carrying CO2 in both gaseous and dense phase states, so costs and funding (and how economically viable these will be) are huge concerns for progressing the T&S industry. As a result, it is also clear that, whatever its initial plan (which may include an element of public ownership), the government's long-term aim is to leverage existing expertise and infrastructure where possible to reduce costs. This is where the offshore oil and gas industry can come into its own – so much so that one of BEIS's consultations looked directly at proposals to re-use oil and gas assets (the O&G CCUS Consultation).11
There are broadly three categories of risks that offshore oil and gas companies should be considering:
1. Decommissioning risk
Perhaps unsurprising given the emphasis of the O&G CCUS Consultation, the OGA consultation, and the requirement for storage facilities in order to make offshore T&S viable, decommissioning and re-use of existing assets and infrastructure is of paramount importance, and is the area where the most regulatory change is likely to be for offshore oil and gas companies. Whilst the government has noted that CCS will not reach commercial scale until the mid-to-late-2020s, in order to reach scale there will need to be some storage facilities and associated infrastructure in place, or at least in development, to meet the new demand from CO2 emitters.12 Under the OGA consultation, the proposed wording could mean that current offshore operators with late-life assets may be forced to hold on to certain assets in order to potentially benefit from CCS revenues when the offshore T&S industry starts to grow, rather than fully exploring EOR recovery for their reservoirs, or simply trying to sell assets to smaller operators able to profit in tighter margin fields. At this stage, what constitutes "viable" is nebulous with regard to timing, commerciality and the progress of other parts of the CCS supply chain, but the ability of the relevant licensees to profit from existing reserves or future CCS revenues will be a key concern and immediate tension for those holding late-life assets both now and in the coming decade.
The concern about how or when fields are decommissioned taps into a real economic issue – the OGA estimates that the total cost of decommissioning UKCS platforms (more than 300) and offshore pipelines (more than 1,000) between 2019 and 2065 will be between £40 billion and £67 billion, with £16.8 billion of this being paid by the Exchequer due to the current regime of decommissioning tax relief.13 If operators are unclear as to whether they should be retaining assets for longer in the hope that they could profit from future CCS revenues, this pot may be closer to £40 billion rather than £67 billion. The OGA expects that 90% of this will be spent before 2040 as UK CCS reaches scale, but it is unclear what impact the proposed changes from the OGA consultation will have on this figure, particularly if assets are re-used or repurposed for CCS.14
The O&G CCUS Consultation looked at a number of issues around decommissioning offshore oil and gas assets. One proposal was to grant the Secretary of State discretionary powers to waive any decommissioning liability for oil and gas operators if their installations were to be used for CCUS. Whilst this seems like a simple and effective solution, industry has recognised that there are a number of issues with this:
- the number of assets that would qualify for this relief is relatively small as there are a number of factors that need to be considered for re-using depleted reservoirs, including location (must be both close to the shore and close to mainland CO2 sources), capacity of pipelines and storage sites, age and condition of infrastructure as CO2 will have a corrosive effect, and the integrity of the reservoir and its seals to avoid leakage. Of the infrastructure, oil and gas reservoirs, and saline aquifers in the UKCS, the government has identified only 51 pipelines (approximately 5% of all offshore UKCS pipelines) and 123 potential storage sites (approximately 25% of all offshore UKCS fields). Whilst CCS is being positioned as a potential benefit for the entirety of the offshore oil and gas industry, it would only be viable to the operators of those pipelines or sites, which represents only a small number of existing UKCS upstream companies;
- the lack of clear rules regarding the transition of an asset from upstream oil and gas to CCS deployment is unfavourable. All indications from the government's current approach to CCUS is for disaggregated commercial models, whereby different stakeholders will own and operate different parts of the CO2 service chain. This means there is a high probability that the operators of the CCUS emissions clusters are not the same as the operators of the T&S infrastructure. Without clear rules around handover and transition, it is unclear whether the expectation is for CCUS cluster companies to start venturing into the offshore world to secure T&S capacity, or for oil and gas companies to start developing divisions solely dedicated to converting their existing assets to be CCS-compliant. Neither of these approaches is straightforward and may act as a further barrier to investment in both CCS and late-life offshore assets. Whilst there are a number of larger oil and gas companies already involved in CCUS clusters (notably the involvement of BP, ENI, Total, Shell and Equinor as members of the Oil & Gas Climate Initiative in the Teesside CCUS Cluster) who can leverage their offshore knowledge, for smaller "upstream-only" players, there is a stark reality of "evolve or die";
- the technical realities of converting existing oil and gas infrastructure to be CCS-compliant will require at least some decommissioning or upgrade work. Whilst it would be sensible for the outgoing oil and gas company to work together with the incoming CO2 storage operator to manage the transition and the technical aspects of this, there is no true clarity as to who would be responsible for undertaking and paying for these limited decommissioning works. It seems counter-intuitive that the oil and gas company could be absolved of the decommissioning liability, and that all the risk of converting oil and gas infrastructure for use in CCS should be placed on companies who have not had the benefit of the reservoir and pipeline data for potentially significant periods of time (not to mention the residual decommissioning costs that will fall due at the end of the CCS operational life cycle). There are also questions as to the value to industry that comes with potentially deferring decommissioning costs, which are likely to form part of discussions with the OGA on the re-use and repurposing of offshore oil and gas assets.
Decommissioning risk is a topic of huge importance for upstream operators. We will explore this issue and different decommissioning regimes in more depth in a future article in the coming weeks.
2. Operational risk
The hallmark of operational governance in the offshore oil and gas industry is the use of joint operating agreements (JOAs) to create unincorporated joint ventures between multiple companies to make decisions related to the development of the project. Typically, the JOA will cover development of exploration, appraisal and production plans, budgeting, how much each participant should contribute to fund the relevant plans, and what happens if they fail to meet those payment demands.
The latest versions of the UKCS industry model JOA include specific provisions related to the development of decommissioning and abandonment plans, but it is highly unlikely that these would specifically cater for plans which contemplate converting assets for CCS use. Therefore, it is probable that adopting the OGA consultation's proposals will spark new discussions and dissenting views amongst JOA participants as projects move towards decommissioning phases. Whilst JOAs will include rules around passmarks for voting on key issues, it is likely that this new perspective for decommissioning may cause some new developments. For example, if the participants agree on a majority basis to progress decommissioning without CCS, and the minority participant(s) disagrees and foresees a decommissioning project with CCS, when the decommissioning plan is proposed and discussed with the OGA and Offshore Petroleum Regulator for Environment and Decommissioning, how proactive will the regulatory bodies be to explore the minority view? How would this view change if the CCUS industry is lacking viable offshore T&S stock?
Whilst oil and gas companies may want to start seeking thoughts about transitioning to CCS projects from their fellow participants sooner rather than later, and understanding what their protections are or could be under the relevant JOAs in case they hold minority views, it is clear that pushing the CCS envelope is not going to suit all UKCS market participants. This could well lead to increased activity in sales of late-life assets as smaller "upstream-only" companies seek to offload their interests in potential CCS projects in order to focus on their core extractive activities. Combined with the introduction of transferable tax histories for oil and gas asset sales in the UK in 2019, this could see the next (and possibly final?) boom of oil and gas M&A in the mature UKCS basin.15
3. Wider CCS industry risk
Although the T&S industry will be key to unlocking the potential of CCS in the UK, it only forms part of the industry as a whole. Whilst there are clearly specific risks for offshore oil and gas companies to consider (outlined above), there are also industry-wide issues that potential offshore T&S stakeholders will need to consider:16
- "cross-chain risks": as with all value chains, the chain is only as strong as the weakest link. With the proposed disaggregation of the CCS value chain, there is an increased risk that non-performance of one part of the chain will have a financial impact on others in the chain (e.g. if a CO2 emitter has an unplanned maintenance period, how does the CO2 storage operator protect itself from lower levels of activity?). These types of risks will be familiar concepts to offshore oil and gas companies that deal with "take-or-pay" and minimum supply obligations in their existing oil and gas service chains to protect their own transportation revenues from shut-ins and reduced production profiles;
- stranded assets: given the formative nature of the CCS industry, there are concerns about certainty of CO2 supply. The current absence of CO2 supply for storage will mean that the initial T&S companies will be taking the risk that their assets and infrastructure will be used later in the process. However, there is the potential that the CO2 supply line for a specific asset does not come to fruition, leading to stranded assets and potentially significant sunk costs. For the offshore T&S pioneers, this is clearly linked to the concerns around when and how to decommission, and any maintenance that may be required in anticipation of potential CCS projects. There are also concerns around "competitive risk" – some of the CCUS clusters being proposed (and, therefore, competing for public funding) are looking at similar offshore pipelines and storage sites for use. Whilst the assumption is that not all clusters will necessarily reach commercial viability, if none do, then the stranded asset risk increases greatly. Conversely, if all the clusters progress, then there are likely to be capacity issues from the start. Again, these risks around potential stranded assets are not new to the offshore oil and gas world as they were a key factor leading to the establishment of the MER strategy, so there are some learnings that oil and gas companies can offer;
- leakage liability: there is a significant investment risk for all CCS entrants as the CCS Directive and the UK's implementing regulations do not place a cap on liability for CO2 leakages, and do create a period of continuing liability post injection of CO2.17 Leakages would require repayment of emissions trading certificates at the prevailing price at the point the leak occurs, along with clean-up, remediation and repair costs, so the costs are highly uncertain. Whilst the risk of leakage is relatively low, the associated liability could be huge. By its very nature, the uncapped risk without a fixed duration is difficult to assess, price and insure against, so acts as a significant barrier to investment for individual companies and financiers. The CCUS Advisory Group (CAG) report indicates circumstances where the government may act as an insurer of last resort. Given the difficulty of assessing and pricing for insurance for leakage liability, this may well be a qualifying scenario for the government to act as insurer (albeit, this is unlikely to be free, so the costs of government insurance will need to be factored into development and operating costs of CO2 storage facilities);18
- funding and regulation: as with any new policy direction and development of a new industry, the two key issues for potential investors and stakeholders concern what the rules are and who is paying. These are significant questions that are still unanswered, although one would hope that, as the two CCUS consultations last year have been closed since September 2019, there will be some news on this in the coming months. While other finance structures (for example, project financing) will need to be explored and carefully evaluated (with some developers potentially looking at a balance sheet financing solution for T&S), the CAG report indicates that government favours adopting a regulated asset base model (RAB) for the T&S industry. This model would guarantee a certain level of revenue and thus reduce the weighted average cost of capital, while supporting an influx of third party financing (both equity and debt) by optimising the allocation of risk by passing through allowable costs to end-users, and provide credible assurances of returns to investors through periodic reviews and incentives to deliver future investment costs efficiently. It is unclear whether the RAB model would apply to both onshore and offshore T&S, who would be the regulator(s) and if these industries would be regulated separately or together. Given Ofgem's experience with RAB models in relation to downstream gas networks and electricity onshore, and the OGA's current regulatory role in relation to offshore infrastructure on a negotiated access basis, it would be surprising if they did not take on similar roles in relation to CCS T&S, and if the entire T&S industry was regulated together. The OGA certainly expects that it will have a role as offshore T&S regulator, given the proposals in the OGA consultation for the rules on asset stewardship and access to infrastructure to extend to CCS installations.
Conclusion: what is the outlook for oil and gas companies and CCS?
It is important to recognise that we are still in the early stages of the UK's CCS journey. By its own admission, the government recognises that full-scale commercial projects are still up to a decade away. As with many Net Zero targets and ambitions, this may well be revised down further if important technological, financial and regulatory hurdles can be overcome in the short term.
In the meantime, there are a number of important problems that will need solving that oil and gas companies will be finely attuned to: concerns around decommissioning liability, the development of a detailed regulatory framework for offshore T&S, clarity on levels of public funding and costs to upgrade existing infrastructure will all need to be resolved before offshore oil and gas companies will fully reap the rewards from CCS.
Whilst the outlook for oil and gas companies currently looks uncertain, it is clear that for those brave enough to evolve and adapt to the incoming CCS and Net Zero world, there are plenty of opportunities on the horizon. The government's specific consultation on the re-use of offshore oil and gas assets is testament to the fact that, in the government's view, the offshore oil and gas industry has a wealth of knowledge and experience that it can lend to developing the UK's CCS industry into a world leader. Whether these opportunities will be directly open to all offshore participants remains to be seen as limitations on the infrastructure and assets that can be used already exist. Even if a company does not directly invest in CCS projects, there is an inherent indirect effect – CCS will enable upstream operators to continue to exploit fossil fuels for petroleum products for longer than was previously envisaged, in a sustainable manner that does not further damage our fragile environment