With security of supply in the public eye and with the Government seeking to maximise the benefits of the mature North Sea oil and gas industry while laying its hopes firmly on the burgeoning offshore wind energy to satisfy its climate change goals, clarity on how one of the potentially thorny conflicts in the North Sea would be resolved has finally been published.

The Crown Estate is responsible for managing and maximising the use of the seabed around the UK up to the 200 nautical mile limit. However its leasing of the seabed to offshore installations (such as offshore wind) has the potential to conflict with the development of oil and gas reserves discovered in the same area. The oil and gas clause, included as standard in The Crown Estate offshore agreements for lease and leases, permits The Crown Estate to terminate or change the agreement for lease/lease at the request of the Secretary of State where the interests of a renewable developer conflict with those of an oil or gas developer.

To date no such conflict has arisen but the threat of an offshore renewable project being scrapped has been seen as a deterrent for investors and has been consistently lobbied against by the renewables industry. Originally, the Government offered no compensation in the event that The Crown Estate exercised this right, then, in July 2011, a ministerial statement from the then Energy Secretary, Chris Huhne, provided some indication of the Government’s intentions: assurance that the Secretary of State would not request The Crown Estate to terminate an offshore wind farm lease unless the oil and gas developer had agreed to pay appropriate compensation – either as agreed between the parties or determined by an independent valuation process.

The fact that it has taken three years after this ministerial statement, for the Department of Energy and Climate Change (DECC) to publish guidance on how such compensation should be determined is perhaps an indication of how difficult it has been to resolve the competing interests involved. 

One concern of the oil and gas industry was whether oil and gas developers had sufficient visibility of potential renewable developments to be able to predict when conflicts might arise – the Government and The Crown Estate have already taken steps to address this including by setting up a process for 27th and 28th round oil and gas licences for applicants to be able to check for possible conflicts before submitting applications, by publishing maps setting out areas licenced or permitted by both entities, and by establishing a process to alert petroleum licence holders and allow them to make representations before agreements to lease are entered into which might conflict with their licences.

The guidance

If the parties are unable to reach agreement on the compensation to be paid for the determination, in whole or in part, of a renewables agreement for lease or lease, an independent valuer may, with the consent of the Secretary of State, be appointed to determine the level of compensation payable to the renewable developer. The principles set out in the guidance apply to all leases/agreements for lease regardless of whether or not there exists any physical overlap between the areas of lease/agreement for lease and oil and gas licence.

The guidance provides details of the process by which an independent valuer would be appointed, what principles would need to be taken into account to set the level of compensation and practical steps that would apply following the appointment of the independent valuer and the giving of the valuation. Some of the key issues are set out below. Conditions for a valuer to be appointed   

  • Have the parties failed to agree through negotiation? The guidance begins by stressing that it would primarily be up to the developers concerned to find a solution by negotiation. The Government has discretion to decide if the parties have really made every reasonable effort to reach a commercial agreement on the level of compensation. If not, the Government can ask the developers to go back to the negotiating table. This power, coupled with the responsibility of the oil and gas developer, unless agreed otherwise, to pay for the costs of the independent valuation should act as a deterrent for spurious claims.   
  • Is the termination really necessary? The Government will reject the request for the valuer to be appointed (and by implication, the request for the lease to be terminated) unless the oil or gas developer can demonstrate that the termination of the agreement for lease/lease is necessary for the oil or gas development to proceed. In order to demonstrate this necessity, the oil and gas developer will need to submit information on alternative locations, options for co-existence and technical solutions which have been assessed and the reasons for ruling these out, and confirmation that the determination sought is for the smallest area reasonably necessary for the oil or gas development to proceed. The emphasis on the oil or gas developer needing to prove that it needs the renewable project to be scrapped for the oil or gas development to proceed, will be welcomed by the offshore renewable industry.

Interaction with oil and gas development consent

A principal concern of the oil and gas industry was that an operator might be obliged to pay compensation without knowing whether or not the Secretary of State was prepared to consent to its development so that if the development was later turned down the compensation would have been wasted.  This might happen because the development proposal was deemed technically inadequate or because the Secretary of State had decided to prioritise renewables development in the area.  The guidance addresses both possibilities:

  • When considering whether to permit the appointment of the independent valuer, the Government will consider whether the oil or gas development seems technically viable based on the information with which it has been provided. While it is not clear how extensive such a consideration will be, more marginal developments may have a harder task on their hands.  In general, however, the industry may take some comfort from this statement in the guidance, even though “the agreement of the Secretary of State to appoint an independent valuer and his preliminary view on technical viability will be without prejudice to any later decision on the technical assessment of the Field Development Plan”,   
  • The guidance goes on to state that any decision by the Secretary of State to appoint an independent valuer will not be made without some consideration of the significance of the matters set out in section 47A of the Petroleum Act 1998. (This section empowers the Secretary of State when exercising his powers under the Petroleum Act, which  include the authorisation of developments, to take into account the fact that activities connected with the generation of electricity are taking place or may take place in the area.) Any such appointment may therefore be taken as an indication that he does not object in principle to the exercise of the oil and gas clause and a possible reduction in the generation capacity of the offshore renewables project.

Further comfort will be obtained from the fact that the Secretary of State may, at a later stage in the process, provide a letter of assurance to the oil and gas developer stating that, at the point in time when compensation is paid, he is not aware of any reason why consent to the Field Development Plan (FDP) should be refused, subject to a satisfactory technical assessment by DECC of the FDP when it is submitted; and that in particular, he is not, at that point in time, aware of any reason why he may refuse consent to the FDP for wider policy reasons, such as increasing or securing renewable energy supply.

How is the valuation made?

If the Government agrees to the application to proceed to independent valuation for compensation, the independent valuer will be expected to make his assessment on the basis of the principle of equivalence as applied in circumstances of compulsory purchase, which aims to put the claimant in the same position, so far as financial compensation can do so, as if the lease or agreement for lease had not in fact been determined. This will require him to assess the overall economic impact of determination on the renewable development and developers, examining a number of factors including wider industry developments and level of the project’s maturity. So, for example, determining an agreement for lease that has only recently been granted may result in a smaller payment compared to an agreement for lease that has been held for longer and where the relevant offshore renewable development may be further advanced.

Once the Secretary of State has agreed to appoint an independent valuer and has notified the parties of this, the offshore renewables developer will be expected to take reasonable steps to mitigate his losses from that point onwards, consistent with normal practice in cases of compulsory purchase. There is no expectation that the offshore renewables developer needs to take any steps to mitigate losses before this point. This may be something of a disappointment to the oil and gas industry which may have hoped for some greater recognition of the fact that the oil and gas clause exists in agreements from the outset.

Conditions for termination of the agreement for lease/lease

Only if the oil or gas developer is willing to pay the compensation and the compensation is paid (or a binding agreement about how it would be paid is in place) within 3 months of the oil or gas developer confirming to Government that it is willing to compensate the renewable developer, will the Government direct the termination of the agreement for lease/lease. The renewable developer is not obliged to refund the compensation if the oil or gas development does not proceed as initially planned.

For a copy of the guidance, please click here See also TCE’s guidance to Petroleum Licence Holders of January 2014