The offshore oil and gas industry in the North Sea is experiencing a defining period in its history.
The implementation of the Wood Review brings with it a promise that a new regulator, the Oil and Gas Authority, will be in place by the end of the year with the potential to change the operating landscape for those active or looking to participate in the North Sea. In a parallel development, the Offshore Safety Directive will require significant changes to offshore environmental and safety regulatory functions.
As a mature basin, the North Sea is experiencing a continued decline in production levels and the political and fiscal landscape is uncertain in the run up to this year's Scottish referendum on independence. Yet the sector remains buoyant with increasing levels of investment in new field developments and an expected increase in M&A activity.
There is an ongoing shift in the North Sea players from the majors to independents. This shift has implications for M&A transactions in the North Sea and for the developing regulatory regime. It is clear that the next few years will be pivotal for the industry.
We highlight below some increasingly important key points to consider in North Sea M&A transactions.
Heads of terms (HOTS)
The importance of detailed and fully negotiated HOTs should never be overlooked. A hands-on approach is crucial to avoid later ambiguity on the terms of the transaction.
Whilst a share deal generally avoids delays from the potential exercise of any pre-emption rights under older JOAs, the acquisition of unwanted assets and/or liabilities is an issue buyers will need to address, as is the additional diligence required on the historic liabilities of the target.
DECC licensee approval
An awareness on both sides as to what DECC is likely to require is essential to minimise the risk of a deal falling through. The requirement to provide a PCG or other security could make a proposed acquisition unviable for a small independent.
As deals become increasingly complex in nature, and new juniors seek to enter the market, early consultation with DECC is strongly advised.
Effective administrative management of the transaction (PEARS, Master Deed) and obtaining of third party consents can still be the cause of major delays to completion of a transaction. The increase in small independent players, especially where the transfer results in a small company becoming an operator, means disputes between the seller and third parties as to the JOA requirements for assignment approval are increasingly common.
The apportionment and correct treatment of liabilities for decommissioning and environmental remediation and catering for decommissioning security is of increasing importance. Many assets are coming onto the market with relatively little production left and high decommissioning costs. As a result, negative asset valuations, more imaginative structures under which sellers agree to pick up some (or all) of the decommissioning liabilities and an increase in disputes between partners as to when it's no longer economic to continue production are becoming increasingly common.
Decommissioning relief deeds (DRDs)
Participators in DRDs can now free up capital by posting security net (that is post-tax relief) under decommissioning security agreements. The DRD also establishes the amount of tax relief participators will receive in both default and non-default scenarios and allows participators to claim shortfall payments if the level of tax relief is not achieved. Careful review of any DRDs in place (or that should/could be in place) post- and pre-acquisition or divestment is important.
Environment and safety liability
Environment and safety due diligence is always important on offshore oil and gas transactions, but rarely has it been more in the spotlight both at government and industry level. Following Deepwater Horizon the EU has passed new legislation, the Offshore Safety Directive, imposing new reporting and safety management requirements on operators and extending offshore environmental liability. Parties to transactions need to understand these new requirements, not only to gauge levels of current compliance, but also to understand the potential future liability exposure involved in acquiring licence interests under the new legal regime.
Sellers are increasingly reluctant to provide full warranty coverage on share deals. Accordingly, buyers need to give consideration early on in the process as to the level of, and methods to achieve, risk sharing on transactions (for example, by way of warranty and indemnity insurance or upfront consideration adjustments).
Drilling rig and accommodation vessel providers under a bareboat charter arrangement could see up to a 10 per cent increase in tax costs. Legislation introduced to cap the amount of lease payments allowed as a tax deduction (arising as part of a composite service) will be calculated by reference to the historical capital cost of the asset which is subject to the lease. Legislation will also introduce a new form of ring fence applicable to composite activity, where relevant profits will only be taxed at standard corporation tax rates, but will no longer be reduced by other tax reliefs derived from activity outside the UKCS. How best to capture liability for these costs should be considered from the outset of a transaction.
The new Competition and Markets Authority (CMA) has already shown itself willing to be more interventionist in the application of the UK merger control rules. It is important to check the position from the outset of a transaction and to carefully consider whether or not any filings will need to be made. If the CMA chooses to investigate a transaction of its own initiative, it can impose "hold separate obligations" to prevent any further integration of the two businesses until the CMA investigations are concluded. These obligations can be extremely onerous on the parties concerned and highlight the importance of considering the application of the merger control rules from the outset.
Upcoming industry changes
thought should be given to future proofing transaction documentation to the extent possible in anticipation of the introduction of a new regulator as a result of the Wood Review. The same applies to the potential of an independent Scotland by September of this year, which could result in a division of Britain's North Sea assets.