Attracting more than 130 attendees from all over the country, King & Spalding’s first Energy Forum for 2017 held at the Houstonian Hotel in Houston tackled one of the most important issues facing the industry: Decommissioning and abandonment of oil and gas assets in upstream operations. Industry leaders in the corporate and legal arena discussed the challenges of the decommissioning process as oil and gas assets mature, oil prices remain low, and environmental regulation raises the cost of doing business. Industry experts, including some of the panelists at the event, are estimating that based on recent studies there will be 600 decommissioning projects occurring globally in the next five years, with a projected cost of approximately $13 billion by 2040. And industry leaders predict, decommissioning will remain a pressing concern for companies in the Energy sector for decades to come.
At the forum, panels of experts discussed emerging issues concerning decommissioning, including managing and allocating risks, strategies for accomplishing legal compliance and potential disputes surrounding the process.
Below are some of the highlights from the event.
Managing and Allocating Decommissioning Risk in Upstream Assets Acquisition and Divestment Transactions
Moderated by Merrick White, a Partner in King & Spalding’s Global Transactions group, the panel covered the risks concerning decommissioning under two different government petroleum contracts: a license regime and a production sharing contract (“PSC”).
In the context of a typical joint operating agreement under a license regime similar to that in the U.S. Gulf of Mexico, federal regulations would make the seller of assets jointly and severally liable in perpetuity for remediation and decommissioning obligations. The panelists recommended proactively mitigating this risk though financial and legal means. Financial methods include surety bonds, insurance policies covering future exposure, or keeping a certain amount of proceeds in escrow. Legally, sellers should consider indemnification contracts and rights to approve the operator.
With respect to PSCs, the language of the agreement is key. Many early PSCs do not contain provisions explaining the parties’ decommissioning responsibilities. Even so, the host government often requires contract parties to contribute to decommissioning costs. The panelists noted that such a requirement could implicate bilateral or multilateral investment treaties and the host government contract’s stabilization provisions, which address changes in law following the execution of the contract.
Regardless of the governing regime and legal options available, the panelists stressed the need to keep in mind the reputational harm of an attempt to avoid paying for decommissioning costs.
Abandonment and Site Remediation (ASR) Strategies for Accomplishing Legal Compliance and Cost Effectiveness
Led by Jim Vines, Partner in King & Spalding’s Tort & Environmental Group, this panel offered suggestions on how to implement decommissioning in compliance with applicable laws and regulations in a cost-effective manner.
The panelists discussed accounting for decommissioning in the asset’s purchase and sale agreement. The panelists emphasized the need for due diligence on the buyer’s financial security and backing to support decommissioning liabilities. They also weighed the implications of specifying the buyer’s obligations in the agreement, noting that this reduces the seller’s risk but also likely reduces the value of the transaction. Given the environmental implications of ASR, both regulatory and real world, the panelists recommended early consultation with environmental experts.
The panelists also noted that decommissioning requirements vary depending on location. The panelists described certain markets, such as Brazil, Africa, and the Asia Pacific markets, as providing some flexibility with respect to decommissioning requirements. In comparison, decommissioning in the North Sea is governed by the Oslo Paris Convention (“OSPAR”), which generally requires removing all of the surface and subsurface assets. But even in developed regulatory systems like the U.S., the EPA, Bureau of Ocean Energy Management (“BOEM”), and Bureau of Safety and Environmental Enforcement (“BSEE”) are still developing decommissioning regulations and industry should play an active role in that process. The panelists noted that differences in the regulatory regime and particular decommissioning requirements could lead to orders of magnitude differences in the cost of decommissioning. Combined with more favorable regulatory regimes, strategic regulatory and scientific advocacy for less costly decommissioning approaches can mean the difference between decommissioning projects costing in the hundreds of millions of dollars versus costs in the tens of millions of dollars.
To industry’s advantage, the panelists described several studies showing the benefits of leaving certain subsea infrastructure in place, which the panelists themselves had used to negotiate with government entities more cost-effective decommissioning methods. For example, studies show that these structures become artificial reefs and are linked to increased fish populations.
With respect to the process, King & Spalding Global Transactions Partner Scott Greer explained that owners sometimes contract with multiple entities to perform ASR, essentially acting as a general contractor. Given the scarcity of decommissioning resources , he cautioned parties to protect themselves from liability in case resources arrive late, leave early, or fail to arrive at all. In that case, the owner might be subject to delay claims, though liquidated damages clauses provide some leverage and protection in this case.
Disputes Surrounding Decommissioning
Wade Coriell, Partner in King & Spalding’s International Arbitration group, moderated this panel, which discussed how decommissioning was a ripe area for disputes because it is highly unpredictable, occurs decades after contracting, and in a fluid regulatory environment.
Carol Wood, Partner in King & Spalding’s Tort & Environmental Group, reminded the audience that decommissioning could encompass remediation of environmental impacts from historic operations due to applicable law, contract language or reputational concerns. She also noted that to avoid subsequent disputes, companies acting globally must think globally when it comes to decommissioning, because there could be comparisons between the steps companies took to decommission projects in the U.S. versus other locations around the world. Being mindful of internal best practices is also important when approaching decommissioning. Even if a company is on solid legal ground, it has to win in the court of public opinion, too. To that end, companies should always be transparent and, where appropriate, might consider engaging with NGOs when developing their decommissioning plans.
King & Spalding International Arbitration Partner Elizabeth Silbert described the contract provisions most likely to be implicated in decommissioning disputes. PSCs often lack provisions expressly governing decommissioning, but other provisions come into play, such as asset transfer provisions, environmental provisions, representations and warranties, stabilization clauses, joint and several liability clauses, forum selection clauses, and choice of law provisions. She explained how parties can sometimes include general principles of international law or industry standards in their agreements.
Further Decommissioning Considerations
Led by John Bowman, partner in King & Spalding’s International Arbitration group, this panel discussed considerations about decommissioning at the beginning of a project and in the context of bankruptcy of an operator.
The panelists noted that the current trend is to fund decommissioning costs up front. Under typical PSCs, the operator recoups all of its costs incurred to develop the project before other parties share in the proceeds. In that context, the parties must account for future decommissioning costs or put money aside during the project or the operator will face substantial costs at the end of the project with no proceeds to offset them. Also, some countries are mandating that companies contribute to a decommissioning fund. But the panelists cautioned that companies must verify the solvency of the bank in which the funds are held, including the host country’s national bank.
King & Spalding Financial Restructuring Partner Ed Ripley noted that many of the steps taken at the beginning of a project, including certain contractual provisions, have no effect in bankruptcy. For example, traditional ipso facto clauses that terminate an agreement in case of party’s insolvency, are generally not enforceable in bankruptcy. Bankruptcy also triggers an “automatic stay,” preventing most collection actions against the bankrupt party. But, the automatic stay does not apply to police or regulatory powers and BSEE can still order that decommissioning take place if the lease is abandoned, even if a party is in bankruptcy. Moreover, at most, a party’s pre-bankruptcy contractual indemnity or contribution claim against a purchaser that ends up in bankruptcy will typically receive no economic return. Thus, that potential outcome should be factored into the overall transactional risk and pricing. Obtaining third party security ie bonds or letters of credit for future decommissioning costs should be considered to mitigate against being forced to bear those costs as a prior owner.