The complexities and challenges associated with decommissioning offshore oil and gas assets have dampened M&A activity in the past, but change is coming
Historically, the attitude towards decommissioning offshore oil and gas platforms has been largely negative, with companies viewing mature installations as a burden rather than an opportunity for a new source of revenue. However, as lawyers at White & Case argued recently in an interesting analysis of the market, the mood has changed.
Following the sharp drop in oil prices in 2014, incumbent owners, keen to repair their balance sheets, started to view their ageing assets as an opportunity to pass on these operations to smaller, more nimble players whose business is better suited to carrying out smaller works and who are likely to enhance overall recoveries.
With an estimated 20 billion barrels of oil remaining in the UK Continental Shelf (UKCS) and prices starting to stabilise at a level at which both buyers and sellers are willing to transact, White & Case says deal activity in the UK North Sea is seeing something of a revival.
According to the UK Oil and Gas Authority (OGA), 680–690 million barrels of oil are expected to come on stream from approved projects in 2017 alone. There are also many fully functioning late-life assets that, in the right hands, should continue to be operational for years to come.
The UK Government, which has ultimate responsibility for decommissioning on the UKCS, is actively encouraging new investment. However, investors need to get comfortable with a legislative regime developed by the UK Government that assigns liability to parties deriving financial benefit from petroleum assets – whether presently or in the past. The costs are broadly intended to fall on companies that hold licences for such assets, those who own the facilities and those who operate them and benefit from the exploitation of related petroleum.
White & Case argues that allocation of decommissioning liabilities has always been a difficult issue in mergers and acquisitions (M&A) deals, as sellers have traditionally sought a ‘clean break’ from these liabilities, while buyers have had to factor in the costs of decommissioning security and be comfortable with the fact that they can be liable even once they have sold on the asset. However, they note, the boom times of high oil prices meant that deals were still getting done. Once the oil price dropped significantly, there was a period where very few deals happened, as concerns about decommissioning were coupled with a difficult pricing environment. “Although US$30 a barrel created potential upside for buyers, sellers were not willing to engage at that level,” they said. “Now that the price appears to be stabilising at around US$50, there is still potential profit for buyers while giving sellers comfort that they are getting meaningful value for their assets."
This stability is prompting interest among producers and the supply chain and service sector, where new business models and innovative deal structures thrive on the opportunity of decommissioning.
There is also a growing appetite among infrastructure investors for pipelines and processing plants, such as CATS, FUKA, SIRGES and SAGE, which have been acquired by infrastructure or private equity investors for their stable long-term revenue streams.
The mix of independents and smaller, private equity-backed companies now active in oil and gas facilities is boosting interest in the North Sea. Larger private equity players may bring capital, but they are keen to ensure that they are backing the right teams.
In short, White & Case argues that “new business models and innovative deal structures thrive on the opportunity of decommissioning”.
The recent increase in North Sea M&A activity has encouraged investors to follow suit, but decommissioning remains a big issue under the UK regulatory regime; previous interest holders can be liable for any default by current or future interest holders if there is a shortfall in security. Residual liability is a particular concern for private equity players.
More recently, there has been a focus on facilitating the use of specific decommissioning security arrangements (DSAs), the broad purpose of which is to create, during a field’s operations, a fund sufficient to meet the expected decommissioning liabilities after cessation of production.
The joint-venture partners responsible for oil and gas facilities will typically make periodic contributions towards a fund to ensure that sufficient money is available when the use of those facilities ceases to meet the costs of decommissioning. The value of the fund is based on the operator’s estimates of decommissioning costs multiplied by a risk factor. The amount and form of security for the ultimate costs of decommissioning is subject to periodic recalculation. Under traditional deal structures, a DSA should help to ensure that a seller receives a ‘clean break’ from any decommissioning liabilities.
As White & Case also argues, the liability in respect of the eventual costs of decommissioning is an important aspect of any M&A transaction in the sector. New entrants and incumbents are increasingly looking for effective – and indeed novel – ways to apportion decommissioning liability. Recent transactions – such as BP’s sale of Magnus to EnQuest and Shell’s sale of its North Sea portfolio to Chrysaor – show a number of innovative approaches to dealing with decommissioning liabilities, they note.
A good example of a contract with retained liability is BP’s sale of its stake in the Erskine oil field to Serica Energy. Among the terms of the agreement was BP’s acquisition of a 5% shareholding in Serica Energy and a partial retention by BP of the field’s decommissioning liabilities. The agreement holds BP responsible for any decommissioning liabilities up to an agreed maximum, with Serica Energy liable for any excess above that amount.
“Several factors are combining to make late-life assets attractive to new investors,” said the law firm. “These include tax incentives, insurance products, specialist operating companies, deferred dismantling and advanced technology. These factors may lead to significant savings for major oil and gas companies while offering plenty of opportunity to the savvy independent or investor in the meantime.”
As they also noted, decommissioning costs are set to decline as more specialist contractors enter this market with advanced technology and compete for contracts. They highlighted oil field services companies that are already investing in top-of-the-line equipment to cater to these projects, with Heerema Marine Contractors serving as a prime example. Allseas with its single-lift vessel Pioneering Spirit is another. “This new equipment is important not only from a cost perspective but also for project timelines, as there are only a few vessels equipped to handle such heavy-lift work,” said White & Case.
“The UK North Sea will see significant change in the coming years as the decommissioning market develops, not just in terms of technologies and players but also with regard to insight about costs and risk,” said the law firm. “Increased collaboration is likely to lead to standardisation of costs and create a knowledge pool that will lower the barrier of entry for new players and make complex projects more manageable. Meanwhile, the insurance market will continue to widen its product base in response to demand, and the advent of fixed-price decommissioning may well set a precedent for contract standardisation. All of these developments point to more favourable conditions and growth opportunities for the market and the further removal of what has historically been one of the main barriers to North Sea M&A.”
Forth Ports links up with AF Decom
Forth Ports Limited and AF Offshore Decom UK have signed a heads of agreement to establish a joint venture, AF Dundee, which would form the basis of a decommissioning hub in the city. AF Offshore Decom UK, a subsidiary of AF Gruppen, is one of the North Sea’s best known decommissioning contractors and operates AF VATS Environmental Base in Norway.
The joint venture partners believe that Port of Dundee is well placed to accommodate a significant share of North Sea decommissioning work due to its proximity to many UK North Sea oil and gas assets, rail and road links, port facilities, its onsite supply chain and the city’s skilled workforce.
As previously reported, earlier this year Port of Dundee appointed a contractor to construct a new quayside at the port specifically designed to handle decommissioning work.
Owned by Forth Ports, the port is spending £10M (US$13M) on the quay extension which, it claims, will be the UK's strongest quayside, specifically designed to equip the port to handle the large-scale loads demanded during decommissioning operations.
Pace of decommissioning picking up
As highlighted elsewhere in this article, the number of decommissioning projects in the North Sea is growing, with the arrival of Repsol Sinopec Resources UK’s Buchan Alpha production unit at Lerwick over the weekend of 12 August.
Decommissioning of the facility is being managed by Veolia and Peterson and it is believed to be the first major North Sea floating production vessel to be disposed of in Scotland. The work will be carried out at the Dales Voe site in Lerwick.
A semi-submersible moored floating production vessel, Buchan Alpha was built in 1973 as a drilling rig and converted for production. The unit commenced production in 1981 from the Buchan field, which is in blocks 21/1A and 20/5A, and has subsequently also produced the nearby Hannay field. Production ceased as planned on 12 May 2017, with the unit having produced around 148M barrels of oil.
Off-station work on Buchan Alpha has been ongoing over the past several months, with the primary objectives of cleaning and reducing topsides weight in preparation for the tow. It will initially be moored offshore Lerwick in deeper water where the thrusters will be removed to reduce its draught, allowing it to be moved to the quayside within the next few weeks. Veolia will then begin dismantling the steel structure to maximise the recycling rate with the aim of achieving 98% recycling rates.
Veolia UK & Ireland senior executive vice president Estelle Brachlianoff said: “We are expecting a growth in the decommissioning market and the Buchan Alpha contract is a significant example of the potential expansion of this sector in Scotland. These offshore assets will now be recycled to give them a second, third or even fourth life creating jobs and investment in the local economy.”
Veolia also recently accepted the first offshore structure into the decommissioning facility in operates with Peterson in Great Yarmouth. The Shell Leman BH topside arrived in the harbour on 11 July 2017. The 50m high steel jacket structure that supported the topside is due to follow later in July.
The topside, which was previously used as living quarters for personnel working on the Leman BT and Leman BK platforms, will now be recycled.
The purpose-built Great Yarmouth decommissioning facility will manage the deconstruction and recycling of both topsides and jacket structures that comprise around 1,600 tonnes of materials and assets.