Decommissioning - five complications in the asset valuation relationship
Decommissioning in the UK Continental Shelf (UKCS) is going to be an expensive and uncertain business
According to The Decommissioning Company, operators in Europe are forecast to spend over £60 billion on decommissioning over the next 30 years.
A major part of this will be in the UKCS and, as stated by Oil and Gas UK’s 2015 Decommissioning Insight Survey, £16.9 billion will be spent on decommissioning over the period between 2015 and 2024.
The cost breakdown
Plugging and abandonment accounts for over 45 per cent of the cost estimate (£7.7 billion); the remainder is attributed to project management and operation of facilities (£3.7 billion), and removal and associated activities (£5.5 billion).
During this period 23 per cent of platforms by weight and 17 per cent by number will be removed. Some 30 per cent of wells will be plugged and abandoned.
Corresponding figures from earlier editions of the Decommissioning Insight Survey indicate that their total cost forecast through to 2040 increased threefold over the six years to 2011, and has continued to increase since.
Some of this increase is attributable to inflation however the greater part arises from changes in the number and type of decommissioning projects brought within scope of the forecast.
The £16.9 billion estimate is itself very uncertain. Some 97 per cent of the project estimates provided by operators were produced according to AACE guidelines as requested. Just over half were Class 5 and 38 per cent were Class 4 estimates, and are thus in early planning stages.
There are factors which may make decommissioning simpler and cheaper. The Twin Marine Lifter technology owned by Shandong Twin Marine Ltd. is expected to be available by 2020 and should alleviate the extreme shortage of heavy lifting equipment required for removal of topsides.
Complete restoration of sites to original clean state has an obvious environmental appeal, however some recent ecological studies have indicated that the environmental impact of removal may be far greater than a simpler approach; lifting and toppling the topside onto the sea bed - the toppled structures will create natural reefs in a few years.
As long as the sea is deep enough to prevent danger to shipping the carbon and money cost of this approach is far lower.
Planning for decommissioning
Planning for decommissioning is a complex process beginning far in advance of the expected execution date and one of the most difficult aspects is the decision as to when, rationally, it should occur.
It involves estimation and reporting of the “economic limit” of the lifetime of producing assets, usually according to Petroleum Resources Management System guidelines or similar, which may not reflect the actual fiscal regime and cash flows which the operator expects.
The economic limit will depend, inter alia, on commodity prices that are notoriously difficult to predict. The date will, in turn, affect the reportable reserves, and hence valuation of the asset by regulators and investors.
Many operators prefer to defer decommissioning as long as possible, hoping for an improvement in market conditions and reducing the net present value of the expected expense.
The economic limit may also be deferred in later years of operational life if improvements in technology make enhanced oil recovery or other options for extending field life commercially-feasible.
For internal planning, developing an economic estimate reflecting the expected cost of decommissioning in all future years x, multiplied by a risk factor reflecting an estimated probability that decommissioning will prove to be the rational choice in that year, could be one way of reflecting this complex reality.
However, this is far from an exact science and does not consider a raft of complications that muddy the waters.
Tax and regulation
There can be complex regulatory and tax implications; all these factors make financial provisioning very complex. The large amounts of dead capital tied up in decommissioning security are unavailable for financing investment.
Given the long history of divestment, mergers and acquisitions the history of liability for decommissioning is now very complex.
A problem shared is a problem doubled?
For most UKCS assets, one or more joint operating agreements (JOA) will have applied at some point, originally or subsequently.
Liability for decommissioning will have been attributed to the partners in the JOA, possibly several decades ago, since when cost estimates will have increased considerably.
Upon sale of all or part of an asset, vendors have the option to keep or to transfer their liability to the purchaser; given the long history of divestment, mergers and acquisitions the history of liability for decommissioning is now very complex.
Under Sections 29 and 34 of the Petroleum Act 1998, the Department for Business, Energy & Industrial Strategy (BEIS) can serve notice on operators to submit a decommissioning programme; the Section 29 parties will be jointly and severally liable to carry out the programme.
If they should prove unwilling or financially unable to do this, Section 34 provides that the Department for Business, Energy & Industrial Strategy can claw back into liability anyone who could have been served a Section 29 notice at any time after the first Section 29 notice was served.
The current weakness of many operators means there are now many potential liabilities under Section 34 for operators who may long since have divested.
Although Section 34 has not yet been used in practice, concerns regarding decommissioning liability have had a chilling effect on asset trades, and the cost of provisioning and providing security (usually by letters of credit, which can be very expensive for smaller companies) has deterred investment.
The industry’s situation is further complicated by the Oil and Gas Authority’s ability to apply sanctions to operators which act in a way deemed contrary to the Maximising Economic Recovery strategy.
Solutions to reduce the cost of providing decommissioning security are needed urgently. Valuing direct and indirect liabilities is very complex, and the internal requirements of operators to act as “rational investors” may not be well served by the public guidelines for estimation issued, for example, by Oil and Gas UK.
Decommissioning activity in the UKCS is still just beginning; I expect a considerable upturn in demand for specialist consultancy for cost estimation, valuation, M&A and dispute resolution in the near to medium future.