07 Jul 2016

In our prior note regarding the impact of the Strategy on a JV we touched on licence revocation as a sanction which, at its simplest, means that a MER Party runs the risk of losing its entire interest – either to the Government or (if applicable) those other parties in the JV. The Strategy requirement to divest should, however, be distinguished from licence revocation.  

Obligation to divest

Pursuant to paragraph 30 of the Strategy, a MER Party "must allow others to seek to maximise the value of economically recoverable petroleum from their licences or infrastructure including by divesting themselves of such licences or assets to other financially and technically competent persons who are able to recover economically recoverable petroleum".

Paragraph 30 doesn't only involve divestment, and clearly this is a last resort, but could include a farm-out or other arrangement which allows the asset to proceed to/through the production phase. For the purposes of this note, however, we refer to divestment only.

Investment

Paragraph 31 requires that where a MER Party is "not able to ensure the recovery of the maximum value of economically recoverable petroleum from their licences or infrastructure for financial reasons they must seek to secure investment from other persons". The paragraph 30 requirement to divest is triggered where the MER Party is "not able to secure sufficient investment in a reasonable time".

Failure to comply

The paragraph 30 requirement to divest is also triggered by the provisions of paragraph 32 where MER Parties "decide not to ensure the recovery of the maximum value of economically recoverable petroleum from their licences or infrastructure, including where the reason for the decision not to recover is because recovery generates returns which are unsatisfactory to the relevant persons, they cannot raise suitable finance or there are technical or other non-economic reasons".

This is therefore a failure by a MER Party to comply with the Central Obligation, and an obligation to do something positive pursuant to paragraph 30 where there is a position which appears to be akin to a lack of a 'Satisfactory Expected Commercial Return' (SECR), an inability to raise finance or other technical or non-economic factors[1].

Terms of divestment

Once the paragraph 30 obligation to divest is triggered, paragraph 33 requires that "that person must seek to do so without demanding compensation in excess of a fair market value or unreasonable terms and conditions, in order that other financially and technically competent persons who are able to recover economically recoverable petroleum may do so".

Relinquishment

If after a "reasonable period" a MER Party has been unable to secure alternative funding or to divest itself of an asset then, if the recovery of the maximum value of economically recoverable petroleum would achieve a satisfactory expected commercial return, it shall relinquish the related licences. Therefore, if a party cannot establish a lack of SECR (i.e. a Safeguard) then an asset must be relinquished.

Observations and questions

  1. In respect of paragraph 31, there is no clarity on what a "reasonable time" is, and this could prove contentious (particularly in the early stages of Strategy implementation where a precedent scenario is not available to use as an objective benchmark).
  2. In respect of paragraph 33, there is no clarity around the methodology for deriving "fair market value" or whether the terms of a divestment are "unreasonable". In the current low price environment headline transaction consideration is a key issue with sellers typically holding assets at (legacy) high net book values and buyers calculating consideration on lower forward curve prices. Decommissioning is an issue too, and it remains to be seen whether the OGA would view a (less frequently deployed) clean break for the seller in respect of decommissioning as being "unreasonable". Decommissioning security (or lack thereof) is often a bar to (or delay in) any transaction – we question whether more innovative models are required in order to facilitate/enable transactions which may otherwise stall due to decommissioning security, particularly given the profile of potential acquirers (weak balance sheet and limited liquidity). Each of these factors has the potential to delay divestment/prove contentious.
  3. Where the requirement to divest is triggered but the process is yet to complete, what will happen in the interim period? Is it possible for it to be 'business as usual' for those remaining in the JV (where applicable) and how does this impact the terms of divestment?
  4. Pursuant to a JOA or other critical agreements, could the OGA force the JV and other affected parties to accept a divestment and associated transfer pursuant to the Strategy and overrule the relevant parties' views on financial and technical capability on the basis that if the OGA is willing to consent to the transfer then the JV/affected parties should too? This scenario would appear to require consideration from an OGA and JV/affected parties perspective as to whether a 'divestment by law' circumvents the usual JV/affected party consent right in order to deliver on the mandated outcome.
  5. The interrelationship between the SECR Safeguard and the paragraph 30 positive obligation and the way these mechanisms will work in practice is yet to be seen (and may prove to be problematic given the subjective/objective nature of SECR as a Safeguard and trigger to a positive obligation).

How can Bond Dickinson help?

The Oil and Gas team at Bond Dickinson have carried out a thorough review of the Strategy and is well placed to guide you through these changes and the impact it will have on your business.

[1] An inability to raise finance or technical or non-economic factors are not Safeguards.