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Energy Law Exchange

February 1, 2012

Decommissioning Liability in the UK and Relief under the Finance Bill


Decommissioning liability is currently a key consideration for oil and gas companies operating in the UK North Sea where production has been in decline for a number of years, and many of the approximately 470 offshore installations are approaching the end of their working lives.

Decommissioning Liability

The UK Governments Department of Energy and Climate Change (DECC) regulates decommissioning of offshore oil and gas installations and pipelines using legislation under the Petroleum Act 1998 (the Act), as amended by the Energy Act 2008. Under Section 29 of the Act the Secretary of State serves notice on field owners/parties to a Joint Operating Agreement (JOA) (in the first instance) typically requiring that they submit a costed decommissioning programme for approval by a specified date. Notice usually is served towards the end of a fields commercial life. Liability of field owners to DECC for carrying out a decommissioning programme is joint and several.

In recent years a significant number of UK North Sea assets have transferred from large companies to smaller ones seeking to extend field life and maximise economic returns. The entrance of these new players is perceived by some in both government and industry to pose a greater risk of default in funding costs associated with decommissioning. As a result, DECC has developed a policy to ensure that adequate security for decommissioning costs is maintained on a field-by-field basis. The policy imposes certain safeguards, including requiring field owners to enter into a Decommissioning Security Agreement (DSA), a process that is explained below.

The UK oil and gas industry has created a pro forma DSA to be entered into by all owners of a specific field that provides an agreed boilerplate format, with options for negotiation. The DSA is intended to function as a stand-alone agreement, but should be linked to the Joint Operating Agreement (JOA) for the relevant field. A key objective of a DSA is to ensure that each field owner provides adequate security in proportion to its decommissioning liability so that other field owners are protected from possible credit risks posed by co-venturers under the principle of joint and several liability at the time a decommissioning expenditure is incurred.

Under a DSA where a field owner has secured status as a Qualifying Surety (effectively investment grade) it may provide a parent company guarantee as security for its share of a decommissioning liability under an approved Decommissioning Programme. A field owner that is not a Qualifying Surety will be required to provide a letter of credit or a performance bond from a Qualifying Surety. Security provided by field owners will be held under a trust fund concept, widely used in potential insolvency cases, to provide a secure account to hold any liquidated guarantees due to default, until such time as they can be used for the decommissioning purpose.

Supplementary Charge Relief Cap

On the tax side, in our June 2011 Newsletter we reported that in March 2011 the UK Government further increased the Supplementary Charge payable by oil and gas companies from 20 percent to 32 percent, in addition to the standard corporate tax rate of 30 percent payable on profits from oil production. [1] As a result of the increase, the minimum tax rate levied on North Sea oil production increased to 62 percent (although oilfields which also still pay the old Petroleum Revenue Tax can be taxed by as much as 81 percent).

On 6 December 2011 the UK Government published the draft Finance Bill 2012 (the Bill), which when enacted as the Finance Act 2012 will pass tax changes into law. The Bill introduces a cap to limit the relief on decommissioning expenditure for Supplementary Charge purposes to 20 percent, notwithstanding the increased rate of 32 percent of the Supplementary Charge. The cap will apply to expenditures incurred in connection with decommissioning carried out on or after the 2012 Budget Day and will be achieved by increasing the Supplementary Charge profits by an amount calculated by using the fraction: (SC-20%/SC), where SC is the rate of Supplementary Charge for the period in question, multiplied by the amount of decommissioning expenditure that is deducted in computing the Supplementary Charge profits for the period. The profits as adjusted after the application of the fraction for Supplementary Charge purposes will then all be taxed at the 32 percent rate.

Where a field owner incurs an expenditure for an appropriate letter of credit in compliance with obligations under a DSA, the cap should not apply, although there are some other limitations provided under the Oil Tax Act 1975 (OTA), as amended. One limitation, for example, would be a situation where a letter of credit goes further than making good the default in respect of decommissioning. Thus, tax relief should be available on the costs of obtaining an appropriate letter of credit both prior to and during decommissioning, although subject to some additional rules where a taxpayer has ceased all other commercial activity.

The cap on relief for decommissioning expenditures has come as unwelcome news to oil and gas companies with UK assets who are already dealing with the consequences of an increased Supplementary Charge.[1] Will the UK Governments Recent Increase in Tax on Oil Profits Deter Investment in the UK North Sea?, June 2011, available athttp://www.kslaw.com/library/newsletters/EnergyNewsletter/2011/June/article3.html.

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