A focus on decommissioning provisions in hydrocarbon deals

Alexander Elliot, a Senior Economist in our Oil & Gas Advisory team, has authored a great thought piece discussing decommissioning provisions in hydrocarbon deals. In several UK Continental Shelf cases, a company with material tax history has sold assets to a relatively new entrant, with no tax paying history. This can leave the buyer unable to claim tax relief against decommissioning. In recent years we have seen some imaginative ways to bridge this gap, as Alexander outlines below.

When a company sells assets, the package will often include a mix of more recently developed assets and late life fields. In several UKCS cases, a company with material tax history has sold assets to a relatively new entrant, with no tax paying history. Because Ring Fence Corporation Tax and Supplementary Charge Tax are tied to the company and not the asset, this may leave the buyer unable to claim tax relief against decommissioning. The quantum of the decommissioning is often comparable with the post-tax value of the hydrocarbon cash flows, which can leave a gap between buyer and seller expectations. In recent years we have seen some imaginative ways to bridge this gap.

When a company sells assets, the package will often include a mix of more recently developed assets and late life fields.

In several UKCS cases, a company with material tax history has sold assets to a relatively new entrant, with no tax paying history. Because Ring Fence Corporation Tax and Supplementary Charge Tax are tied to the company and not the asset, this may leave the buyer unable to claim tax relief against decommissioning. The quantum of the decommissioning is often comparable with the post-tax value of the hydrocarbon cash flows, which can leave a gap between buyer and seller expectations. In recent years we have seen some imaginative ways to bridge this gap.

In 2018, Serica Energy purchased interests in Bruce, Keith and Rhum from BP, BHP, Total and Marubeni. This involved a consideration, plus a profit-sharing arrangement with BP, BHP and Total. BP, BHP and Total will pay for decommissioning for the working interests that they sold, with Serica paying a deferred consideration of 30% of the post-tax decommissioning costs.

Importantly, BP and Total have each retained a 1% working interest in Bruce, enabling them to access their corporate tax history to claim relief against the decommissioning costs. If they did not remain as licence holders, they would not be able to use their tax history.

Delek’s 2019 purchase of Chevron North Sea Limited (CNSL) differs in that it was a corporate deal, enabling Delek to access the tax history of the transferred entity. Chevron will however provide security and retain financial responsibility for decommissioning of CNSL’s interests in the Heather and Strathspey fields and the Cambo exploration well.

The potential value gap between buyer and seller has also attracted the attention of the UK Government, seeking to maximise the economic recovery of remaining hydrocarbons in the UK. If asset transfers are hindered then assets would remain in the hands of sellers, who may be less willing to invest, risking early cessation and future tax revenues. In the

Autumn 2018 budget, the UK Government announced that it would introduce Transferrable Tax History (TTH). This enables a portion of tax history to be transferred with an asset, to a buyer, capped at twice the decommissioning cost estimate. This applies to licence transfers approved on or after 1 November 2018.

Whether future deals are structured as asset or corporate deals, arrangements may need to be made to bridge the gap between buyer and seller. An asset package becomes difficult to sell when the remaining value of hydrocarbons in the ground approaches a level which no longer covers the decommissioning cost; especially as most buyers are looking for growth.

The seller retaining financial responsibility for decommissioning as a capped sum, a percentage, or identified fields are all ways to help bridge the value gap, as would be the transfer of tax history via TTH. Ensuring that the portfolio includes enough room for growth is another.