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We are living through a perfect storm. Russia has withdrawn from the OPEC+ arrangement and both Saudi Arabia and Russia are ramping up production. At the same time demand is being destroyed by the measures required to combat the spread of Covid-19. The oil price has crashed. It is 30^th March 2020 and this morning Brent Crude Oil Futures are sitting at slightly under $23 per barrel. 

Companies are busy keeping workers safe in the face of a global pandemic. They are also busy re-running economics on projects, stress testing the resilience of co-venturers and contractors, dealing with force majeure notices and assessing how to slash costs without compromising safety.

Many upstream companies in the UK are party to decommissioning security arrangements (DSAs) under which they and their fellow field owners provide financial security for the costs of decommissioning.   The idea is to ensure that funds are available to decommission and that if an owner fails to pay its share of decommissioning costs then those who have to pick up the cost are able to access funds to cover them.  

The effects of dramatic drops in petroleum prices can lead to dramatic effects under DSAs – some of which are rapid and some of which are longer term issues. It is important for companies not to lose sight of these amongst everything else that is going on.

Credit ratings drops

Security under DSAs is often provided in the form of letters of credit or corporate guarantees. Usually these forms of security are only acceptable if the issuer has a credit rating of at least a minimum level set in the DSA. Where a company has a parent or other group company with the necessary credit rating it will usually provide a corporate guarantee as this will be cheaper than providing bank letters of credit under its bank facilities.  Where a corporate guarantee is not an option companies will provide bank letters of credit or, very uncommonly, cash.

All is well unless the credit rating of the group company providing a guarantee or the bank providing a letter of credit drops below the required credit rating. If the rating drops below the required level it is imperative that you act quickly to replace the security.  Last week Standard & Poors’ reduced Apache Corporation’s credit rating from BBB to BB+ and Apache stated that  “the primary impact of the ratings change is that Apache will post letters of credit aggregating approximately $650 million related to asset retirement obligations in the U.K. North Sea.”

Apache is fortunate in that it already has the bank facilities in place to quickly swap to provision of letters of credit and so avoid problems under its security arrangements.

Less financially robust companies might not be so fortunate if its parent is faced with a credit rating downgrade. DSAs often provide that failure to replace the security within a short period of a rating drop is a default under the DSA which can lead to a call under the security. Depending on the particular DSAs such a breach of the DSA might also be a cross default under the relevant field operating agreement.   

Security might be required sooner than anticipated

DSAs usually provide that security is to be provided by owners from a Trigger Date which is a date when the net value to be generated from the field (such as the petroleum to be sold) is equal to a percentage (generally 100-150%) of the estimated net cost of decommissioning. The oil & gas prices to be used in calculations could be stated to be the operator’s estimates but in practice DSAs often provide that estimated prices are to taken from a third party source. The Oil & Gas UK template DSA gives the option to use the assumptions in the WoodMackenzie Economic Assumptions for March in the relevant year.  If you use the WoodMackenzie assumptions then the recent price slump should not have an immediate effect on your Trigger Date and there would be no effect unless and until WoodMackenzie changes the assumptions which you are to use in your calculation. You should check exactly what your own DSAs says about the issue as depending on the particular assumptions used you could find that the Trigger Date for the provision of security will be earlier date than you might have anticipated.

Increased Security

A drop in oil price can lead to a higher security requirement. Security to be provided by an owner is often calculated by taking that owner’s share of the net cost of decommissioning, applying a risk factor and then deducting that owner’s share of value (including petroleum to be sold).  When and if the effects of current low prices are reflected in the assumptions for petroleum prices used in your DSA the result may be a requirement for higher levels of security in future.         

Times may currently be very testing for all but in the midst of everything that is going on it is important not to forget about your DSAs. Watch carefully for credit rating drops as these can require quick action to avoid defaults.  Petroleum price drops will also have effects under DSAs but, depending on the provisions of your DSAs these are likely to be less time critical from the security perspective.

If you need assistance on any decommissioning related issue please get in touch with your usual contact at Stronachs. We are ready to help.