CC(U)S—Spotting problems in the pipeline

Introduction

Even though the carbon capture sector is only just taking off, those thinking about getting involved need to consider the costs of decommissioning.

The importance of carbon capture for tackling climate change, whether coupled with utilisation and/or storage (CCUS), is now generally accepted. It is slowly gaining momentum, with projects such as Net Zero Teesside, Project Acorn and Tata Chemicals Cheshire progressing in the UK, and as governments around the world continue looking for ways to encourage investments in, and otherwise support, CCUS projects.

So far, oil and gas companies are leading the pack. The experience and know-how they have gained from decades in ‘traditional’ energy should pay dividends in navigating risk and reward as they embrace initiatives to help transition their businesses to a low-carbon future. Regardless of prior experience, these new projects will involve long-term contracts which, as with any long-term relationships, will inevitably be at risk of running into problems in the future. Companies’ fortunes, government policies and economic conditions change over time and that all feeds into the prospect of potential disputes further down the line. In this article, we consider three potential areas where disagreements may arise and offer some suggestions on how to mitigate the risks. Although we have cited various issues from the viewpoint of the UK government, the themes are universal.

The more things change

One of the big issues around the cost of CCUS projects is carbon pricing, both at the production end and at the onward supply—the utilisation element—stages. Making the production of carbon expensive—either via a direct tax or by cap-and-trade arrangements such as the EU’s Emissions Trading System—will, it is said, encourage companies to look for ways to reduce carbon and invest in offtake. The obvious commercial question, then, is how to make the resulting CCUS projects profitable? The higher the price paid by users of processed carbon, the more profitable the CCUS project. But will there be sufficient (global) utilisation to develop a thriving industry, or is CCUS destined to remain a cost on company balance sheets?

We have seen with other initiatives that as a concept takes off it can become less lucrative over time. More players enter the market, and supply can reduce in response to incentives and disincentives such as government policy changes, tax increases and tightening of regulation. There may be community or commercial pressures and the price of carbon may be volatile, especially if it is indexed to the oil price. Eventually, the parties involved will be looking for ways to reduce costs and improve their profit margin or, in the worst-case scenario, for a quick exit. Energy contracts sometimes include provisions that enable parties to rebalance the bargain they struck as unforeseen events have an impact—for example, material adverse change or price escalation clauses or, more generally, change in law clauses.

However, clauses of this type can cause difficulties. The party not impacted—or not negatively impacted—by the change may be reluctant to redress the balance. There may be wording that might make it an ‘agreement to agree’, which would not be enforceable under English law. There may be ‘good faith’ or similar wording, or a discretionary element which poses interpretative challenges in English law; what does ‘good faith’ mean in your contract? There may also be evidential burdens—how do you show the other party has not been acting in ‘good faith’? How do you quantify the impact of more onerous regulation on your cost base?

The more they stay the same

It would be great to not mention Covid-19, but unfortunately it is generally accepted that this is not the last pandemic we will experience. This means it is important to plan for the potential of pandemic disruption in the future life of long-term contracts. At the very least, the painful lessons learned over the last year or so should assist.

Pandemic-related energy disputes have, so far, been primarily in relation to the force majeure clause: were the notice provisions followed, did the impacted party take mitigating steps, what is the ‘force majeure’ definition (remembering it has no specific meaning under English law), and of course, is a pandemic captured (by the definition of force majeure)? Then there are the nuances of a change in law to consider—are the laws, regulations or restrictions that are brought in at a local level covered, and how about guidelines from quasi-legal authorities? And then there is the question of what the precise cause of the loss can be attributed to, and whether the loss itself is covered. Related to this, is the impact geographic or via the supply chain?

In the case of carbon storage, businesses negotiating contracts relating to the facility may want to try to address protection in circumstances where either the staff or the product is impacted. For example, employees may be prevented from going to work at the facility, or at the facilities that capture the carbon. If the transportation process uses pipelines there may be no interruption in service—but if it is using vessels, there could be interruptions either relating to crewing capabilities, or prevention from departure or docking. Where a facility can no longer receive carbon because it has a backlog with offloading, suspension of service rights could leave carbon suppliers with higher tax liabilities, or even sanctions for breaching emissions limits. It would be prudent to seek a way to contractually address recovery of such losses.

When all is said and done

Decommissioning has long been a topic of discussion in the oil and gas context, and the same considerations will apply in relation to CCUS infrastructure in the future. It may be challenging now to think about the end of the CCUS project or the exact activities required for such decommissioning, and it is almost impossible to predict what the regulatory, legal and governmental landscape will look like at that stage. The UK government, for example, has so far been very clear that decommissioning obligations remain for existing infrastructure, whether it is repurposed for CCUS or not. It is, however, considering how to encourage CCUS investment by reframing the responsibilities that arise under the Petroleum Act 1998.

A possible solution proposed by the UK government is to grant the secretary of state a discretionary power to relieve the original owners of oil and gas infrastructure of their decommissioning responsibilities where they transfer their assets for use in CCUS. However, if this power is only discretionary, there would still be a risk that liability for decommissioning would remain with the original owner post-transfer, or that a future government could retroactively impose liabilities on previous owners—as the current legislation permits.

Regardless of the legislative position, the parties are of course free to apportion risks and liabilities however they choose in the contracts between them. If a new owner is taking on the risks of decommissioning, it will want to obtain certain warranties and indemnifications from the original owner. Since decommissioning is such a huge expense, these are likely to be fertile areas for debate when the time comes.

Preparation is key

CCUS offers the energy industry numerous opportunities and benefits, not least the mitigation of climate change. However, companies should always keep an eye on the future to scan for potential disputes, particularly as the market attracts new entrants throughout the supply chain that may be less sophisticated or experienced. Being prepared is key—the sooner a company becomes aware of a prospective dispute, the sooner it can look to resolve the situation and protect itself.

Penny Cygan-Jones is a senior knowledge lawyer and Phillippa Hook is a senior associate at Norton Rose Fulbright