Takeaways

In a dispute concerning a decommissioning security agreement (DSA) based on an amended form of the industry standard, the Commercial Court has held that:

  1. The DSA does not require the operator to take decommissioning costs and / or the impact of inflation on those costs into account when calculating the amount of security to be provided – this is a matter of judgment for the operator (or expert) applying the reasonable and prudent operator (RPO) standard.
  2. In an expert determination pursuant to the terms of the DSA:

    1. the test for the expert when asked to determine whether the RPO standard has been complied with is not whether no reasonable operator could have reached that conclusion but, instead, what in their own view an RPO would have done; and
    2. where there are disputed issues of construction of the contract, the expert can proceed with the expert determination without those issues first having to be resolved by the Court.

Key Facts

This case concerned the construction of a DSA between Apache North Sea Limited (the Claimant) as operator and Esso, Shell and bp (the Defendants) as former licence participants in the Forties and Brimmond Fields (the Field or Fields). 

The forecast for decommissioning spend over the next decade in the UK North Sea is £20bn demonstrating the very significant cost of dismantling and removing oil and gas infrastructure. To ensure that the taxpayer does not pick up the cost there is a wide ranging statutory liability regime in the UK which provides that oil and gas companies involved in the exploitation of oil and gas pay these costs on a joint and several basis. To mitigate exposure to decommissioning costs, oil and gas companies enter into DSAs in order to ensure that there is sufficient security held on trust to cover anticipated decommissioning costs at the end of an assets productive life.

In this case, the DSA was an amended form of the industry standard DSA. As the Judge acknowledged, in a DSA arrangement the security provider’s aim is to minimise the amount of security provided for the field, while the aim of the those who benefit from the security is to ensure that full security is provided so as to minimise or eliminate their decommissioning liabilities. It was this conflict of objectives which gave rise to the dispute.

The amount of security provided each year by the Claimant is calculated by a formula set out in the DSA which includes estimates for Net Cost and Net Value. That estimation exercise is necessarily judgmental since it involves looking into the future, most notably in terms of anticipated costs, capital expenditure and production projections. The DSA includes detailed provisions as to how the exercise is to be conducted, including certain assumptions to be taken into account when calculating the estimates.

Where the Defendants dispute the Claimant’s calculation of decommissioning security, there is a contractual mechanism under the DSA for resolving disputes through expert determination.

In this case, the Defendants disputed the Claimant’s security calculation for 2023 and sought to refer the dispute for expert determination. The Claimant began court proceedings, applying for an injunction to stay the expert determination on the basis that the dispute concerned the construction of the DSA, and that issues of construction should be resolved by the Court not an expert. At the injunction hearing, where the Defendants cross applied for a stay of proceedings, the Judge ordered an expedited trial, out of which this judgment arose.

Issues

There were a number of issues before the Court for determination, three of which are likely to have wider interest for industry players:

  1. First, the Court found that the Claimant was not required to take decommissioning costs and/or the effect of inflation on decommissioning costs into account in its assessment of Net Cost. Instead this was a matter of judgment for the operator applying the RPO standard. In the context of the current inflationary environment, the impact of inflation on security calculations may be substantial and claimants will be looking to mitigate that impact in their decommissioning plans in order to minimise security provisions. In this case, however, the judge found that the operator was not required to do so by the terms of the contract and was only permitted to do so if that was the approach an RPO would adopt.
  2. The two further points of interest relate to the scope of the exercise to be undertaken by the expert to whom disputes relating to the provision of security are referred under the DSA:
    1. Where an expert is asked to determine whether an estimate is prepared in accordance with the standard of a RPO, the Court held that the expert is not required to conclude that the Claimant’s estimates were ones that no reasonable operator applying the RPO standard could have arrived at but instead to form their own view about what a RPO would have done (in other words, there was no Wednesbury type unreasonableness test).
    2. Where there is a dispute as to the construction of the DSA, the expert may nonetheless proceed with his or her determination and form their own view on that issue, provided that, if the expert make an error of law in doing so, the matter may be referred to the Court.

Conclusion

While the case relates to the interpretation of a specific contract, as DSAs are used widely across the industry and there is an industry pro-forma, the Court’s treatment of how inflation may be taken into account in the calculation of security is likely to be of interest in the current global inflationary environment. Equally, the RPO standard is widely used in oil and gas contracts and the Court’s guidance on how the expert should approach the question of whether that standard has been met also provides helpful insight. Finally, on the basis of the wording of this DSA, an expert faced with contested issues of construction was found to be able to proceed with their determination, and only after they have done so may their interpretation be challenged on the basis of an error in law. While this will depend on the wording of the particular expert determination provision, this may provide some assistance to those involved in expert determinations in general, the process for which can become contentious before parties even reach the substantive dispute.



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