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Financial Security Arrangements for Abandonment

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					                                                                                  PP/14/01



Financial Security Arrangements for Decommissioning
- Status Report at July 2001
The purpose of this brief report is to provide the Progressing Partnership Work Group with a
summary of the work done, status and proposed next steps on the above subject.

Background

With the increasing maturity of the UKCS basin for exploration, development and production
of oil and gas, the DTI and the oil & gas industry have endeavoured to remove barriers which
may prevent new entrants or existing players from participating in maximising the recovery
of UKCS hydrocarbons. One area looked at under the auspices of PILOT, relates to
arrangements for present and prospective participants in UKCS licences to provide financial
security in respect of their future decommissioning obligations.

Under the provisions of the Petroleum Act 1998, the DTI can require participants in a licence
to provide Financial Security Agreements (FSAs). These are normally required by DTI in
situations where DTI consider that the remaining partic ipants in a licence may not include
parties with the financial strength to be able to carry out the decommissioning work.

FSAs may also be required to be provided by and between participants in a JOA.

The work which has been done, and the focus of this report, is on the DTI’s requirements for
FSAs.


Work Done and Status

The nature and format of FSAs can include Parent Company Guarantees (PCGs), Letters of
Credit (LOCs), Performance Bonds, etc.

Until the publication of revised DTI guidelines under the Petroleum Act 1998, it had been
anticipated that PCGs would constitute adequate FSAs for DTI purposes. However, those
revised guidelines indicated that:
a) DTI sought Cash, Irrevocable Standby Letters of Credit or on-demand Performance
    Bonds issued by Prime Banks; i.e. banks with AA rating or better as defined by Standard
    & Poors or Aa2 or better as defined by Moodys;
b) DTI may consider alternative insurance based schemes; and
c) PCGs were very unlikely to be acceptable to DTI.

The requirement to provide FSA per a) above would potentially result in significant additional
costs for many companies, particularly the larger and more financially robust companies.
Since 1999 the industry Insurance Steering Group (comprising representatives from Shell, BP
Amoco, Enterprise, Conoco and Talisman), have therefore looked at how best to meet likely
DTI requirements in a sound, even-handed and practical manner.

A number of discussions were held with Peter Holt of DTI during 1H/2000 and progress was
made in considering a number of options additional to those envisaged by the ‘guidelines’.
The aim being to enable a more flexible and practical choice of security types and
providers than the limited choice described in the ‘guidelines’. This would benefit the
Industry as a whole, particularly the smaller and middle sized players, and at the same



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time provide the DTI with the same or a better level of comfort than under the
guidelines.

One avenue explored was the development of an ‘Industry Mutual Guarantee Fund’ type
product which would apply to the whole industry and would address the following key areas
of concern:
• The provision of security guarantees per se;
• Protection against decommissioning cost overruns;
• Specific instruments which may assist the trading of assets/interests; and
• Development of a residual liability product (i.e. for potential future liabilities which may
    arise after decommissioning has been completed).

The IMGF approach, unfortunately, proved not to be a sound way forward – principally
because of the disproportionate cost and liability burden it would place on the ‘major’
companies (e.g. Shell, BP Amoco and Exxon-Mobil).

Sadly, Peter Holt passed away in 2000 and, not surprisingly, this delayed progress of
discussions with DTI on this matter. These discussions were reopened in April 2001 with
Keith Mayo of DTI.

The present situation was summarised in a letter dated 8 May 2001 from Shell to Keith Mayo.
Key points are:

1. The DTI appear not to require FSA for a particular licence where one of the ‘major’ oil
   companies remains a licencee. This informal practice is not, however, reflected in the
   ‘guidelines’.

2. The FSA options under consideration are:

    a) Cash, Bank Bonds and or LOCs all as per the existing " guide-lines " but with a more
       practical level of security rating of the security provider. The level of this security
       rating is yet to be confirmed.

    b) A Guarantee provided by an alternative UK security provider, credit rated as above,
       capable of providing a guarantee on an equivalent basis to an LOC to industry
       participants who themselves have a credit rating of less than the required level and/or
       whose country of domicile is outside the UK.
       This option would permit the more creative use of insurance, insurance/banking, and
       other commercial arrangements which were seen as being more flexible instruments
       that those listed in a) above.
       Commercial instruments along these lines are emerging in the markets and purport to
       be able to offer a range of different benefits to the purchaser, from the provision of
       simple guarantees to the funding of the decommissioning itself and in some cases the
       actual carrying out of the decommissioning. Such instruments have yet to be
       confirmed and proven and it is not intended that the DTI be put in the position of
       having to endorse generic products, but rather that such products would be acceptable
       if they met certain specific criteria, for example:
        - The guarantor would need a credit rating of at least XX
        - The guarantor would be domiciled in the UK
        - The guarantee would be non-cancellable
        - The guarantee would be not less secure than an LOC.
       By permitting the Industry to look at and develop alternative forms of security in
       conjunction say with other markets e.g. insurance and or capital markets, but freed
       from the restrictive nature of the guidelines would in itself be seen to be helpful, and
       could lead to the creation of new initiatives in these markets.


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    c) The use of a Mutual Guarantee Fund for those Industry companies who:
        - have a large spread of JV Participants in a variety of different JOAs; and
        - who are capable of putting such a Fund together and providing on behalf of all
       members of the Fund a form of security acceptable to the DTI.
       Such a fund may not, at first glance, be seen to be of great value to the DTI but could
       assist the trading of assets as between the members of the Fund facility. The key
       requirement would be that any such MGF met similar specific criteria as outlined in
       b) above.

    d) A guarantee for the security by the simple mechanism of a self-guarantee to the DTI
       by all Industry companies with an acceptable credit rating.
       The present guidelines indicate that PCGs are unlikely to be acceptable to DTI, and
       we understand that this was intended to create a more level playing field for all
       companies. However, actual practice seems to be to deem certain companies (the
       majors) to be in themselves acceptable security. So enabling PCGs in the right
       circumstances to be acceptable as FSAs would seem appropriate.

    e) A "Sinking Fund" whereby cash amounts are set aside by participants and the fund is
       managed by the Industry.
       This option was raised recently by DTI and has not been explored in great detail, as:
        - for it to be an attractive option for Industry, all contributions would need to attract
       all relevant fiscal reliefs at the time the funds are set aside; but
        - it is recognised that such fiscal allowability is extremely unlikely to be acceptable
       to the OTO or Treasury.

    The above options have been discussed within the Industry and with dTI, but no formal
    acceptance or agreement has been reached yet.


Proposed Next Steps

There are two key initial steps to move this matter forward with DTI and the Industry as a
whole.
1. Reach agreement with DTI that FSAs are acceptable if the criteria outlined in 2b) are
    satisfied. This would provide more flexibility to the Industry compared with the recently
    issued guidelines.
2. Reach agreement across the industry and with DTI on the rating level for an acceptable
    FSA guarantor. The starting point here would be what the present guidelines require, i.e.
    AA rating or better as defined by Standard & Poors or Aa2 or better as defined by
    Moodys.
Although the focus of this report, is on the DTI’s requirements for FSAs, moving forward as
indicated above would also give a clearer basis for what should be acceptable for FSAs
required to be provided by and between participants in a JOA.




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