Weathering the storm

For those of us with North Sea clients, 2015 has been a challenging time, which looks set to continue. But with every threat comes an opportunity for specialist advisers, across a range of legal and technical disciplines, to work together to identify the key trends in the UK offshore industry and, wherever possible, to highlight constructive options to weather the storm.

Competition v Collaboration

It is clear that collaboration will be the order of business for the basin, following the Wood Review and the establishment of the Oil & Gas Authority, but how many in the industry understand the legal limits on that collaboration? A recent report for the Competition & Markets Authority suggests that levels of awareness of competition law are pretty abysmal across industry in general, although better in larger businesses.

So how can businesses meet the aspirations of the new regulator, and their management, without violating competition rules? As always, the devil is in the detail, and the oil and gas industry has to become more sophisticated in its understanding of competition law principles. Importantly, just because the Government or the OGA thinks that greater collaboration would be a good thing does not mean that the industry can ignore competition law from now on.

If the particular collaboration being scrutinised is required by the OGA under threat of significant sanctions, this will be a defence to claims of competition law infringement – but there must be a specific and legally enforceable requirement from the OGA, not merely an exhortation.

Collaboration on technical and operational matters which has no material commercial implications (and is not used as a smokescreen for other less legitimate issues), is unlikely to infringe competition law.

Collaboration on commercial matters may be justified if the benefits for the production or distribution of hydrocarbons outweigh the restrictions on competition (for instance, if it enables a field to be developed which otherwise would have been stranded), but this will in some cases require fairly detailed analysis of the effects on markets.

The key will be to get the balance right in ensuring that competition law principles are respected without unduly hindering valuable initiatives.

The role of private equity?

Although there has been a slowdown in oilfield services M&A activity, there is general consensus that there is still a healthy appetite for quality assets at the right price.

Substantial private equity money has already been raised and is looking for a home in the sector, despite the challenges of $50 oil. Banks continue to be flexible and this, together with longer term equity commitments from private equity, has perhaps meant that businesses with cash flow issues have fared better than expected and there have to date been fewer distressed situations than previously predicted.

This highlights the significant benefits of a strong relationship between management and private equity. Private equity investors are still keen to invest, but it seems there are two key considerations:

(1) the price has to be right – no one is going to overpay in the current market, but equally sellers are reluctant to exit cheaply, so commercially vendor and investor/buyer price expectations need to converge; and
(2) the assets have to be good quality, as credit committees are unlikely to back investment into assets with contractual or compliance issues.

To become, or maintain a position as, a quality asset, a business has to be able to withstand investor and buy-side due diligence investigations. Management teams need to create and further enhance value by finding ways of doing things better, smarter and by presenting a cleaner shop to potential private equity investors. Then, if they are involved in any exit event or a funding process, management can justify and maintain the offered price and minimise the chances of there being any claim after the event.

Some work upfront by management, working with their lawyers and experienced oilfield services corporate finance advisers, pays off. Not only should it make any bid and investment terms more concrete, it should cut time out of any transaction through anticipating and resolving any issues which might arise and providing information to allow investors to satisfy themselves.

Decommissioning

Decommissioning, and decommissioning security, has been one of the principal features, and hurdles to overcome, in upstream oil and gas M&A over the last few years. With the growing maturity of North Sea assets, potential buyers do not want to take on liability for decommissioning where there is little if any guarantee of profit at the end of the day. Sellers are therefore left with a near-term choice as to whether to hold on to assets until end of field life, or exit and use any cash generated from such exit for other purposes.

The net result of a requirement for buyers to take on liability for decommissioning and/or for security provision has been that some relatively recent planned sales simply have not happened at all.

There have, however, been positive developments making provision of decommissioning security, in particular, more economic. While in the past a request for security might have been made separately by sellers and the buyer’s new joint venture partners, the advent of the industry standard field-wide decommissioning security agreement has alleviated the requirement to provide multiple security in the majority of cases.

Additionally, the recent contracts entered into between Government and industry (decommissioning relief deeds), assuring availability of tax relief on decommissioning expenditure, have allowed buyers to move away from provision of security on a “pre-tax” to a “post-tax” basis, reducing security required by between 50% and 75%. Notwithstanding this, in real terms many companies have seen no reduction in security (and some have seen an increase), as a result of the effect of the low oil price on the security calculation and the connected timing of anticipated decommissioning under their DSAs.
While a sale for positive consideration and a clean break is still the most desirable outcome for a seller, more innovative disposals of assets are emerging where elements of decommissioning or related liabilities have been retained by the selling party in order to get deals over the line. We can expect to see this feature continue.

Health and safety

With production declining as the most easily accessed reserves are exhausted, recent discoveries tend to be in deeper waters and under higher temperatures and pressures, pushing the boundaries of technological capabilities with workforce and assets facing ever more extreme environments and conditions.

There might be a temptation in the current climate to assume that simply keeping heads above water where matters of safety and asset integrity are concerned, will suffice until the economic climate begins to improve. However, decisions and actions taken now have the potential to impact on ability to carry on operations and increase production once prices pick up again, and safety can and often does affect bottom line in a way that is frequently overlooked.

So, at a time when many good and experienced staff are being lost by the industry, clients may want to consider divesting idle resources into addressing these matters. Could safety performance be reviewed or improved? The danger is that those staff with the knowledge, experience and familiarity with assets and company procedures may not still be here when they may be sorely needed. The workforce needs to be not only competent to understand what is necessary and what should be in place to protect them, but actively engaged in major hazard control and recognising systemic failures. The focus on health and safety should always be at the forefront, from leadership downwards.

The people dimension

Although contractors have borne the brunt of the job losses in the North Sea – a recent estimate by Oil & Gas UK puts the figure at 65,000 jobs since the start of last year – significant numbers of other employees have also been made redundant.

Industry insiders were well aware that, for many years now, operating costs had been too high and wage bills inflated (as contrasted with reducing efficiency and production). Unfortunately the downturn made salary reductions a priority issue requiring immediate attention. In many cases these consultations have sat alongside negotiations over equal time rotas, and a background of large-scale redundancies.

The threat of industrial action in the North Sea has been at its highest for a generation. Both disputes over pay deals and the return by many operators to equal-time shift patterns triggered a standoff with the unions, although at the time of writing employers have managed to avoid dealing with striking workers offshore. Never has it been more important for affected businesses to focus on their industrial relations strategy.

With experts predicting that this downturn is going to be with us until at least 2017, even companies that
made cuts at the start of the year are being forced to consider further measures.

There are a range of options available to employers looking to reduce people costs, either on a temporary or longer term basis. These include taking a creative look at resourcing models, terms and conditions, holiday and leave arrangements as well as pay and reward structures. Large-scale projects like this, which normally involve changes to terms and conditions, are not straightforward and involve significant input from HR, and consultation. In this way some investment in planning has reaped rewards for clients who have managed to limit unrest as a result.

Compared with further job losses, amended terms may well be the lesser evil to deeper cuts. However, and as current tensions illustrate, unions and workers themselves will not accept low oil price and reduced profits as unchallengeable reasons for change, and a well-designed legal, employee and industrial relations strategy is therefore vital to success.