Chris Kidd Head of Shipbuilding and Offshore Construction, Joint Head of Energy & Infrastructure, Partner
The High Court reminder: Where does liability for decommissioning costs lie?
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Apache UK Investment Limited v. Esso Exploration and Production UK Limited  EWHC 1283 (Comm)
Liability for decommissioning costs is one of the greatest concerns for a company carrying out energy-related activities on the UK Continental Shelf. This liability is found in international law and imposed in the UK through the Petroleum Act 1998, which aims to ensure that the UK Government will not bear the significant removal costs of offshore installations.
Under the Petroleum Act 1998, the Secretary of State has powers to extend such liabilities not only to parties that have benefited from production, but also to related parties such as parent companies, affiliates and previous licensees. It is therefore common practice for a company that sells interests in an offshore field to request security from the buyer against future decommissioning costs.
In the recent case of Apache UK Investment Limited v. Esso Exploration and Production UK Limited , the High Court considered a dispute in the context of a Sale and Purchase Agreement dated 21 September 2011 (“the SPA”), between the buyer, Apache UK Investment Limited (“Apache”) and the seller, Esso Exploration and Production UK Limited (“Esso”).
Pursuant to the SPA, Apache acquired 100% of an LLC company which was the licensee in a number of hydrocarbon producing fields in the North Sea (“the Fields”). Apache agreed to indemnify Esso for all potential decommissioning obligations whether arising before, at or after the effective date of the SPA. Accordingly, the parties entered into six Bilateral Security Agreements (“the BDSAs”) detailing, among other things, the process of how the amount of security was to be calculated.
The first issue
Apache’s obligation to indemnify Esso was, at all material times, supported by a guarantee from Apache’s parent company. However, on 26 March 2020 the parent company ceased to be a “Qualified Surety” under the BDSAs. This event triggered provisions of the BDSAs which obliged Apache to:
i) provide further security in the form of Letters of Credit within 10 days of the event; and
ii) within 3 months, submit a proposed decommissioning schedule and budget (the “Proposed Plan”), covering “an estimate of the highest Net Cost during the immediately following Year (such immediately following Year being the “Relevant Year”).”
The Initial Amount of security (as defined in the BDSAs) was substantial, nearing £550 million. It was therefore unsurprisingly in Apache’s interest, amid a global decline in demand for oil, to reduce that amount as far as possible. By contrast, Esso wanted to ensure it was fully secured against any potential liability.
Apache initially provided security in the form of 11 Letters of Credit, for the aggregate of the Initial Amount. It then issued two Proposed Plans to Esso including the highest Net Cost for the years 2020 and 2021. It insisted that the security amount should be recalculated on the basis of the figures of the year 2020, and thus reduced the amount by around £140 million. Esso disregarded the 2020 Plan and contended that the “Relevant Year” upon which the plan should be based was the next calendar year (i.e. 2021) not the year immediately after the day of the event.
Charles Hollander QC, sitting as a High Court judge, ruled for Esso on the basis that the “Relevant Year” was a calendar year – the immediately following calendar year at any given date in 2020 was 2021. This, in his view, made more commercial sense because it encouraged planning for upcoming rather than past years. He found various problems with Apache’s interpretation of Relevant Year, one such problem being that it would potentially render another obligation of the BSDAs impossible to perform.
Nevertheless, he acknowledged the difficulty of reconciling Esso’s argument with provisions of the BSDAs which seemed to be the result of inconsistent drafting, but he noted that it had no effect on the amount of the security to be given. As such, he ruled that the obligation to prepare a Proposed Plan was related to 2021, not 2020.
The second Issue
The second issue concerned Esso’s objections to Apache’s Proposed Plan of 2021. Prior to the effective date of the SPA, the Secretary of State served a number of Section 29 notices on the acquired licensee company (“the Notices”) to submit decommissioning programmes and set out the measures for the abandonment of the Fields. It was common ground that notices served after the SPA came into effect could not hold Esso liable for decommissioning costs. However, Esso’s concern was that the Notices identified Fields installation very broadly, such that they could give rise to an obligation in respect of four wells that were omitted from Apache’s 2021 Plan (“the Additional Wells”). The Offshore Petroleum Regulator for Environment and Decommissioning (“OPRED”) was also consulted and expressed the view that Esso could be liable under the Act in relation to the Additional Wells.
Apache argued that, on proper construction of the Petroleum Act 1998, the Additional Wells could not be covered by the Notices or give rise to such liabilities because they did not exist when the Notices were served, and were drilled for the first time after the effective date of the SPA. Esso, on the other hand, contended that this was immaterial, and the Additional Wells could be captured by the Notices because it was possible to treat an entire Field as an “Offshore installation”. Esso maintained that additional security was required for the potential costs of decommissioning the Additional Wells.
The Court sided with Apache on this issue. It referred to sub-section 44(1) of the Petroleum Act 1998 which defined “Offshore installation” as “any installation which is or has been maintained or is intended to be established for the carrying on of any activity”. Under sub-section 44(5), “installation” included “floating structure or device maintained on a station”. This meant that “Offshore installation” naturally referred to equipment or structure within a field, so it could not mean the entire field.
The Court concluded that the Notices could not have related to the Additional Wells unless there was an intention to construct them when they were served. On the facts, it was never suggested that such an intention existed, plus the last Notice predated the SPA by around 15 years. The Court also clarified that OPRED’s views were not determinative of the Act, nor did they aid its conclusion. The Secretary of State had no power to impose a liability on Esso for the decommissioning of the Additional Wells, and no security was therefore required to be provided by Apache in relation to them.
The Court’s ruling in Apache v. Esso serves as a reminder that a company (or a company associated with it) selling interests in offshore fields can, subject to the service of Section 29 notices, be liable for decommissioning costs. Not only for existing offshore installations, but also installations that are intended to be established when the notices are served. It also clarifies that the Secretary of State’s powers to determine the meaning of the Petroleum Act 1998 are limited.