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18 December 2017
After a decline in oil price in the late 1990s, the government opened up to a wider variety of players on the Norwegian Continental Shelf (NCS). As a result, activity grew in the transaction market for petroleum production licences, attracting both large and smaller companies. Lately a number of corporate transactions and mergers have been observed, as several oil majors and traditional downstream companies with upstream assets have begun to reduce their presence on the NCS. In general, these companies have been replaced by smaller or medium-sized companies and, to some extent, by private equity-backed players.
This is a concerning trend for the government, which seeks to attract and retain strong, competent industrial players to achieve a high level of activity on the NCS and ensure safe and efficient operations. As the NCS is maturing as a petroleum province and the industrial players reduce in size, the government has increased its focus on ensuring that the substantial cost of future decommissioning of petroleum facilities will be covered. To this end, in 2009 a new provision in the Petroleum Act(1) was included, establishing a secondary decommissioning liability for sellers of petroleum licences.(2) In Autumn 2016 the Ministry of Petroleum and Energy announced that in all future corporate transfers it would consider requiring security from the seller establishing a secondary liability for future decommissioning costs.
This update discusses the scope, content and effect of this new security requirement. To understand the context and implication of the new regime, it also provides a short introduction to the transfer approval regime.
Scope of approval requirement
Pursuant to Section 10-12 of the Petroleum Act, the "transfer of a licence or a participating interest in a licence for petroleum activities may not take place without the approval of the Ministry".(3) This applies to the transfer of all kinds of licences for petroleum activities, but the transfer of production licences is by far the most common.(4)
In addition to the direct transfer of such licences, the approval requirement also applies to "other direct or indirect transfer of interest or participation in the licence". The act provides examples of such transfers, including: "assignment of shareholdings and other ownership shares which may provide decisive control of a licensee possessing a participating interest in a licence".
A transfer that results in a change in positive control of the licensee (eg, where the transfer results in the transferee holding more than 50% of the participating interest or shareholdings representing a majority of the voting rights in the company) will require the ministry's approval. However, according to the preparatory works of the Petroleum Act(5) and the ministry's administrative practice,(6) even a transfer that results in a party attaining negative control of a licensee requires ministry approval. Where the licensee is a Norwegian private limited company, negative control is generally achieved by holding more than one-third of the company shares. In addition, control of a licensee may follow from other controlling rights in the company (eg, special voting rights). Therefore, whether a transfer requires ministry approval must be assessed in each individual case.
The Ministry of Petroleum and Energy has substantial freedom in its decision to approve transfers pursuant to Section 10-12 of the Petroleum Act. In cases where the ministry has grounds to decline approval of the transfer, it may instead choose to approve it subject to stipulated conditions. If an approval of the transfer is declined, the licence will not be legally transferred and the intended transferee will not become a licensee.
Pursuant to Section 72 of the Petroleum Regulations,(7) several requirements for the award of petroleum rights(8) shall apply mutatis mutandis when assessing the direct or indirect transfer of a petroleum licence. For such assessment, Sections 10 and 11 of the regulations are the most relevant. These were amended by the ministry with effect on June 26 2017.(9) The main criteria for the assessment of award of licensees (and approval of transfers) outlined in Section 10 were not altered in substance. The section states that:
"In the interest of furthering the best possible resource management, production licences are granted on the basis of the applicant's technical competence, financial capacity and the plan for exploration and production in the area for which a production licence is sought."(10)
To obtain approval, the transferee must fulfil the minimum requirements of the prevailing pre-qualification procedure for companies seeking to become a licensee or an operator on the NCS.(11) In addition to the minimum requirements, the assessment generally covers the activities planned for the licence and the size of the transferred participating interest in the licence. Additional requirements may apply for the transferee where particular circumstance warrants.
Where the licensee is part of a corporation or group, the ministry's assessment of the licence transfer will include not only the transferee, but also its corporation or group, depending on the licensee's financial robustness and technical competence and capacity. A similar assessment of the transferee's corporation or group will be made when the ministry considers approval of a transfer of a licensee or a transfer that results in a change to the direct or indirect control of the licensee.
Financial strength and security assessment
Pursuant to Section 10-7 the Petroleum Act, both upon granting a licence and at any later point in time, the ministry may:
"decide that the licensee shall provide such security as approved by the Ministry for fulfilment of the obligations, which the licensee has undertaken, as well as for possible liability in connection with the petroleum activities."
This requirement is closely related to that of financial strength. The ministry may choose security instruments or requirements pursuant to this provision, but it will require any licensee that has a parent company to provide an unlimited parent company guarantee (PCG) from its ultimate parent in the form of the model PCG prepared by the ministry. The ministry's practice on what constitutes a 'parent' is based on the applicable corporate law and reflects whoever holds positive control of the licensee. Thus, a company is regarded as a 'parent' if it holds or controls – directly or through subsidiaries – more than 50% of the participating interest or shareholdings, which represents a majority of the voting rights in the licensee. If a transfer results in a change in control of the licensee, the existing general PCG will be returned to the former parent and the new parent (if any) will need to issue a similar general PCG to the ministry based on the standard model.
If the ministry finds that a transfer of (or change in control over) a licensee will result in the security available for covering the company's obligations falling below the sufficient level, it may decline the transfer or conditionally approve it subject to establishing security in another form. The ministry has considerable freedom in its judicial assessment of what it considers a sufficient level of security pursuant to Section 10-7 in each individual case. Such assessment will generally be based on the financial strength of the licensee and its parent company, as well as the licensee's obligations and liabilities, the activity in which it is involved and other relevant facts. The ministry generally requires the maximum security available through the licensee's group or corporation (through the PCG) and will require additional security from third parties only where special circumstances warrant.
Regulated secondary liability
In 2009 Section 5-3 of the Petroleum Act was amended to establish secondary liability for sellers of petroleum licences in relation to future decommissioning costs. Pursuant to this, sellers remain secondary liable to any future licensees at the time of decommissioning for defaults in payment of decommissioning costs by the buyer (or its successors). This liability is limited to the participating interest share of the cost relating to the transferred participating interest in the licence and the cost of decommissioning facilities which were present in the licence at the time of transfer.
The seller will also be liable to the Norwegian state for the participating interest part of the decommissioning cost executed by the state on behalf of the licensees if such costs are not covered by the present licensee or another responsible party.(12)
This mandatory secondary liability covers the direct transfer of petroleum licences or participating interest in such licences, but does not cover the transfer of a company holding petroleum licences.
New security requirement
On November 8 2016, in a letter to the Norwegian Oil and Gas Association, the ministry widened the scope of secondary liability for future decommissioning cost, stating as follows:
"The ministry will in its assessment of all future transfers of licensee companies with licence field(s) in operation on the NCS, consider stipulating conditions of secondary liability for the parent company for relevant cost of carrying out future decisions on decommissioning."(13)
As legal basis for its new practice, the ministry referred to Section 10-18 of the Petroleum Act, which provides the right to stipulate conditions in relation to a decision on a transfer pursuant to Section 10-12 of the act. Further, the ministry referred to the preparatory works for the amendment of the act in 2009, in which the possible condition for an indirect transfer was described. The ministry also pointed to the increased maturity of the NCS, making the issue of liability for future decommissioning costs more acute, and highlighted that the transfer of licences and licensees should be treated equally with regard to the seller's secondary liability for future decommissioning costs.
The ministry has developed a model parent guarantee document, which has recently become available. As far as is known, this model is similar to the guarantees provided by sellers in corporate transfers approved after the letter was issued.
Application of requirement
Thus far, little is known about the detailed elements of the ministry's assessment and the situations in which the guarantee will be required. However, an individual assessment of the transfer will be made in each case, as opposed to the mandatory secondary liability regulated under the Petroleum Act. This enables the ministry to make an assessment based on more general resource management objectives, in line with the practice of transfer approvals. This might indicate that a secondary liability guarantee will be required only where the transfer results in a real change to financial strength and security (eg, where the transferee or its parent is substantially weaker financially than the transferor or its parent – as in the example referred to in the ministry's letter). However, the ministry's practice(14) and recent signals from ministry representatives indicate that a change in financial strength may not be a deciding factor. Further, it has been indicated that a guarantee may be required more generally and that exceptions will be made only in special cases (eg, where the extent and cost of the decommissioning work is limited or its execution lays far in the future).
The ministry's letter refers only to the transfer of a licensee as a basis for guarantee requirements. However, the model guarantee document structure clarifies that the guarantee may also be used in the transfer of shares in the licensee or in its parent. Transfers of less than 100% of the shares in a licensee or its parent may also be subject to the guarantee requirement, provided that the transfer results in a direct or indirect change in positive control over the licensee.
Scope and beneficiaries under guarantee
The model guarantee states that the transferor must guarantee the transferred licensee's and its successors' payment of the licence share of the decommissioning costs in relation to both production licences and licences for installation and operation of facilities.(15)
In its letter, the ministry stated that it will consider stipulating conditions in all transfers of licensees with "fields in operation". This indicates that the guarantee practice will be aligned with the scope of secondary liability pursuant to Section 5-3 of the Petroleum Act, excluding transfers involving licences without facilities. This is confirmed by the model guarantee, which states that the obligation relates to all licences held by a transferred licensee with facilities (including wells) that existed at the time of the transfer. Further, the guarantee will cover the transferred licensee's subsidiary liability at the time of the transfer to buyers of participating interest pursuant to Section 5-3 of the Petroleum Act.(16) The guarantor will thus be liable under the guarantee for such costs until all of the relevant facilities have been decommissioned.
Under the guarantee, 'beneficiaries' are the other (future) licensees which are responsible for carrying out the decommissioning work. To call on a guarantee, the licensee and its successors must have defaulted on their payment obligations in relation to decommissioning. However, claims under the guarantee must follow the line of succession of transfer as far as possible, and must first be made against the last transferor. The Norwegian state is also a beneficiary for costs incurred in implementing the necessary decommissioning measures on behalf of the licensees pursuant to the Section 5-3 of the Petroleum Act.(17)
The procedural rules of the guarantee (eg, dispute resolution, applicable law, venue and enforcement) are largely similar to those that follow the general PCG model.
The PCG requirement creates a more complex situation in relation to liability for future decommissioning costs on the NCS. This in turn creates uncertainty and risk, which result in increased transaction costs. Although transferors will mostly require a counter-guarantee from a transferee, the complexity and uncertainties of the liabilities covered by the guarantee make this solution unattractive to transferees and could be expensive to solve though a third-party guarantee. In addition, these inter partes counter-guarantees do not relieve the transferor of its obligations under the original guarantee and thus no clean exit can be achieved. This challenge affects both existing industry players and new entrants with a shorter investment horizon and different corporate structure (eg, private equity-backed players).
Further, including all licensees of the licences comprised by the transfer beneficiaries under the guarantee substantially expands the scope of the parties involved and the risk of future claims and legal action. This will especially be the case if there are subsequent transactions of the licensee or the participating interests in the licensee's portfolio are transferred. Thus, the guarantee creates a substantial need for coordination of rights and updated information in relation to licence and corporate transfers, the state of facilities, assessment of costs and decisions made by the ministry, on which the model guarantee provides no regulation or guidance.
Questions have also been raised about the robustness of the security achieved by the guarantee and the extent to which the ministry will – and has sufficient legal basis to – follow up on a guarantor's ability to fulfil its obligations in future cases, which may arise decades after the transfer and after the company has left the NCS.
The model guarantee document may be considered the result of discussions with industry parties during the process of approving relevant transfers. However, it remains to be seen whether there is room for negotiating or tailoring the model guarantee in future cases. Although the ministry will likely be reluctant to make substantial changes in individual cases and will most likely require the model to be used with minor or no amendments, it may consider including some procedural requirements in order to meet the criticism voiced by the industry.
The challenge for the government is achieving sufficient security for decommissioning costs without jeopardising a positive and healthy investment climate. Many have argued that the increasing maturity of the NCS and the necessity of a wider spectrum of industry players to uphold NCS activity calls for a new approach in obtaining the necessary security for future decommissioning costs. Indeed, some have argued that it is time to consider individualised, horizontal licence-specific guarantees or a decommissioning fund solution on the NCS. However, there is no indication that the ministry is actively considering such solutions at present.
For further information on this topic please contact Frode Vareberg at Simonsen Vogt Wiig Advokatfirma by telephone (+47 21 95 55 00) or email (email@example.com). The Simonsen Vogt Wiig Advokatfirma website can be accessed at www.svw.no.
(4) Production licences are awarded pursuant to Section 3-3 of the Petroleum Act, while licence for installation and operation of facilities (typically pipelines) are awarded pursuant to Section 4-3 of the Petroleum Act. Exploration licences (Section 3-1 of the Petroleum Act) are short term, non-exclusive rights where transfers are not practical.
"If a decision relating to disposal is not carried out within the stipulated time limit, the ministry may take necessary measures on behalf of the licensee or other responsible party, and for their account and risk. Costs of such measures are grounds for enforcement of distraint."
(15) Production licences are awarded pursuant to Section 3-3 of the Petroleum Act, while licences for installation and operation of facilities (typically pipelines) are awarded pursuant to Section 4-3 of the act.
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