New requirements to demonstrate financial responsibility for E & A wells

Last week DECC has issued new guidance (the “DECC Guidance”) on its requirements for those wishing to drill exploration and appraisal wells in the UKCS to show financial responsibility before consent for such wells will be granted. The DECC Guidance, which comes into force from 1 January 2013, arises out of reviews conducted following the Macondo incident in 2010. It will require operators on behalf of their co-venturers to estimate the costs of bringing wells under control following an incident, cleaning up pollution and compensating affected third parties, and then to demonstrate that they have in place the financial resources to meet those costs.

OPEPs

Under the Merchant Shipping (Oil Pollution Preparedness, Response and Co-operation Convention) Regulations 1998 it is the duty of every operator of an offshore installation to have an oil pollution emergency plan (OPEP) and to implement such OPEP in the event of an oil pollution incident. So far as drilling is concerned, OPEPs must set out assessments of the worst case scenarios which could occur in relation to the well and the steps which would be taken in such scenarios to prevent or mitigate pollution. In the case of a well blow-out these steps are now expected in appropriate cases to include deployment of a capping/containment device and the drilling of a relief well. The operator is also responsible on behalf of its partners for dealing with the clean-up of any pollution which does occur and the compensation of affected parties.

In order to be satisfied that an operator is in a position to implement its plan, DECC must also be satisfied that the operator (together with its partners) has appropriately estimated the possible costs of implementing these steps and has in place the funds to do so.

The DECC Guidance

The DECC Guidance requires companies applying for consent to drill exploration and appraisal wells to provide DECC with their estimates of:

• the cost of bringing the well under control (this may involve use of capping device to temporarily restrain the flow but is likely ultimately to require the drilling of a relief well);
• the cost of addressing oil pollution and compensating affected third parties.

Having made these estimates the companies concerned must then provide evidence that they have funds to meet those potential liabilities through:

• the balance sheet strength of the operator or co-venturer
• insurance
• an undertaking from a parent company or affiliate;
• or a combination of the above.

The OGUK Guidelines

To assist companies in complying with this DECC Guidance, Oil & Gas UK has issued guidelines (the “OGUK Guidelines”) setting out how companies might go about estimating costs and demonstrating their financial responsibility. While the OGUK Guidelines are not binding in any way on DECC, DECC has indicated that it intends to give considerable weight to operators who can show that the guidelines have been met in the case of their application.

It is very difficult accurately to estimate the potential costs of a well control incident. The OGUK Guidelines provide methods of cost estimation for the two cost elements identified by DECC.

• For well control, unless there is a specific relief well cost estimate, costs are based on a multiple of twice the estimated cost for drilling the well which has suffered the incident plus a fixed sum for the deployment of a capping device. Wells which will not flow without artificial lift are excluded.
• For clean up and compensation, wells are placed into bands depending on their potential impact on pelagic fishing, and fish farming, the length of shoreline which might be affected and the amount of oil which might come ashore. Based on modelling carried out under OSPRAG, levels of potential cost are then set. For many wells the existing provision of $250 million of insurance under the OPOL Scheme is likely to be sufficient but for a minority, more provision will be required, of up to $500 million on top of the OPOL requirement.

These two figures in aggregate determine the amount of financial responsibility to be demonstrated by the joint venture. The OGUK Guidelines go on to specify in more detail the methods by which financial responsibility should be demonstrated by each partner for its share of the total, and provide certificates which the parties can provide to DECC to demonstrate that the required resources are in place. These certificates will generally be provided by each partner, collated by the operator and supplied to DECC with the OPEP. It is unlikely that DECC will give consent to drilling before it has received all of the relevant certificates and supporting paperwork.

DECC’s verification requirements

In addition to providing the certificates recommended under the OGUK Guidelines, the DECC Guidance also requires that:

• certificates should be signed by two senior members of the Board of the relevant company.
• certificates should be accompanied by a certified copy of the resolution of the Board which-

(a) confirms that the Board has read, understood and intends to comply with the DECC Guidance Note and the OGUK Guidelines;

(b) gives authority to the signatories to sign the certificate and confirms that those signatories have appropriate responsibilities within the company for the operations to which the certificate relates. Which members of the Board are given the authority is down to each company but to ensure the appropriate seniority, the DECC Guidance suggests that it may be appropriate for one of the signatories to be the managing director.

• a parent or affiliate company undertaking should be accompanied by a letter from the parent or affiliate company addressed to DECC which confirms that the parent company is aware of the DECC Guidance and the OGUK Guidelines.
• these Board resolutions must be renewed on an annual basis and when a significant change is made to the DECC Guidance.

Next steps for companies

Companies should read the DECC Guidance and the OGUK Guidelines carefully as they will apply to all wells for which application is made after 1 January 2013. Companies will wish to put in place the necessary Board authorities and to give early consideration as to how they would satisfy the financial responsibility requirements so as not to hold up any future applications for consent.

It is important to note that the assessment of financial responsibility does not constitute any sort of limit on the liability of the joint venture for a pollution incident but instead represents a pragmatic approach to estimating and providing for the potential costs of a very remote contingency.

Judith Aldersey-Williams was part of the working group which developed the OGUK Guidelines.

CMS Cameron McKenna has more than 20 UK based energy partners working in its London, Aberdeen and Edinburgh offices