Oil & Gas: Impact of shut-in of production on gas sales agreements

Introduction

The English Commercial Court has recently decided the impact of a shut-in of production, for the purposes of tie-in works, on the respective rights of producers/sellers and buyers under related gas sales agreements. In Scottish Power UK Plc v BP Exploration Operating Company Ltd & Ors [2015] EWHC 2658 (Comm) the Commercial Court decided that the buyers were entitled to compensation for the period of the shut-in. The issues dealt with in the case highlight some of the dilemmas likely to face the North Sea industry in implementing MER UK alongside existing contractual obligations.

Facts

Scottish Power entered into four long-term agreements (on materially identical terms) for the sale and purchase of natural gas (“Agreements”). It agreed to purchase from the sellers (BP Exploration Operating Company Limited, Talisman Sinopec North Sea Limited, ENI TNS Limited and JX Nippon Exploration and Production (UK) Limited (the "Andrew owners" or the "Sellers") natural gas produced from the Andrew Field.

The obligation to deliver an amount of natural gas in accordance with Scottish Power’s proper nomination was contained in Article 6.12 of the Agreements, which provided that:

"the Seller shall deliver on each Day at the Delivery Point the quantity of Natural Gas properly nominated by the Buyer under this Agreement for delivery on such Day."

Article 16 established a regime whereby, when an underdelivery occurred on any day, the quantity of gas which the Sellers had failed to deliver was classified as Default Gas and the Buyer would become entitled to receive a like quantity of gas in a subsequent month at the Default Gas Price, which was 70% of the Contract Price.

The provision at the centre of the dispute was Article 16.6, which stated:

"The delivery of Natural Gas at the Default Gas Price and the payment of the sums due in accordance with the provisions of Clause 16.4 shall be in full satisfaction and discharge of all rights, remedies and claims howsoever arising whether in contract or in tort or otherwise in law on the part of the Buyer against the Seller in respect of underdeliveries by the Seller under this Agreement, and save for the rights and remedies set out in Clauses 16.1 to 16.5 (inclusive) and any claims arising pursuant thereto, the Buyer shall have no right or remedy and shall not be entitled to make any claims in respect of any such underdelivery."

The agreements also provided a reasonable and prudent operator (RPO) standard at Article 7.1:

“Throughout the Contract Period the Seller will, in accordance with the Standard of a Reasonable and Prudent Operator, provide, install, repair, maintain and operate those Seller’s Facilities which are (in the opinion of the Seller and the other Sellers) necessary to produce and deliver at the relevant times the quantities of Natural Gas from the Andrew Field which are required, in accordance with the terms of this Agreement, to be delivered to the Buyer at the Delivery Point."

A Reasonable and Prudent Operator was defined in Article 1 as:

“a Person seeking in good faith to perform its contractual obligations and, in so doing and in the general conduct of its undertaking, exercising that degree of skill, diligence, prudence and foresight which would reasonably and ordinarily be expected from a skilled and experienced operator engaged in the same type of undertaking under the same or similar circumstances and conditions, and the expression the ‘Standard of a Reasonable and Prudent Operator’ shall be construed accordingly."

Production of natural gas was shut-in for a period of over three and a half years, between 2011 and 2014, so that work could be done to tie-in a nearby oil and gas field to the Andrew platform.

In summary, the Sellers (the Andrew owners) broadly accepted that their failure to deliver gas to Scottish Power was a breach of Article 6.12 of the Agreements. It was common ground that the sole remedy for any breach of that clause was Default Gas under Article 16. However, it was Scottish Power’s case that, during the relevant period, the Andrew owners were also in breach of their obligation under Article 7.1 to operate the Sellers’ Facilities for which it was entitled to separate damages. The Andrew owners denied that they were in breach of Article 7.1 but argued that, even if they were, Default Gas was also the sole remedy for the alleged breach of that clause.

Decision

Liability

Scottish Power’s position was that the Andrew owners were to carry out, in accordance with the RPO standard, five activities in relation to the relevant facilities. In order to carry out any of these activities to the required standard, the Andrew owners had to carry them out in the first place. On that basis, Scottish Power argued that if they were not operating the facilities at all, they could not be operating them in accordance with the RPO standard.

However, the High Court rejected Scottish Power’s contention for the following reasons:

1. The language of Article 7.1 was not language which parties would naturally have used if they intended to impose two distinct obligations – one absolute and the other qualified.
2. Scottish Power’s interpretation arguably leads to an unreasonable result. For example, it may be necessary to cease operating the facilities for a period while repairs are carried out. If the obligation to operate the facilities was an absolute one as Scottish Power asserted, the Andrew owners would be subject to two mutually inconsistent obligations and would be in breach of the clause whatever they decided to do. The court stated “to place the [Andrew owners] in a situation where they must violate the contract in order to perform it is not something that rational parties would have intended.”

That said, the High Court went on to find the Andrew owners in breach of the RPO obligation for the following, contract specific, reasons:

A. The natural and ordinary meaning of the words “a Person seeking in good faith to perform its contractual obligations” in the definition of RPO meant that the RPO obligation related to performing the Agreements and not wider industry concerns relating to best practice.

B. The High Court did consider the impact of the Andrew owners’ obligations under the Petroleum Act 1998, Gas Act 1995 and the Industry Code of Practice on Access to Upstream Oil and Gas Infrastructure on the UK Continental Shelf (“ICOP”), concerning good practice relating to tie-ins and DECC’s ability to intervene to grant third party access.

C. The High Court decided that the Andrew owners did act “as a reasonable operator in their position would have done, take account of and seek to comply with the provisions of ICOP”.

D. However, “[t]here was nothing in the language of the definition [of RPO] to support” an interpretation that ICOP or statutory obligations had a role to play in deciding whether the Andrew owners had acted in accordance with the RPO standard for the purpose of the agreements.

E. As the decision to shut-in production was a purposeful decision not to provide services to provide, install, operate and maintain the Seller’s Facilities during the tie-in period it was a breach of the RPO clause giving rise to a separate claim under Article 7.1.

Damages

The Andrew owners maintained that in the event of a breach of the RPO standard in Article 7.1 the agreements provided for a comprehensive remedial framework in such circumstances where there was an under-delivery of natural gas, i.e. Scottish Power’s only remedy could be Default Gas. Scottish Power claimed that it was entitled to bring a separate claim for damages, which it accepted in Court would have to be reduced to account for any double recovery with Default Gas.

In this respect, the Commercial Court recognised that Default Gas was not a remedy at the election of the parties. The word “shall” in the Default Gas provision meant that, in the circumstances of underdeliveries, Default Gas automatically accrued. Against this background the High Court decided:

1. The Agreements did not provide a complete code for remedies available for the breach of the RPO provision. In certain circumstances, general damages would be available.
2. However, where the compensation claim related to underdeliveries “the remedy of Default Gas, is the sole remedy available for the loss” – effectively meaning that the Andrew owners’ position prevailed.

In reaching this conclusion, the Court undertook a detailed analysis of this issue. It accepted that there was more than one possible interpretation and therefore considered the differing interpretations based on the commercial purpose of the clause.

Comment

This case brings into stark clarity the issues that the industry may face in the next few years between balancing obligations under the new Energy Bill to be maximising economic recovery from the UKCS (MER UK) and complying with existing contractual arrangements.

The Commercial Court was unwilling to use the factual matrix to expand the scope of the Andrew owners’ RPO obligation beyond the natural and ordinary meaning of the words, which required the Andrew owners to “perform its contractual obligations”. The approach of the High Court arguably sought to apply the principles in Arnold v Britton [2015] UKSC 36 (click here for our Law-Now on this earlier decision). In that case, the Supreme Court appeared to place a renewed emphasis on the natural and ordinary meaning of the words and less emphasis on the factual matrix behind the parties’ agreement. As a consequence, the Andrew owners’ arguments that it acted as an RPO due to the shut-in being for the purpose of facilitating a tie-in so as to accord with ICOP were not of relevance to deciding if there was a breach of Article 7.1.

The Commercial Court’s decision suggests that sellers with similar clauses, in the same position as the Andrew owners, might in the future be placed in the invidious position of having an RPO obligation to continue performance of sale and purchase agreements, whilst having a regulatory obligation concerning MER UK that requires it to shut-in production for a period so as to facilitate tie-in of additional fields to further the government’s stated policy objective of maximising economic recovery on the UKCS, which is simply inconsistent with its RPO obligations.

Once the Energy Bill becomes law, it might be that the compatibility of contractual obligations and MER UK will warrant consideration and discussion between parties.

This case also raised an interesting issue on consequential loss that shall be dealt with in a separate Law-Now.

Please click here for a copy of the judgment.