Oil and Gas: UK Petroleum Licences – Contract or Regulation?

Summary

In R. (Benjamin Dean) v The Secretary of State for Business, Energy and Industrial Strategy [2017] EWHC 1998 (Admin) the Administrative Court considered an application by judicial review to quash a Deed of Variation, which extended the “Initial Term” of an onshore UK petroleum licence.

The decision contains useful clarification as to the contractual and regulatory considerations applicable to onshore and offshore licences, including: (i) whether a licence was governed entirely by the statutory provisions; (ii) if so, whether the Secretary of State for Business, Energy and Industrial Strategy (“DBEIS”) had the power to vary a licence; and (iii) if so, whether DBEIS had the authority to enter into a Deed of Variation.

Facts

The case concerned an onshore Petroleum Exploration and Development Licence (PEDL 189) in Cheshire, granted under section 3 of the Petroleum Act 1998 on 3 September 2008. The licence had an “Initial Term” (an “exploration” phase, whereby the Work Programme and Budget agreed with DBEIS is to be performed) of six years on and from 1 July 2008. This was followed by a “Second Term” (within which a Field Development Plan is formulated and land rights acquired to conduct the development) of five years. The final term, the “Production Period”, was to last twenty years.

The initial Work Programme and Budget envisaged the exploitation of coal bed methane, but when the shale gas potential was realised, discussions were held in respect of restructuring the term of the licence between the licence holders and the predecessor of DBEIS (the Department for Energy and Climate Change).

In 2013, the Initial Term was extended by a Deed of Variation to eight years. Expiry of the Initial Term was then due on 30 June 2016. The Second Term was reduced from five to three years. The Production Period and overall duration of the licence were unaffected.

To explore the shale gas potential further, the Initial Term required fracking. Protesters occupied the site, preventing work, between 2014 and 2016.

Due in part to this delay, the licence was again amended in 2016 by Deed of Variation between the licence holders (Engie, Ineos and Dart Energy; Dart Energy also being the operator), and DBEIS (the “2016 Deed”). The Initial Term was extended to ten years. The Second Term was reduced to one year. Again, the Production Period and overall duration of the licence were unaffected.

The Claimant was a parish councillor in the area and applied for judicial review of the 2016 Deed. Dart Energy appeared in the case as an “Interested Party”.

Arguments of the Parties

The Claimant argued that the licence was granted under the Petroleum Act 1998 and was governed entirely by that Act as a “complete statutory code”, which did not permit DBEIS to vary a licence once granted. In the alternative, the Claimant argued that DBEIS had no authority to vary the licence.

DBEIS (and Dart Energy) argued that the licence was contractual as it concerned the grant of proprietary rights. It was therefore variable by agreement in accordance with the usual contractual principles.

Decision

It was common ground between the parties that: (i) petroleum vests in the Crown, irrespective of land ownership (the Court referred to the leading judgment confirming this key principle: Bocardo v. Star Energy [2010] UKSC 35); and (ii) labelling the licence as “contractual” or “regulatory” should not replace the correct legal analysis, which is to look at the substance and effect of the rights and obligations created by the licence, viewed objectively in the context of the legislation under which it was issued.

Nature of Licence Rights

The Court drew upon the history of mining leases; mining licences coupled with a grant; and bare licences and noted the contrast between: (i) a right to carry away the minerals won, which conferred property in the minerals won; and (ii) a bare licence simply to search for minerals, which conferred upon the licensee no property in the minerals obtained.

It was held that a licence granted under section 3 of the Petroleum Act 1998 is an exclusive licence to search for, bore for and get petroleum. The licence also granted to the licensee rights of ownership over product once won. The licence therefore created private law rights.

A petroleum licence was “essentially a property transaction, akin to a mining licence or a mining lease…more than simply a contractual agreement between two parties, it is a grant of an interest in land” the terms of which were “entirely consistent with a normal grant of property rights in a mining lease or a mining licence”. In this respect, it affirmed the position in Halsbury’s Laws (5th Ed) Vol 76 that “since minerals are part of the land it follows that a lease can be granted of the surface of the land and the minerals below”. As with mining leases and licences, the creation of the interest was achieved by the execution of a deed. The creation of a section 3(1) Petroleum Act 1998 licence by deed reflected the need for that formality when creating an interest in land. The use of the word “grant” in section 3(1) was indicative of an interest in land.

The interest in land was the exclusive right to “explore” and “get” petroleum. The petroleum became personal property, capable of sale to third parties, once “won”.

A grant of interest in land was subject to contract law principles in respect of the ability of parties to vary their agreement. A consensual variation was an instance of the “normal dealings within a commercial relationship created by a contractual deed of licence”. The fact that a licence was granted under a statutory provision did not alter that analysis, unless such a right was excluded or modified either by the statute or the licence itself.

The Right to Vary the Licence

Having assessed the nature of the licence rights, the Court concluded that neither the legislation, nor the terms of the licence itself, prohibited the variation in the 2016 Deed. As such, the variation was lawful.

The Court nonetheless considered whether, assuming the licence was governed entirely by the statutory code, the 2016 Deed fell within the incidental powers of the Crown and DBEIS under the legislation – i.e. whether the 2016 Deed was ultra vires (i.e. outside of legal authority).

The Court noted that the doctrine of ultra vires required it to assess what ought to be reasonably and fairly be regarded as incidental to, or consequential upon, those things which the legislature has authorised. The licensing regime under the Petroleum Act 1998 had the objective of encouraging applications for licences by enterprises prepared to take on substantial risks involved in exploring for and getting petroleum, so as to promote and maximise the economic recovery of a valuable UK recourse. It could be said that there was a public interest argument in favour of the flexibility afforded by recognising the power of DBEIS to vary a licence by agreement with the licensee.

It was held that, even if licences were governed solely by a statutory code, there was nonetheless an implicit or incidental power to vary a licence subsequently by agreement. Again, it was noted that this implicit power could be expressly excluded by the legislation, but this was not the case.

The Authority of DBEIS

The Court gave short shrift to the final argument by the Claimant, which was that DBEIS only had authority from the Crown to enter into the licence, not to vary it. The Court noted that the Petroleum Act 1998 gave substantial authority to DBEIS beyond simply executing the licence, for example: setting the consideration or terms of the licence. It was a settled principle that, when dealing with a lease or similar property-related transaction, there was no distinction between Her Majesty in her public capacity, the Crown or the Secretary of State responsible for exercising governmental functions. There was no legal requirement for the 2016 Deed to state that DBEIS was acting for and on behalf of the Crown.

It was entirely consistent with the statutory scheme that, whilst acting on behalf of the Crown, DBEIS should be able to agree variations in the terms of the licence.

Further Matters Decided by the Court

The decision clarified the impact of previous case law on the question of the legal nature of petroleum licences. Some practitioners may be familiar with the case of Inland Revenue Commissioners v. Mobil North Sea Ltd [1986] 1 WLR 296, (“Mobil”) where it was held that a petroleum licence did not fall within the meaning of “a contract” as used in s.111(7) of the Finance Act 1981.

However, the Administrative Court reached the “clear conclusion” that Mobil was “not in point” and so the Court was not bound to follow the decision. Mobil turned on a principle that not every document containing contractual obligations could properly be described as a “contract” “for the purposes of a particular statutory scheme”, even though it is otherwise contractual. Mobil had “nothing to do with the question whether a petroleum licence can properly be described under the general law as a contract and thus capable of consensual variation” (our emphasis).

The judgment also confirms that a right to vary a licence is not in breach of EU law (i.e. the 1994 Directive (94/22/EC) – the Hydrocarbons Licensing Directive). EU law did not seek to control a Member State’s decision to subdivide the overall duration of a licence into constituent parts (in this case, Initial Term, Second Term and Production Period). Nor did it prohibit a decision to allow those phases to be increased or decreased – a fortiori when the overall duration of the licence was unaffected.

Comment

The decision makes it clear that, whatever its nature, a petroleum licence is an instrument capable of amendment by the agreement of the parties, subject to any restriction on that ability that might be expressly set out in legislation or the terms of the licence itself.

The Court took evidence from Mr. Simon Toole, former Director of Licensing and Legal at the Oil and Gas Authority. The Court took note of the vital role flexibility can play in the conduct of petroleum projects, both onshore and offshore. It was in the national interest for DBEIS to be able to react to the changes of circumstance that can take place during the term of a licence by agreeing to variations – even substantial variations. There would be an adverse effect on market confidence and interest in opportunities for exploration if the parties could not legally agree variations of the licence.

The decision will provide some comfort to onshore and offshore licensees. The Court was aware of the need to avoid significant disruption to the operation of the licensing regime.

If it were not possible to vary a licence by a deed of variation, it was estimated that 121 onshore licences, including PEDL 189, would have no other mechanism available to vary Work Programmes or the duration of the Initial or Second Terms. A further 79 onshore licences would have no other mechanism available to vary a Work Programme or other clause.

In addition, as at 3 February 2017, there were 530 offshore licences extant. Although the decision was specifically concerned with an onshore licence, much of the analysis is equally applicable to offshore licences (albeit the courts would not categorise these as “an interest in land” to the same extent, given the UK’s rights at international law extend only to the rights to search, bore for and get petroleum, with no ownership rights in the petroleum itself until won).

Indeed, the Court noted that the problems for offshore licensees – and the consequent need for flexibility – would be much greater, as their costs are typically an order of magnitude greater than those onshore. The fact that there were certain consent stages in an offshore licence, which must satisfy further regulatory requirements before certain works can begin (e.g. Environmental Impact Assessments), did not alter the nature of the grant by the Crown of exclusive property rights and the incidental power to amend the licence by agreement. The only restriction was that no agreed variation to the licence could override those further regulatory requirements.

Link to case: R. (Benjamin Dean) v The Secretary of State for Business, Energy and Industrial Strategy [2017] EWHC 1998 (Admin)

This Law-Now will be followed shortly with a supplementary piece on the consenting implications of the case.