Oil & gas industry veterans are no strangers to oil price volatility. Yet the sheer scale of the collapse in demand from COVID-19, compounded by an ill-timed supply glut flowing from the Saudi/Russia price war, has sent the industry reeling. With Brent Crude and West Texas Intermediate falling to levels not seen since 2002, global storage capacity rapidly filling and the prospect of production shut-ins looming, oil & gas companies worldwide are assessing their liquidity positions, rushing to secure capital, deferring capex projects and slashing costs to put themselves in the best position to weather the storm.
Whilst it might not be front of mind in present circumstances, E&P companies operating in the North Sea should not lose sight of their decommissioning security arrangements and the potential impact these could have on their liquidity analyses. A sustained period of subdued energy prices could rapidly bring forward the end of life for ageing North Sea fields and infrastructure. North Sea E&P companies should ensure they are stress-testing existing assumptions around the crystallisation of decommissioning costs accordingly.
But even for assets with more distant maturities, the implications of the current crisis under the decommissioning security agreements (DSAs) widely used across the North Sea could be immediate. Based on the principles common to most forms of DSA used in the North Sea, key implications include:
Rating downgrades: Rating agencies have recently slashed their commodity price assumptions and downgraded the credit ratings of many oil & gas issuers. Rating downgrades could result in parent company guarantees that have been provided as security for future decommissioning obligations ceasing to qualify as acceptable security (or ‘Qualifying Surety’) under the DSA. This would result in the licence holder being required to provide alternative security in a relatively short timeframe, either through a cash payment of the required provision amount into a trust or (more typically, to the extent commercially available) the provision of a bank guarantee or letter of credit. When applied across an extensive North Sea portfolio, this could have a significant impact on debt capacity and liquidity.
Asset valuations: DSAs typically require a recalculation and re-posting of security on an annual cycle. The amount of security to be provided is usually calculated by a formula which considers, among other things, the ‘Net Cost’ of anticipated decommissioning expenditure relative to the ‘Net Value’ of the licence interest. Revisions to both commodity price assumptions and the production profiles of assets as a result of the current crisis could have a potentially material adverse impact on the amount of the ‘Net Value’. This would have the corresponding effect of eroding the security buffer for licence holders, potentially bringing forward the requirement to provide security and increasing the provision amount. Even though many standard DSAs will not require a recalculation of the security provision amount until the end of June with security to be posted towards the end of the year, the extent of the global demand decline is widely expected to see low prices remain for a sustained period (despite the recent OPEC+/G20 rapprochement), so North Sea E&P companies would be well advised to take a conservative view in preparing for upcoming decommissioning security recalculations.
Debt facilities: Many North Sea E&P players are already assessing their debt facilities and reserve based lending redetermination calendars as part of their liquidity review processes. Part of this should include an examination of existing credit lines to ensure ready access to bank guarantee or letter of credit facilities sufficient to cover any anticipated increase to DSA security requirements. They should also be wary of the impact maintaining these facilities could have on their debt capacity when assessing near term liquidity. The potential for DSA counterparties to eat into borrowing headroom by calling for additional letters of credit could be of great concern to CFOs at this difficult time.
To find out what North Sea E&P companies should be doing about this in practice, click here.