Managing decommissioning risk in M&A transactions
Wednesday 9th December 2020
With $14 billion of commitments before 2024, according to Rystad, decommissioning costs have long been a risk to and blocker in transactions, especially portfolio and corporate deals. The sector has moved a long way since early stage bilateral decommissioning agreements as sellers sought to navigate Section 29 of the Energy Act 2008 and other commercial risks in pursuit of the "clean break".
As the ownership of assets has evolved, so too has the structuring of arrangements regarding the allocation of decommissioning liabilities. In 2000, 80% of licences were held by 30 operators, most of them majors. Since then, utilities have come (and mostly gone), private equity has come (and some will look to go), and the majors have rationalised portfolios. Successful "innovate" licences introduced a new breed of start-ups who then look to optimise their portfolios with production assets.
What are the options when it comes to deal structuring? In our experience, this depends on the assets, counterparties and deal objectives. Some companies have benefited from acquiring "cheap" production due to asset valuations being reduced by future decommissioning costs. Others have preferred to pay a higher price to avoid dealing with the decommissioning costs.
Ithaca were early pioneers with their Beatrice acquisition in 2008 before returning the asset to Talisman in 2015 for decommissioning. Variations of this model including lease arrangements have been used especially where the seller is better positioned to decommission due to experience and economies of scale. This makes most sense where the seller holds 100% interest as this requires "policing" of the asset prior to return.
Other models have seen the seller retain all or some of the liability upon exit, paying its contribution at the end of field-life or even an up-front "pre-payment". For example, Premier-EON shared the costs of decommissioning the Ravenspurn and Johnson fields, and Shell and Esso's sale of the Anasuria cluster allowed the buyers to contribute to a decommissioning fund subject to profit levels. In these models, sellers often seek to mitigate loss of control over decommissioning spend using a cap or take a view on the consideration level. In other deals cash security from profits has allowed the build-up of provision in a more gradual way than traditional DSA models but this approach is often seen as unattractive financially.
Whilst the 2013 introduction of decommissioning relief deeds proved successful in freeing up capital by making provision on a post-tax basis, there still often remains a discrepancy in the credit rating of deal parties. Sellers have taken the "credit risk" where the buyer's back-to-back security is weaker. Where the seller may be able to provide a relatively costless PCG, this model has been particularly successful given the buyer might otherwise have to post a LoC, encumbering its borrowing base or even posting cash collateral. The new transferable tax history is yet to see deployment, but it is another tool to manage commercial risk within deals to ensure companies avoid being on the wrong end of decommissioning defaults.
Chris Starling - Managing Director