Mandatory Financial Requirements for Oil Industry Operations in the UKCS

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1 Mandatory Financial Requirements for Oil Industry Operations in the UKCS This briefing note provides details of the mandatory financial requirements that must be met before drilling or other operations can take place in the United Kingdon Continental Shelf (UKCS). These financial requirements are linked to petroleum licensing and the Offshore Pollution Liability Agreement (OPOL). This briefing note looks only at mandatory financial requirements. Beyond these, participants involved in exploring for, or producing hydrocarbons, in the UKCS will put in place their own additional financial provision to cover contingencies according to their own assessments of risk. Such provision is likely to include insurance for loss or damage to property, operators extra expense, which covers the cost of controlling a well, redrilling costs and liability for oil pollution in the event of an incident, and third party liability. Petroleum Licensing The Department of Energy and Climate Change (DECC) regulates oil and gas activity in the UKCS. Before any drilling or other operations can commence, a licence must be issued by DECC to those companies (licensees) who have formed a joint venture in order to explore for, or produce hydrocarbons from, a particular location in the UKCS. In addition, DECC must give approval before any individual well can be drilled, suspended or abandoned. There are checks that take place before the licensees are awarded a licence, and those relating to financial provisions are detailed below. At the time of a licence award or assignment, DECC may undertake two types of financial checks covering exploration and development activity. These are: Financial Viability Assessment and Financial Capability Assessment. DECC applies these financial checks to individual companies within an applicant group, so each company within a joint venture must provide its own set of financial/corporate information as required. -Financial Viability Assessment DECC must be confident that any proposed licensee is likely to continue in sound financial health for the foreseeable future and as such, must demonstrate its financial viability. Each company must therefore provide a copy of its most recent published accounts or if these are not available, a pro-forma balance sheet which has been certified by a director and is sufficiently detailed to enable the assessment to be undertaken. -Financial Capability Assessment DECC requires that each company must demonstrate adequate financial capability to cover its share of the proposed work programme as well as all of its existing commitments,

2 including overseas commitments. The means by which a company can demonstrate this capacity will vary from one company to another and will depend on the company s size:- Many are sufficiently large that shareholders equity alone will satisfy this requirement and DECC will generally be satisfied by evidence that the company s net assets are significantly greater than the estimated cost of existing commitments, or A company whose shareholder s equity is not significantly larger than the estimated cost of its proposed commitments will have to prove its capacity by reference to specific funding arrangements. More specific information on this matter, drafted for the 26 th Offshore Licensing Round in 2010, can be found on the DECC website, at: The Offshore Pollution Liability Agreement (OPOL) All operators currently active in offshore exploration and production on the UKCS are party to a voluntary compensation scheme known as OPOL. The original agreement came into being on 1 May 1975 and was originally introduced by the oil industry as a short term measure and also as a viable alternative to the 1976 Convention on Civil Liability for Oil Pollution Damage, which never came into effect. After 1976, further inter Governmental negotiations failed to establish and agree the limits to be placed on liability and in 1981 the OPOL Agreement was amended to continue indefinitely and the liability limits were increased. In 1983 the UK Government accepted that the principles and aims of the 1976 Convention were best achieved through OPOL and today recognises that the Agreement satisfies its requirements for the availability of funds for pollution damage as laid down in its licence conditions. Under OPOL, operators are required to meet claims up to a maximum of US$250 million (as of 1 October 2010) per incident, comprising third party pollution damage claims and public authority costs for remedial measures. Companies are required to provide satisfactory evidence of financial responsibility to the OPOL Association, which administers aspects of the OPOL Agreement, to meet the above limits of liability. The parties to the OPOL agreement are operators of, or intend to be operators of, offshore facilities used in connection with the exploration for or production of oil and gas. OPOL represents the committed response of the oil industry to ensure appropriate dealing with compensation claims and the reimbursement of the costs of remedial measures arising from the discharge of oil from offshore facilities ( including wells, drilling units, production platforms, oil storage/loading systems and pipeline systems, but excluding abandoned wells and temporarily abandoned wells). In practice, DECC will require that the operator is (or intends to become) a member of OPOL as a condition of granting a production licence, or the approval of an assignment of such a licence. 2

3 OPOL also accepts applications from operators in respect of offshore facilities located in Denmark, Germany, France, the Republic of Ireland, the Netherlands, Norway, the Isle of Man, the Faroe Islands and Greenland. The Agreement does not, however, apply to any offshore facilities located in the Baltic or Mediterranean Seas. OPOL currently has 133 members, 118 of which are UK based. The remainder comprise members in the Faroe Islands, Greenland, the Netherlands, Norway and the Republic of Ireland. How OPOL Works The agreement and the rules together provide a unique mechanism comprising 3 key elements as follows: (i) OPOL CREATES A BASIS FOR REIMBURSEMENT/ COMPENSATION : Pursuant to the agreement each operator agrees that it will reimburse public authorities the costs of remedial measures and pay compensation to third parties for pollution damage arising from a discharge of oil from its offshore facilities up to an aggregate maximum of US$250 million (as of 1 October 2010) per incident. Remedial measures are defined as reasonable measures taken by any public authority to prevent, mitigate or eliminate pollution damage or to remove or neutralise the oil involved in the discharge, but they exclude well control measures and measures taken to protect, repair or replace the offshore facility involved in the incident. Pollution damage means direct loss or damage (other than loss of or damage to the offshore facility involved in the incident) by contamination which results from a discharge of oil. In the absence of OPOL, public authorities and third party claimants would have to rely on their rights at law. (ii) OPOL CREATES A FINANCIAL RESPONSIBILITY REGIME: OPOL requires that all of its members submit evidence of financial responsibility, and renewal or replacement thereof, for their offshore facilities throughout the period of their membership. Evidence of financial responsibility must be provided for an amount of not less than US$250m (as of 1 October 2010) per any one incident and US$500m (as of 1 October 2010) in the annual aggregate. Evidence of financial responsibility must be submitted by the operator to OPOL prior to the operation of any offshore facility of which that party is the operator and if the financial responsibility is limited in time or terminated, replacement evidence is required to be submitted. Evidence of financial responsibility must be submitted to OPOL by one or a combination of the following: (a) a certificate of insurance from an insurer or broker; (b) a surety bond issued by a surety company acceptable to the board of OPOL; (c) a guarantee issued by a guarantor acceptable to the board of OPOL; and (d) a member may qualify as a self insurer provided it demonstrates financial responsibility by satisfying the specific financial requirements detailed in the rules. 3

4 (iii) OPOL GUARANTEE/DEFAULT BY A MEMBER Claims under OPOL If a member fails to make a payment to a claimant of any sums which may be due under the Agreement, the other members of OPOL have agreed that they will contribute pro rata to such payment according to the number of facilities operated by them at the time of the relevant incident. In these circumstances, it will be for the Board of OPOL to investigate whether members have such an obligation to contribute and to advise the claimant as to the payments which will be made by the members to its claim. There are two categories of claims: reimbursement of public authorities for remedial measures and compensation to third parties for pollution damage. The maximum amount per incident payable in each category is US$125m (as of 1 October 2010), however any amount remaining unused in one category may be used to pay outstanding claims in the other category. If the aggregate of claims for remedial measures or pollution damage exceeds these maximum amounts, then the claims will be pro rated. However, OPOL does not act as a limit on a member s liability at law and claimants are free to pursue their rights through the courts for losses which exceed the maximum recoverable under the agreement or those beyond the scope of the agreement. In order to encourage the taking of remedial measures by operators, in calculating whether or not the limit of an operator s liability for reimbursing the costs of remedial measures has been reached, account shall be taken of the costs already incurred by the operator in taking remedial measures to deal with the discharge. Claimants are required to submit their claims within 1 year of the date of the relevant incident direct to the relevant operator who is obliged to handle and pay the claim directly. OPOL is not a fund nor does it provide a claims handling service. OPOL s role is to (a) administer applications for membership, (b) ensure compliance by its members with the appropriate financial responsibility regime, (c) at the request of the Governments of the states referred to above, provide that state with a list of its members who are operators within its jurisdiction and confirm to that state that such members have complied with the Rules relating to financial responsibility and (d) if necessary, investigate whether members may have an obligation to make payment to claimants by virtue of default by another member and advise claimants of the same. This document is only a brief summary of OPOL. Full copies of the OPOL Agreement and Rules and other documents and details relating to OPOL are available on the OPOL website at 4

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