This newsletter provides high-level answers to what we believe are some of the considerations to be made before entering the NCS. This newsletter is the first of a series of newsletters from Thommessen's oil & gas team which will cover various topics in relation to investment and operation on the NCS.
Norwegian corporate ownership
In practise only Norwegian limited liability companies own interests ("Ownership Interests") in production licenses ("Licenses") on the NCS. A non-Norwegian entity planning to enter the NCS will therefore need to acquire or incorporate a Norwegian limited liability company, and use such as the acquiring vehicle ("Buyer").
It should also be noted that the Ministry of Petroleum and Energy ("MPE") will require that Ownership Interests are owned through one single legal entity. This means, for example, that an investor will not be allowed to divide its portfolio of Ownership Interests on several legal entities.
Approvals required to enter
Completion of a transaction requires prior approval by MPE and the Ministry of Finance ("MoF"). It is therefore important that the timing for obtaining approvals is factored into a sale and purchase process and that the estimated completion date for a transaction caters for this.
Approval by MPE
In order to obtain approval of a transaction, and thus qualify as a licensee, the Buyer has to comply with the following main criteria:
- Technical competence
- Financial capacity
- Health, safety and environmental ("HSE") competence
These requirements may, however, be different for Licenses in the production phase than for Licenses in the exploration phase. It should be noted that MPE will generally require the Buyer to have in-house competence in relation to relevant technical disciplines and HSE. However, approval may be granted on the condition that the Buyer comply with all requirements within a certain time frame after the Buyer has become a licensee.
MPE offers newcomers the possibility to prequalify as a licensee, which can be regarded as an acceptance of the Buyer's general qualifications as a licensee. Based on our experience, the prequalification approval process will normally take around four to six months. If prequalification is not obtained, approval of the Buyer as a licensee will be part of the ordinary approval process for the transaction. This will usually result in the approval process for the transaction taking longer than if the Buyer had been prequalified.
MPE has wide authorisations to require any form of security it deems appropriate in connection with the approval process. If the Buyer is directly or indirectly owned by another legal entity by more than 50%, MPE has a fairly consistent practice to require a parent company guarantee ("PCG") as a condition for its approval. The PCG has a standard format and is granted to the Norwegian State as security for the Buyer's compliance with its obligations and liabilities arising from the Buyer's petroleum activities on the NCS. MPE's practise implies that a legal entity owning less than 50% of the Buyer is not required to issue a PCG, although it is a risk that MPE also will require a PCG if such legal entity is deemed to be in "control" of the Buyer, e.g. through shareholders' agreements or otherwise. Furthermore, trusts, foundations and similar will normally not be required to issue a PCG, even if they own more than 50% of the Buyer. To date there has not been a tradition to require PCGs from managers of funds, which in the circumstances may be deemed to be in "control" of a Buyer without ownership.
Approval by MoF
Approval by MoF relates to the tax effects of the transaction, whereby the governing principle is that the transaction shall be based on full tax continuity and be neutral in terms of tax revenue for the Norwegian State.
A simplified route, where only a notification to MoF is required, is available if certain requirements are met. In general, these requirements are:
- the consideration being based on a post-tax amount (i.e. not taxable income for seller ("Seller") and not tax deductible for the Buyer)
- the transaction having an effective date 1 January the year of the approval by MPE or the following year
- the consideration being unconditional and a finally determined cash amount
- the Buyer acquiring the undepreciated tax balances and uplift related to the Ownership Interests
With some exceptions, the parties are not prevented from agreeing terms that deviate from the requirements above, but the consequence is that a formal approval from MoF is required.
Joint venture and governance
By acquiring an Ownership Interest, a Buyer will automatically become a party to the joint operating agreement ("JOA"). The JOA is a standard agreement with a format and content decided by MPE. The licensees in a License do not have the right to amend or change the terms of the JOA without prior consent from MPE, which in practice is very difficult. For a Buyer, it will therefore be key to understand the various regulations of the JOA before entering into a transaction.
Handling of decommissioning obligations in a transaction
Each of the licensees in a License are jointly and severally responsible for decommissioning liability towards third parties (including the Norwegian State). As between the licensees, this liability is however primarily pro-rata based on each licensee's Ownership Interest in the License, alternatively joint and several in case any of the licensees do not meet their obligations in this respect.
A former licensee having sold its Ownership Interests remains "secondary liable" by law for the costs of decommissioning of installations and facilities that existed at the "time of transfer" of the Ownership Interest to the Buyer, in case the Buyer does not fulfil its decommissioning obligations as a licensee. In a transaction, the Seller and the Buyer normally agree that the decommission obligations, in the valuation of the assets, are deducted and transferred to the Buyer. If so, the Seller will generally require to be indemnified by the Buyer should the secondary decommissioning liability materialise. Such indemnity is normally secured by a security arrangement agreed in a decommissioning security agreement with more or less standardised terms. The security is often a PCG or letter of credit arrangement.
Contrary to other jurisdictions, there is no legal basis for the other licensees to require any form of decommissioning security from the Buyer in connection with a transaction.
Handling of tax balances and uplift in a transaction
A special feature of the Norwegian license transfer practice is that tax balances and uplift linked to the Ownership Interests normally are transferred from the Seller to the Buyer as part of the transaction. In a pre-production phase, the economic value of the tax balances and uplift may be the most significant basis for the consideration from the Buyer to the Seller.
In recent transactions, we have however seen a tendency that newcomers explore the possibility to not acquire the tax balances and uplift. The immediate effect will normally be a significant reduction in the consideration. Provided that the Buyer is a "first-time" buyer on the NCS, this has, in some cases, been accepted by MoF.
The tax refund regime
Refund of exploration costs
Exploration costs are tax deductible when they are incurred. If such costs cannot be set-off against taxable income, they can be carried forward against future income. However, in order to incentivise newcomers on the NCS, the right to claim refund of the tax value of exploration costs was introduced in 2005, which means that the taxpayer (i.e. the Buyer), instead of carrying the loss forward, may claim payment from the Norwegian State of the tax value (currently 78%) of such exploration costs.
Refund of tax value of loss and uplift at cessation of petroleum activity
It is possible to claim payment from the Norwegian State of the tax value of tax losses carried forward if the business activities subject to the special tax regime are ceased. This supplements the refund regime related to exploration costs since the Buyer may have incurred other costs than exploration costs, e.g. depreciations of investments, decommissioning costs etc. The possibility to claim such refund will effectively mitigate investment risk and is generally viewed by investors as an attractive "downside protection".
The tax value of such losses is determined by multiplying the respective tax losses by the rates applicable to losses under the ordinary income regime and losses under the special tax regime on the termination date (currently 78%).
 Remaining tax depreciations in relation to costs of acquiring pipeline and production facilities, including installations which form part of, or are related to, such facilities.
 Under the Petroleum Tax Act a special uplift (Nw.: friinntekt) may be deducted in the basis for the calculation of the petroleum tax.
In the next NCS newsletter we will discuss key questions arising in connection with qualifying as a licensee as well as exploration and development of a field, including minimum work obligations as conditions to a License.