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Alliance contracting on the NCS

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"Alliancing" is a current buzz-word in the oil and gas industry, spurred on by the industry-wide cost-cutting initiatives in recent years. However, when alliancing was last attempted on the NCS in the 1990s, it never quite won the affection of contracting parties. Will alliancing gain a stronger foothold this time around?

What is alliancing?

"Alliancing" or "alliance contracting" are not defined terms, but are used to describe a cooperation whereby the parties agree to work closely together, typically in long-term collaborations with a large degree of mutual involvement. Alliance contracts come in many shapes and forms, but a main distinction can be drawn between horizontal and vertical alliance contracts. In a horizontal alliance, two or more contractors enter into an alliance contract in order to work together, e.g. to develop a product or deliver a project. In a vertical alliance, the alliance is between a company (e.g. an NCS operator) and one or more key contractors in the supply chain. This newsletter focuses on the vertical alliance model.

The intention of alliance contracts is to reduce the costs and time spent on a project through aligning the commercial interests of the parties. Alliance contracts contain various mechanisms to achieve this objective. For example, vertical alliance contracts typically include an incentivized compensation philosophy, often based on the estimated project cost, where an overrun or underrun of the estimate is shared between the company and the contractor. Other typical features include a large degree of transparency with regards to direct project costs and an integrated project team consisting of participants from both company and contractor, which is established at an early stage.

NCS alliance contracts – will they prevail this time?

In principle, there are many advantages of choosing the alliance model over the traditional contracting methods. From the operator's point of view, a successful alliance contract has the potential of improving project execution time, reduce CAPEX over time and stimulate continuous improvement. The contractors will on the other hand typically benefit from a "preferred partner" status, and will have the possibility to earn increased profits if the project costs are lower than the estimated project costs.

However, ensuring that all parties achieve the benefits envisaged by an alliance contract may not always be feasible. One challenge which is often referred to is the discrepancy between the interests of the license group and the contractor, where the former earns its profit on the sale of petroleum outside of the scope of the alliance contract, while the latter earns its profit within the scope of the contract and will therefore have less of an incentive to reduce the total project costs. Another challenge is ensuring that the alliance contract is not merely a high level principle declaration, but a robust legal instrument.

In our opinion, the above challenges can to a large extent be addressed by initiating the alliance contracting process with the parties' project organizations mapping out how they can ensure collaboration and early-stage involvement in the specific project. Legal assistance is only brought in to formalize these principles after the project organizations have discussed and established them. Approaching alliance contracting in this manner first and foremost ensures buy-in from the project organizations, which is essential in a contract model which requires two or more organizations to work together in such a close manner, and also tailors the collaboration principles to the project in question. This approach is distinctly different from the process in the 1990s, which focused heavily on developing a standard alliance contract, and which culminated in a standard which NCS players generally did not consider to be workable.

Whether the parties on the NCS are able to actually achieve the potential advantages of entering into alliances this time around is yet to be seen. As can be inferred from the above, we do not see the immediate benefits of another alliance contract standardization effort, but rather recommend a more practical approach.

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