The oil and gas industry has been hit hard by the COVID-19 outbreak. The situation leads to a number of challenges for the E&P companies and new risk factors are emerging.
The situation in the oil market is very challenging with significant oversupplies of oil and price levels that are currently around USD 20 per barrel. The oil price reduction is mainly driven by significant reduced oil demand due to the COVID-19 lock-down. In addition, there has been an oil price war within OPEC+ which has led to oversupply in the market and a further reduction of prices.
We have looked at a few legal issues which businesses on the Norwegian Continental Shelf (NCS) should take into consideration.
Contracts in the industry commonly have force majeure provisions releasing a party from a contractual obligation if and to the extent fulfilment is prevented by force majeure. The COVID-19 situation may establish a force majeure situation under ongoing contracts. This have to be resolved based on an interpretation of the relevant contract wording and an assessment of the concrete facts. In order to establish a qualified force majeure situation, it is normally required that a contract party is prevented from performing his contractual obligations due to an occurrence beyond the control of the party affected and furthermore that the situation was not possible to foresee at the time the contract was entered into.
In some cases there will likely be a factual basis to claim that a force majeure situation has occurred. We recommend that time limits for notifying of force majeure events and preclusion of claims are carefully considered. Unless otherwise is explicitly stated in the contract, we recommend for the sake of good order that notification about force majeure event is sent as soon as possible
For new contracts to be entered into, we recommend that the parties carefully assess how to address potential risk elements caused by COVID-19 and ideally regulate this specifically in the contract. For new contracts, the courts will likely not recognize the COVID-19 situation as a force majeure event, as the crisis and its consequences, however uncertain, is a known fact and should be carefully considered by anyone entering into new contracts going forward.
Force majeure provisions versus change of law provisions
The outbreak of COVID-19 has also caused authorities in Norway and around the world to adopt new regulations to tackle the pandemic. Such new and changed regulations could affect the parties' fulfilment of contractual obligations. Offshore contracts on the NCS commonly have provisions indemnifying a party from cost and schedule effects from new regulations adopted after a contract is entered into. To the extent the same circumstance that has resulted in the change of law also constitute a force majeure situation, it is a question which provisions that shall take precedence and govern the situation. The answer may have significant commercial implications between the parties; e.g. in offshore contracts, such as the NF 15/NTK 15 widely used on the NCS, more of the risk for a change of law is placed with the customer than if the same occurrence is regulated solely by the force majeure provision. It is also worth taking notice that there might be different time limits for raising a variation order due to changes of law than for a force majeure event. It is recommended that the contracts and factual circumstances are carefully considered. We expect this issue to be a hot topic in the coming weeks and months.
In the US we have seen that there have been problems with securing storage capacity for oil, even resulting in negative forward prices (May contracts). One question is whether the E&P producers may meet similar challenges in Europe; typically with oil at a delivery point/lifting point without a supplier to purchase the volumes and/or the supplier not being able to ship out the volumes from the agreed delivery point. The difficult market situations could also make it hard to dispose of the non-lifted oil in the spot market to mitigate a breach of lifting obligations and could in the end, depending on flexibility in the lifting agreement, cause the field's storage capacity to be overflowed and making it necessary to curtail production.
The COVID-19 situation could also affect the capacity in the down-stream systems caused by e.g. personnel restrictions and/or authorities requirements affecting the operations of the systems' normal operation level, maintenance etc. Such limitations could impact parties possibilities to deliver and take delivery under sale and purchase agreements of petroleum, and parties in such contracts should be careful of and duly review how possible restrictions could affect applicable delivery and lifting obligations, regulation of breach of such obligations and whether a party could be released from its performance as a result of force majeure. It should also be assessed whether flexibility in applicable lifting agreements could mitigate consequences of downstream restriction by postponing the lifting sequence. Further, parties in transportation capacity agreements should assess how the capacity provider's obligation is affected by restrictions caused by COVID-19, for instance whether the possible restrictions qualify as force majeure, and shippers in such contracts should review its payment obligations for instance how must-take-obligations is affected by downstream restrictions.
Decision making - capex reductions
All E&P players are looking for measures to reduce capex and other costs. The key is to secure liquidity and credit lines in the short term. Typically, the operators will consider to cancel work or supplies against payment of cancellation fees, or use the contractual flexibility e.g. under rig contracts to reduce duration or scope of work, to reduce costs. Normally, decisions relating to change of activities will on the NCS be subject to a standard majority vote requirement in the respective management committees.
In certain cases, parties may be willing to reduce costs/capex with immediate effect, albeit such efforts certainly will result in an increased cost exposure in the longer term. Typically, if there is a firm commitment to do certain work, the work can only be postponed. The change in plans may be uneconomical and unwise. Decisions of this nature, will also be subject to a majority vote in the management committee of an NCS joint venture. In our opinion, there is limited protection in the standard NCS JOA for the minority against majority decisions of this nature. There is some protection against so called "misuse" of majority powers, but we consider this to be limited as the threshold for finding a majority decision to be invalid with such legal basis is quite high. In other words, each licensee is allowed a large degree of freedom in voting to protect its own business interests in the license. As we know, different companies may have different views on long term versus short term losses or gains, and such tensions are expected to increase going forward. Accordingly, stakeholder management in the licenses and towards the management committee will be increasingly important – often the operator will depend on another partner backing its proposals.
Financial exposure license partners
In a situation with significant reductions in cash flow due to lower commodity prices, there might be an increased risk for partners facing financial problems and a risk for default under the standard NCS JOA. The NCS JOA establishes joint liability across the joint venture. For a prudent licensee/partner, it is now more than ever important to be monitoring the financial performance of the JV partners, particularly if the joint venture runs significant capex intensive projects (typically development projects).
For insight into a partner's financial situation, monitoring stock exchange information for shares or bonds issued by a partner or obtaining reports from credit rating agencies etc., are some of the options available. The default provisions under a the standard JOA are quite strict (loss of voting power and rather quickly loss of the license share as such), and normally licensees/JV partners will avoid such default for as long as possible. However, going forward we can not rule out that such default provisions may come into play.
Debtors under reserve based lending ("RBL") facilities should carefully monitor that all covenants and conditions are fulfilled, in order to avoid default. There are a number of provisions in RBLs that may come into play in the current market. The RBL facilities will often contain MAC (Material Adverse Change) provisions which may be affected in the current situation and which may ultimately lead to termination of the facility. Whilst these provisions may be a last resort for lenders, borrowers will nevertheless have to pay close attention to these default mechanisms. Borrowing base determinations may be required by the lenders, and could have significant consequences for the debtors' liquidity going forward. Reporting requirements under the RBL should be carefully considered, as borrowers will want to avoid breach of such obligations in today's market. To the extent an RBL facility contains financial covenants, these should also be closely monitored. Note also that force majeure invoked by the supply chain is not reflected in a typical RBL, leaving the E&P company exposed to the gap that arises between, on one hand, a market with force majeure escape mechanisms and, on the other hand, an RBL with no force majeure defences applicable to monetary payment obligations. Close communication with the lenders is advised.
Implications for DSA and/or LOC arrangements
Under Sale and Purchase Agreements for assignment of interest in production licenses/JVs or sale of shares in NCS E&P companies, sellers will in many cases have executed a DSA (Decommissioning Security Agreement) as security for a potential claim against the buyer for abandonment obligations associated with the transferred assets/shares. Often, the buyer group has provided a parent company guarantee (PCG) to the seller under the DSA, in case the seller is held responsible for any decommissioning costs after selling the assets/shares. If the financial rating of the buyer parent is reduced (as defined under the DSA), there might be a basis for the seller to require a LOC (letter of credit) from the buyer-side. Such LOCs carry significant costs, as they are linked to a significant potential liability and with long ranging time schedules. The costs themselves may therefore be an issue. Further, having a duty to issue a LOC in the market may be problematic if the financial situation of the buyer is challenging. In such case a bank may require proper security to issue a LOC (i.e. assets not already pledged or with a priority providing values to the "new" bank). It should also be noted that the current market environment may lead to changes in expected production levels and life of field expectancies, thereby further impacting the valuation of the abandonment obligation associated with the interest. This may also lead to an increase in the amount to be guaranteed under the DSA and or a LOC. We recommend DSA parties to look into such mechanisms sooner rather than later.
The Norwegian government is currently considering to cut NCS oil production in an effort to reduce supplies to the market, as a follow-up to the production cut backs agreed by OPEC+. Pursuant to the Petroleum Act Section 4-4 fourth paragraph the Norwegian government has wide discretionary powers to implement production cut backs based on resource management considerations. It is an open question whether production cut backs will be implemented across all fields with a certain percentage or whether certain fields may be selected for cut back. The starting point from a legal point of view is a pro rata cut for the different fields, however with a legal basis to deviate if "reasonable". A key factor underlining the petroleum act and all policies on the NCS is to optimise the resources in all major policy decisions. Accordingly, if one field can handle a production reduction without future production problems, whilst other fields may experience technical difficulties or even shut in resources, we expect that the Norwegian authorities will consider individual factors associated with the various fields. The risk of losing wells permanently or risk of stop of production with a certain facility, will probably be taken into consideration and this may result in other fields being selected for cut backs. The NCS policy makers will have to balance resources on the NCS as such against equal treatment – and such balancing is sure to raise discussions in a hard pressed industry.
HR: Possible downsizing of the organisations
The industry has already been through significant cost reductions and lay-offs during the down-turn starting in 2014. Still, we have already seen that E&P companies look to down-scale their work-force even further. A starting point will often be to look at contracts with contractors/hired personnel which normally have relatively short termination notice period, before considering reductions in the employed workforce. Norwegian case law related to downsizing, shows in particular that employers face complex and difficult selection processes when entering into downsizing processes. In our opinion, it is likely that the tension between seniority of the employee as opposed to competencies/skills will increase. Based on practice from the Supreme Court, it will always be challenging to strike the right balance in the individual case, and the trade unions will monitor very closely how these processes are carried out. However, done right and with a transparent and well-rooted process in the organization, employers have good legal opportunities to secure necessary competence going forward.