Coronavirus (COVID-19)—impact on North Sea oil and gas industry

Coronavirus (COVID-19)—impact on North Sea oil and gas industry

Energy Analysis: Judith Aldersey-Williams, partner at CMS, discusses what the combination of the coronavirus (COVID-19) pandemic and the recent crash in oil price means for the North Sea oil and gas industry.

The North Sea oil and gas industry is currently facing a ‘perfect storm’ of coronavirus and an oil price crash. The combination of which is placing incredible strain on the industry. The share prices of quoted oil companies and oil service companies have fallen significantly—operators have reported plans to cut operating costs and reduce their capital expenditure by up to a third, and supermajors have halted share buyback schemes. BP’s Bernard Looney has said that ‘this may be the most brutal environment for oil and gas businesses in decades’.

Practical impacts of coronavirus (COVID-19)

The most immediate challenge for the UK oil and gas industry is that of coronavirus and the associated government restrictions. The oil and gas sector is considered an essential service as the government needs to ensure continued security of supply; the UK’s oil and gas industry still provides 45% of UK total energy needs, and 59% of its oil and gas demand.

Whilst companies have sent their head office workers home, key workers remain offshore, at terminals and in warehouses and logistics facilities. Onshore sites are presently not mandated to close but must carry out an individual risk assessment to confirm whether work can continue in the circumstances, bearing in mind the application of health and safety requirements and the obligation to ensure a safe working environment for employees. Arrangements are also in place to assist the continued travel of key workers to and from heliports—an Oil & Gas UK (OGUK) template travel letter, that can be carried by key workers and shown to police if challenged, has been made available across the industry. The industry is also monitoring the impact on supply of equipment due to border closures and restrictions on port operations and is engaging with the police to try to ensure continued transportation of permitted goods.

Given the risk of a shortage of offshore workers due to infection, self-isolation etc, and the requirement to ensure a safe working environment, many operators have down-manned installations to the minimum required personnel and limited work to that which is urgent or safety critical. The number of offshore workers has fallen from around 11,500 to 7,000.

New medical protocols have been introduced to try to minimise the risk of coronavirus cases occurring offshore with personnel having their temperature checked at the heliport. Oil & Gas UK are currently waiting for the UK government to approve a private testing technique which can be performed outside the NHS and be accepted. It is possible that once this occurs operators may self-fund this testing, which in turn will dramatically speed up and increase the availability of workers able to go offshore. In the meantime, however, there have been reports of significant coronavirus outbreaks on at least one offshore facility.

Operators are implementing advice from Health Protection Scotland on minimising the risk of transmission in the workplace and have collaborated to put in place special arrangements for bringing coronavirus cases back to shore without exposing further personnel (special helicopters are set aside for this task), and to provide information for operators on ‘safe haven’ hotels where workers can be accommodated when back on shore.

The Forties Pipeline System (FPS) shutdown due to take place in June 2020 has been postponed until at least August 2020. The FPS is a crucial part of the North Sea’s infrastructure, carrying approximately 40% of the UK’s oil and gas production from around 80 fields onshore. Most fields tied into the FPS will have to halt production during the shutdown, and operators were planning to take the opportunity to conduct simultaneous maintenance of their own assets. However, such a major amount of work would have required perhaps 2000 additional personnel offshore. The industry was already concerned about a constraint on resources to do all this work simultaneously—coronavirus constraints would have exacerbated this situation. Work is ongoing on collaboration to share human resources and equipment to ensure safety critical work can be undertaken.

Industry regulators are also taking steps to adapt their approach to the new situation. The Oil & Gas Authority (OGA) is working closely with BEIS and HM Treasury on financial resilience, while supporting the work of industry and trade associations such as OGUK on operational and logistical resilience. The OGA has said it will take a pragmatic approach to compliance where it can, specifically when considering amendments to licence timelines, but encourages operators to engage with it early with evidence on any specific requests. It still plans to offer 32nd Offshore Licensing Round awards in summer 2020 and has said it will be considerate and open to dialogue with applicants at the time of award. The OGA has de-prioritised MER UK stewardship reviews, by, for example, only holding reviews with operators in relation to regulatory or materially significant matters. It is working with operators and the supply chain to help secure timely payments to ease the cash flow of oil service companies.

The Health & Safety Executive has postponed routine inspections and is looking at how to deal with renewal of certifications for offshore personnel and offshore equipment. The Marine and Coastguard Agency has issued guidance to mariners on contingency planning for coronavirus.

The oil price crash

The massive and sudden fall in the oil price, from around $70 to $25 in the three months to the end of March, occurred in a market where supply was already high due to the expansion of US shale oil production and further increased by Saudi Arabia’s decision to ramp up production following the failure of talks between OPEC and Russia over continuing production restrictions in March 2020. This excess supply has hit the market at time of falling demand due to the impact of coronavirus. Demand is reportedly down by as much as a 25% (roughly 25m barrels a day). That is close to the production of OPEC or the consumption of the USA, Canada and Mexico combined.

The impact of this price crash will be worst for heavily indebted operators, who face breach of covenants and possible insolvency if unable to meet debt repayment obligations or to restructure debt. Operators have hurried to reassure the market as to their ability to withstand the price falls. Even those without significant debt are looking at cutting opex, cutting capex, and in some cases cutting dividends (though currently Shell and BP which pay 20% of FTSE 100 dividends are not talking about a change to dividend policy). Opex cuts may involve layoffs of non-essential staff and postponement of non-essential maintenance work, while capex cuts will involve the postponement of exploration and development plans, especially developments where the break-even price is higher than current prices. However, Wood Mackenzie reports that cost reductions achieved during the last downturn mean 95% of onstream production is economic at $30 a barrel. There may also be early decommissioning of assets with high operating costs. Enquest has announced that it will not restart production on Thistle, Heather and Deveron fields.

The oil and gas supply chain—many hundreds of companies, some of them SMEs, employing tens of thousands of staff, just recovering from the oil price crash in 2014 / 15, now faces another significant slowdown in activity. This will in turn lead to layoffs and redundancies restructurings or sales to avoid insolvencies and indeed insolvencies themselves. There is concern that the Government’s current coronavirus support packages for business are not entirely suitable for the oil & gas industry because the financial thresholds leave a ‘gap’ in terms of the size of undertakings covered.

On a contractual level, disputes will arise over the application of liquidated damages clauses for delay, material adverse change, force majeure and change of law clauses in contracts, especially as contracts may offer relief for some but not all of these events. Furthermore, where relief might have been available, parties will be faced with the difficulty of separating the impact of coronavirus and the oil price crash.

Default and forfeiture provisions in joint operating agreements (JOAs) will once again come under scrutiny as co-venturers struggle to pay their bills. Those issues are likely to be exacerbated later in the year when we approach the annual dates for renewal of decommissioning security arrangements.

The industry, only just recovering from the oil price falls in 2014 / 15 is bracing itself for another rollercoaster year. There is a significant risk that redundancies and business failures will result in the loss of expertise and niche technology currently in development in the supply chain, impacting work towards the transition to a net zero carbon future, in which the industry is a key player. However, enormous efforts are being made by regulators, trade associations and other stakeholders to ensure that businesses are able to cope, at least with the impact of coronavirus.

Interviewed by Marie-Gabrielle Williams

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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