Middle East faces major decommissioning challenge
Many oil producers are unprepared for the inevitable and expensive task of disposing of oil and gas facilities at the end of their productive life
Exploitable oil reserves were first discovered in the Middle East in 1908 and hydrocarbon exploitation has been a bulwark of regional economies for the best part of a century. However, even as exploration continues, much of the industry’s infrastructure is ageing and will soon come to the end of its useful life.
It has been estimated that there are around 700 such facilities that will need to be decommissioned in the Middle East, and as the region’s older oil and gas facilities grow in number, the imperative only rises.
Yet, many producing countries in the region do not yet have mature legislative and regulatory structures for decommissioning, while many of the older oil and gas contracts do not address the issue in detail. This is creating uncertainty with regards to the allocation of decommissioning liabilities, the standards applicable to the abandonment of infrastructure and the handling of residual long-term liabilities.
The technical and commercial landscape
Decommissioning is the natural end of the life cycle of an oil and gas field; it may be delayed, but it cannot be avoided, and the need to retire this infrastructure may even accelerate as the region adopts new sources of energy.
In addition, many fields have been more prolific than expected. As a result, a lot of infrastructure still in use has already reached the end of its original design life. Age degrades infrastructure, but declining production means investment in new infrastructure may not be viable. This presents governments and oil companies with a conundrum: how to maximise production while operating safely.
There are strong economic incentives not to retire assets, as the longer a production facility remains available, the more opportunity there will be for adjacent fields and resources to be exploited. Regulators across the world recognise the attractiveness of maximising opportunities and the inter-dependency of oil field operations.
At the same time, large-scale decommissioning can be expensive. Eight international oil companies have asset retirement obligations (AROs) on their balance sheets of more than $10bn each and, since 2010, the AROs of the seven largest international oil companies have increased year on year.
Estimating future costs is inherently risky, as the industry does not know how technology or standards will develop, and while decommissioning is clearly a critical issue, it is difficult to tell whether sufficient or excess capital is being set aside.
The challenge is clear: to produce safely and efficiently for as long as possible and to have sufficient financing to dispose of the infrastructure responsibly and return the land or sea to future legitimate use. This creates a three-dimensional challenge for policy makers with cost, risk and governance/legislation on the separate axes.
The regulatory landscape
Allocation of decommissioning liabilities is an area of tension between governments and oil companies. Governments want the companies that benefit from petroleum operations to be liable for the costs of decommissioning infrastructure used during such operations.
On the other hand, oil companies want to ensure that their liability is proportionate to the benefit they have received from such infrastructure and for other beneficiaries to contribute their fair share. Oil companies also want to be able to cost-recover decommissioning expenses during production pursuant to the terms of the relevant government contract.
In the Middle East, the specific decommissioning liabilities and obligations of the relevant oil companies (the contractor) are typically set out in the applicable host government granting instrument (HGGI).
There are a range of different types of HGGIs utilised by governments in the Middle East: production-sharing agreements, technical services contracts, concessions, royalty and tax agreements or others (such as hybrids). Whatever the type of HGGI, as a minimum, modern HGGIs usually have provisions dealing with liability for decommissioning of assets.
In many cases, modern HGGIs provide for, first, when and how the contractor must contribute towards the costs of decommissioning; and, secondly, whether the contractor is required to provide any security for decommissioning costs, which may not crystallise for many years after the HGGI is signed.
Although decommissioning provisions in different HGGIs vary, often they stipulate when the contractor is required to establish a decommissioning fund and to start paying into it. The trigger point might be calculated on a unit of production basis and be based on remaining petroleum reserves, or be triggered after a certain number of years following commencement of production.
The HGGI will usually provide how decommissioning costs are accounted for and whether they are cost recoverable. No methodology or trigger point is perfect. Changes in oil prices can result in a premature trigger of funding obligations or a trigger that occurs too late. A trigger based on a bright-line time period may also be problematic, if it does not also take account of the reserves that are available to fund the obligation, or the condition of the assets.
Decommissioning funds may contain significant sums of money. Both oil companies and governments are loathe to tie up capital. In future, Middle Eastern governments may consider the merit of allowing such funds to be used for authorised investments with an appropriate risk profile.
There may also be instances where decommissioning is underfunded, and oil companies will doubtless make the case that the governments should share the risk. In order to reduce such risks and to encourage investment in new projects, governments may wish to consider whether tax rebates should be available for some or all of any unfunded decommissioning costs.