While it is becoming commonplace to hear the names of investors reported alongside the names of their investee companies who have acquired UKCS assets, obtaining investment in oil and gas projects remains a complex area for independent oil and gas companies looking to grow their presence, or international organisations hoping to invest in the UKCS.
Such investments typically involve a package of different types of assets which require a corresponding package of various securities that need careful consideration when applied in the context of oil and gas assets. UKCS regulation of oil and gas assets impacts the taking of security over those assets; that taken together with applicable laws regulating the granting and enforcement of securities (where both English and Scottish law may be relevant), often means that both the investors and the oil and gas companies find themselves dealing with multiple advisors and a range of guidance and advice.
Why is it so complex?
In some oil producing jurisdictions (such as Canada or Russia) companies holding oil and gas interests can leverage the value in the asset by granting an over-riding royalty in favour of an investor in respect of production to be received. At a basic level, this royalty is acknowledged as a ‘secured obligation’ in its own right and will be preserved in the event of both an insolvency and revocation of a licence allowing the holder to become a preferred creditor automatically.
In the UK, the granting of a royalty is a more complicated procedure and, more importantly, it does not yield the same result. Approval from the regulator is required and the royalty is deemed a contractual commercial arrangement between the parties rather than a secured obligation. While an over-riding royalty granted in favour of an investor does become attached to the asset it relates to, this only subsists while the licence remains in force. In the event of insolvency, and certain other situations, the regulator still has the ability to revoke the licence leaving the royalty arrangement as a simple unsecured payment obligation.
As a result additional or alternative security provision is required. Typically an investor, whether in receipt of a royalty or not, will also look to take at least a floating charge over the moveable assets of the company and may also look to take a wider range of more bespoke securities such as charges over production sale income, fixed security in respect of property holdings or pledges in respect of shareholdings across a group of companies.
This means that both the party granting and the party receiving the royalty will need advice on regulation, property, corporate and banking matters and oil and gas specific advice which all adds to the costs of investment.
Typically this leads to royalty arrangements being disregarded in the context of UKCS investment – a significant difference between the UKCS oil and gas investment regime and other international regimes. So what can be done to ensure that international investors and / or international oil companies are not deterred by this issue?
Investment for UKCS projects is usually either on the basis of debt or equity investment. Either the investor will acquire share capital in the oil and gas company or will provide funding under a contractual arrangement with a security package.
Equity investors are usually working within criteria relating to a rate and period for the return on their investment. Accordingly the investor is likely to implement strategic and / or growth plans for the underlying company with a target sale or exit date in mind. Where an equity investor is forced to take a longer term approach than they had originally envisaged (as can happen when there is a downturn in oil price) this can lead to issues with lack of access to further capital to develop the business (due to possible restrictions of further borrowing or an unwillingness to increase risk) leaving the underlying company and assets stagnating beyond the initial acquisition or development.
As highlighted above, debt finance largely requires the same document intensive approach as a royalty, although without the added regulator consent and revocation risks. In addition, many oil and gas organisations are wary of over-leveraging as this could risk their ability to demonstrate strong financial capability – a requirement of the regulator and other co-venturers.
However, deals still get done and investment is available. With the right support and guidance both the investor and the oil and gas company can structure a mutually beneficial arrangement that meets both their needs as well as avoiding overly complex arrangements, gaps in protection or falling foul of the regulator.
As a full service law firm with one of the largest oil and gas teams in the UK advising on UKCS matters, and offering advice on all aspects of applicable UKCS law, Brodies can provide all this support in one place, avoiding the need for multiple advisors and ensuring seamless guidance across all the relevant areas. The key to securing investment, and ensuring that investment is properly secured, is to get that advice as early as possible.
By Laura Petrie, legal director and oil and gas expert, Brodies
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