Over the last year or so there has been increased activity in mergers and asset transactions in the oil and gas sector. This certainly includes the UK Continental Shelf. With respect to asset transactions, in the immediate aftermath of the oil price collapse, there was little activity. Both potential sellers and buyers had to assess the effects of the price fall on the value of assets. Cost reductions and valuation of their effects were a priority. Also, there was great uncertainty regarding future price behaviour which made agreement valuations more difficult.
Over the last several months the price volatility has lessened and the average level has risen. The reduced volatility has meant that the possible range has become rather less wide. Also, cost reductions have now become bedded in and their implications are better understood. For asset valuation purposes these developments are important because there is now a greater likelihood that the aspirations of both the seller and buyer can be met in a transaction. It is thus not a coincidence that there has been an upsurge in the volume of transactions in recent months.
A further causal aspect which is particularly relevant to the UKCS relates to the pent-up restructuring wishes of some oil companies and the presence of new entrants. For some time major companies in particular have distinguished between core and non-core assets. Non-core assets include fields in the later stages of their lives where production is relatively low. The remaining potential may not be regarded as substantial by a large company where operating costs per barrel are relatively high and it is difficult to justify an incremental investment against opportunities elsewhere, not only in the UKCS, but worldwide.
On the other hand smaller companies my find the opportunities in mature fields more attractive. They may have lower costs per barrel, and a given absolute expected profit could be of greater value to a smaller company compared to a major.
Funding incremental investments in late field life projects is unlikely to be easy for an asset buyer, but such projects could be higher up the priority list of a smaller company compared to a major.
A significant issue here relates to decommissioning. In the UKCS the costs may be very high, especially where large, old platforms are concerned. The UK Government will also be concerned to ensure that the decommissioning obligations are fulfilled. When a transaction takes place the Government can insist that the seller be obliged to undertake the work if the buyer defaults.
In recent years, with asset transactions there have been cases where the seller has agreed to be responsible for the decommissioning. Without this the transaction would have been more difficult, and perhaps impossible.
Generally, sellers will not wish to retain the decommissioning obligation. Apart from the principle they may have concerns about the state of the platform when it is returned to them. Despite this, there have still been several cases where transactions have taken place with the decommissioning obligation remaining with the seller.
It is quite likely that there could be more late field life transactions if a mechanism could be found which would make it easier for the buyer to accept the obligation. One potential obstacle relates to tax relief for the decommissioning costs. Currently in the UK, when an asset transaction takes place, the tax history of the field for corporation tax and Supplementary Charge remains with the seller. This can mean that the buyer does not obtain full relief for the decommissioning costs because the tax which he has paid over the comparatively short time which he has had to operate the field is insufficient to achieve full relief for the decommissioning costs. This forms the context for the current debate between the industry and the Treasury on the idea of permitting the tax history of the seller to be transferred to the buyer as part of the contract between the parties.
It is to be hoped that the outcome of the present consultation will result in a scheme which ensures that asset transactions in the UKCS are not inhibited by this problem. Of course, it is not easy to demonstrate how many transactions are stifled by the tax rules. There are many other factors which determine whether a transaction proceeds or not. But, in the interest of achieving Maximum Economic Recovery, the tax system should not be an impediment.
Alex Kemp is a professor of petroleum economics at the University of Aberdeen as well as director of Aberdeen Centre for Research in Energy Economics and Finance.
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