Alliancing, gainsharing and partnering were all buzzwords in the North Sea oil&gas industry of the mid-1990s. There is some talk of the return of these agreements, given the economic challenges faced by the industry in 2009.
The fluctuations in the oil price, the difficulty some North Sea players face in securing lending to finance offshore projects and – given these factors – the concerns of some contracting parties over the financial stability of their counterparts have given a new impetus to alliancing and partnering as a way to do business in the North Sea.
So what is it all about? Win-win, aligning interests and creative incentive schemes is a good starting point. Also, it is fundamental to these arrangements that risk is identified and placed and managed most cost-effectively.
Partnering describes the nature of the commercial relationship between the oil company and the contractor – the contractual mechanisms involved range in scale from relatively straightforward extensions of the traditional North Sea contracting strategy to radically different (and often bespoke) compensation and risk/reward allocations. In essence, companies enter into alliancing arrangements with a view to working together to achieve a common set of aligned objectives on the premise that they will share both the risk and reward.
The concept has remained alive since it came into vogue in the mid-1990s in the form of Master Services Agreements and Global Services Contracts, although perhaps without the incentive scheme which is often seen as the motivating factor in alliancing. However, these agreements have clear commercial motivations in their own right – the oil company has certainty over rates and quality and the contractor has more certainty over reward and demand without the need to renegotiate the terms for every piece of work.
But in an alliancing or a partnering arrangement in its truest form, the parties will either both benefit from the joint arrangement or they will both lose. It is not intended to shift all the risk on to the contractor and squeeze profit margins; nor is it intended that the contractor will be protected from all the risk in the project.
A simple example might be a contract priced by reference to a schedule of time and materials costs with a target price in which the parties agree that if the contractor can complete the project for less than the anticipated price, he will share a certain percentage of the saving to the client.
The clarion call in the North Sea is to cut operating costs. These have (until the last few months) been on a strong upward trend and will inevitably take some time to respond to the falling oil price, given the need to work through existing contracts.
But, as contracts come up for renewal, so oil companies are looking at a range of options to reduce their costs. One option is simply to negotiate hard with contractors for lower prices.
In appropriate cases, however, operators are recognising that successful alliancing produces tangible commercial results through the elimination of inefficiency, aligning of interests and streamlining of operations. As a result, targets are achieved without compromising safety or quality, costs are reduced through the effective and efficient use of resources and the contractor is rewarded appropriately, for example, through bonuses for meeting performance criteria.
Alliancing was not a new concept even when it was first introduced into the North Sea. It had previously been used in the manufacturing sector for years. But given the complex and high-risk nature of the North Sea service industry, any alliancing arrangements are, by necessity, sophisticated.
In its purest form, alliancing is a different way of contracting, requiring both parties to be committed to the success of the project and to the alliance. There may be a framework or umbrella agreement setting out the parties’ philosophy in terms of the minimum conditions of satisfaction, with separate project agreements which may be added (and added to) as the circumstances require, or there may be a single project agreement with gainsharing terms.
Each agreement will be different: the legal challenge is to draft creatively, concisely and commercially, maximising the upside for commercial gain and trying to minimise the adversarial approach.
And, for all the talk of “partnering”, lawyers should be concerned to avoid creating a partnership in legal terms where this is not appropriate and is not the intention of the parties, as it may have unanticipated consequences for tax and liability.
They also need to be very aware, as always, of the potential competition and procurement-law issues which may be raised by the arrangements. In structuring the arrangement, the risk/reward allocation must be clearly set out.
Alliancing and partnering agreements are success-orientated – setting out which bonuses will be paid for meeting what targets, how savings will be shared, and so on, but the lawyer needs to look also at the consequences of failure, setting out how the pain will be shared should targets be missed or if a project overruns.
As well as financial risk, the agreement also has to allocate performance risk and address the risk of injury and damage through the liability and indemnity regime.
By popular account, partnering and alliancing were, for the most part, successful in the last oil-price crunch. Their contribution to this latest crisis will be judged not only on their delivery of benefits to individual parties, but also on what they contribute to the future of the North Sea.
Penelope Warne is head of oil&gas at law firm CMS Cameron McKenna LLP
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