Service contracts - it's good to share!
A key finding in the Wood Report was the need to drive down costs and remove inefficiencies, particularly if the UKCS was to remain an attractive investment for exploration and production companies and lead to a sustainable recovery in production levels. In response to these challenges, the Maximising Economic Recovery Strategy ("MER Strategy") was developed and is now in force. In tandem, Oil & Gas UK has launched the Efficiency Task Force to improve the international competitiveness of the UKCS by encouraging greater cooperation among operators and the supply chain.
There are many action points that companies will be considering in order to drive efficiencies and reduce costs. One of which will be to focus more closely on contract sharing arrangements. Although the industry has a history of contract sharing, it was generally seen as periphery to operational strategy. The implementation of the MER Strategy will help to shift this focus, ensuring that it is more central to the strategic development and operation of each field and no longer in the margins.
Contract sharing arrangements can be implemented in a number of ways, each with their pros and cons which need to be considered on a case by case basis. They include the simple novation of an agreement at a strategic 'break point', a subletting arrangement, a consortium arrangement or by separate contracts with a sharing agreement.
Novation agreements transfer the rights and obligations under a contract to a third party and effectively, a new contract is entered into by the contractor and the third party. The original party is released and discharged from the contract and the third party assumes those rights and obligations under the contract.
Novation agreements are advantageous where the operator no longer requires the services and there are ongoing costs that are being incurred. It may be the case that there is another operator that requires the same service. The novation agreement will discharge the original operator's obligation to pay the costs under the contract and allows the third party operator to be able to use the services.
One noticeable disadvantage with a novation of the original contract is that if the original operator later decides they do require the services of the original service provider, a new contract must be formed with all the associated costs.
As with all things, clarity is required when dealing with contractual issues. A novation agreement will need to set out clearly when each party assumes or is released from liabilities incurred towards the counter-party. It also enables amendments to the contract to be made at the time the original contract is novated, which allows a tailoring effect to meet the needs of an incoming party.
Under a subletting arrangement, the rights and obligations, under a contract, remain with the original parties. There will be a separate subletting agreement between the operators, setting out the terms under which the third party operator is entitled to use the services. Consent from the contractor may be required.
Subletting agreements maybe considered preferable over a novation agreement when the original party wishes to retain control of the contract and the services. However, a disadvantage is that the sublessor sits in the middle and is still responsible for all the liabilities and obligations to the contractor (such as payment), during the sublease period. Therefore, the subletting agreement will need to ensure that all obligations and liabilities are back to back and indemnities will need to be drafted to ensure that, during the sublease period, the sublessee indemnifies the sublessor for all loss and costs.
Operators may elect to form a consortium as they contract for services with the contractor. Any agreement will need to state clearly the order of priority for performance of the services, including providing for any delays an operator may have. There can often be intense commercial discussions around scheduling as the operator that is further down the chain bears the most risk of disruption to its specific timetable. Solutions can be found and it would be prudent to capture these in a separate sharing agreement.
Consortium agreements are best suited where parties wish to have oversight of the other parties' terms and operations. However, a material disadvantage is that each party in the consortium may not have autonomy or first right to the service and may have to consult with the other operators on various matters.
Each operator will need to indemnify the other operators for their breach of contract, personnel, property, and environmental events. The contract will also need to address issues such as the consequences of one operator issuing a dispute notice, terminating or suspending the contract.
Lastly, each operator could enter into services contracts individually with the contractor for the same services, using the same equipment and personnel. Along with the services contract, the operators will need to enter into a sharing agreement to determine the priority over the services, sharing costs (such as mobilisation and demobilisation) and the specific point that the handover of services would occur.
This arrangement enables each party to negotiate specific requirements in their services agreement but a disadvantage is that there is no transparency on the terms that each operator has contracted the services.
With the implementation of the MER Strategy and the constant need to reduce operating costs, operators are finding it increasingly attractive to collaborate with their peers as a means to cut out inefficiency and cost in the system. Although the contracting strategy will depend on the commercial imperatives of the particular transaction and the specific operational requirements, there are many benefits to considering sharing services and equipment with other operators. In regions where the cost of production is high, operators have been creative in the way they contract the services and sharing arrangements are common as a method to decrease operating costs. Operators on the UKCS should take note.