UK oil & gas industry: the evolution of an independent midstream sector

April 2018 | SPOTLIGHT | SECTOR ANALYSIS

Financier Worldwide Magazine

April 2018 Issue

In recent years we have seen significant change in the UK upstream oil & gas industry, spearheaded by the disparate but equally defining forces of the Wood Review and lower oil prices. The need to change and adapt has also trickled down to the midstream sector, as integrated oil & gas corporates re-evaluate their business models and seek to restructure their balance sheets, while investors, particularly infrastructure funds, seek new opportunities.

The traditional ownership model for midstream assets

While the exact definition of what comprises the midstream sector, as opposed to upstream and downstream, is not black and white, the term ‘midstream’ is generally considered to be broad and includes the transportation, storage and processing of oil & gas and derivative products. For the purposes of this article, we are focused on UK gas & oil pipelines, primarily offshore, and associated processing and storage infrastructure.

In the early days of the UK Continental Shelf (UKCS) oil & gas industry, upstream oil & gas companies constructed and operated midstream infrastructure required to realise the value from newly discovered oil & gas fields. As early as the 1970s it was clear that it was not desirable to replicate new infrastructure for each project, and therefore an ownership model evolved whereby assets originally commissioned for a particular field or fields are made available to third-party users (that is, owners of other fields) who pay a tariff for the use of the existing infrastructure.

Therefore the traditional ownership model for UKCS midstream assets has involved ownership by one or more oil & gas companies, with a designated operator (typically an oil & gas company with a majority interest in the relevant fields or its subsidiary) and a number of third-party users, being other oil & gas companies producing oil & gas from other fields.

The need for change

The Wood Review, published in February 2014, noted a need for the efficient management of existing ageing infrastructure, as well as investment in new infrastructure, and that therefore a new model involving the “independent transporting and processing on third party production” should be encouraged.

The publication of the final Wood Review report was followed by the dramatic fall in oil prices, creating an economic impetus for oil & gas companies to closely scrutinise their asset bases. The disposal of midstream assets presented, and continues to present, an opportunity to generate immediate cash which can be applied in other directions, be that payment returns to shareholders, paying down debt or used for investment elsewhere in the group. Additionally, much of the existing UKCS infrastructure is in need of investment to maintain and upgrade it, and new ownership brings with it the potential for much needed capital investment programmes.

The new model in practice

There have already been a number of examples of disposals of midstream assets, resulting in ownership by companies that are not themselves users of the relevant assets. The Frigg gas processing and transportation system (FUKA), which originally served the Frigg field, together with a 67 percent interest in the SIRGE pipeline, was sold by Total to North Sea Midstream Partners (NSMP) in 2016. NSMP was formed by ArcLight Capital in 2012 through the acquisition of the Teesside Gas Processing Plant. It is no surprise that NSMP has US roots, as the independent midstream sector is well established in the US.

Similarly, BP sold the Central Area Transmission System (CATS) pipeline to Antin Infrastructure Partners. This acquisition followed an earlier disposal by BG Group of its interest in the CATS pipeline to Antin, resulting in Antin currently holding a 99 percent interest in CATS.

More recently, in November 2017, Ancala Midstream Acquisitions Limited completed the acquisition of Apache’s interests in the Scottish Area Gas Evacuation (SAGE) System and the Beryl Gas Pipeline. By acquiring Apache’s interest, Ancala now holds a 30.28 percent share of SAGE and a 60.58 percent share of the Beryl Pipeline. The transaction had the full support of the regulator, the Oil and Gas Authority (OGA), with the OGA saying that “this transaction clearly demonstrates that ‘right assets, right hands’ is working”.

Ensuring a safe and efficient operating model

For the disposing owners of midstream assets, where those outgoing owners will need to use them going forward, as well as third-party users of the assets, one of the key aspects to any sale is the safe and efficient operation of the assets going forward. Typically, infrastructure fund buyers will team up with leading operators, such as the Wood Group, as in the Ancala acquisition, to operate the assets on an arm’s length basis post-completion of the transaction. In addition, the existing UK petroleum regulatory regime provides important parameters to support how the asset is maintained and operated.

In terms of new field owners securing access to infrastructure, new infrastructure owners are likely to be motivated to sign up users of any spare capacity. In addition, a key component of the UKCS regulatory structure has been a right of recourse to the regulator in cases of disputes between the owners of midstream assets and third-party users. The current third-party access regime, underpinned by a voluntary industry code, allows a party that seeks access to upstream infrastructure, and cannot agree such access with the owner, to apply to the OGA for a notice granting the relevant rights.

The risks and opportunities for the buyer

Midstream oil & gas assets can present a sound investment in the same way as other similar energy infrastructure, such as downstream gas and electricity distribution and transmission networks. Midstream assets are not usually subject to a formal monopoly price control, unlike downstream assets, but a potential buyer will need to conduct thorough due diligence on what tariffs are currently paid by the users of the pipeline and the certainty of duration of those tariffs.

One significant issue that can present a challenge to investors not familiar with midstream assets, particularly in the UKCS context, is the decommissioning liability that applies particularly to offshore pipelines. The UK Petroleum Act 1998, which governs oil & gas activities in the UKCS, imposes an obligation on owners of pipelines to decommission them at the end of their life. While for most midstream assets, decommissioning may still be a distant prospect, a combination of the relatively significant cost of decommissioning, although not as high as the cost of field decommissioning, and the fact that the UK government is able to pursue former owners to cover decommissioning costs should the works not be carried out, means that in any midstream transaction the parties will wish to robustly document who will take responsibility for decommissioning the infrastructure, as well as any security that is required to back-up that agreed position. Buyers should also be aware that the decommissioning regime effectively pierces the corporate veil, meaning that entities associated with the buyer can potentially be brought into the liability net for decommissioning costs. This is often a key structuring discussion early on in any transaction on the buyer’s side.

Conclusion

The new ownership model in the UKCS business is now well established and remains popular with investors looking at the midstream infrastructure space. It should be welcomed; it presents an opportunity to achieve the objectives of incumbent oil & gas corporates, financial investors and the government alike.

Michael Burns is a partner and Justyna Bremen is a senior expertise lawyer at Ashurst. Mr Burns can be contacted on +44 (0)20 7859 2089 or by email: michael.burns@ashurst.com. Ms Bremen can be contacted on +44 (0)20 7859 1848 or by email: justyna.bremen@ashurst.com.

Michael Burns and Justyna Bremen

Ashurst