The need to change and adapt has also trickled down to the midstream sector, as integrated oil and 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 include the transportation, storage and processing of oil and gas and derivative products. For the purposes of this article, we are focusing on UK gas and oil pipelines, primarily offshore, and associated processing and storage infrastructure.
In the early days of the UK Continental Shelf (UKCS) oil and gas industry, upstream oil and gas companies constructed and operated midstream infrastructure required to realise the value from newly discovered oil and gas fields. As early as the 1970s it was recognised 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 (i.e. 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 and gas companies, with a designated operator (typically an oil and gas company with a majority interest in the relevant fields or its subsidiary) and a number of third party users, being other oil and gas companies producing oil and gas from other fields.
Currently there are approximately 300 offshore fields operated by a mix of large and small oil and gas companies, with 20,000 kilometres of pipelines connecting these fields and platforms to onshore terminals.
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 and 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 (now no longer in production), together with a 67 per cent 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 (Antin). This acquisition followed an earlier disposal by BG Group of its interest in the CATS pipeline to Antin.
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.
In December 2017 Antin announced that it is increasing its portfolio of UKCS assets: CATS Management Limited (CML), an Antin portfolio company, agreed to buy a 65 per cent interest in the Esmond Transportation System, which comprises a 165-kilometre pipeline that transports gas from fields in the southern North Sea to the Bacton gas.
Ensuring a safe and efficient operating model
For the disposing owners of midstream assets, where those outgoing owners will need to continue to use the assets, 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. Often infrastructure fund buyers will team up with leading operators, such as Wood Group, to operate the assets on an arm's length basis post completion of the transaction. In the case of the Esmond Transportation System, one of the outgoing owners, Perenco, is expected to continue in its role as operator. In addition, as discussed in more detail below, 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.
Regulatory and third party consents
The UK offshore oil and gas industry is subject to a highly developed regulatory regime, encompassing economic, environmental and health and safety oversight involving a number of different regulators. The remit of these regulators extends to not just exploration and production, but also to the offshore infrastructure.
As a consequence of this, there are a number of different regulatory consents that will be required upon a pipeline changing ownership, and this regulatory oversight will continue for the life of the asset. A comprehensive list of the consents that may be required will depend on the nature of the individual transaction – in particular, the characteristics of the assets in question, as well as the sale structure (e.g. asset sale versus share sale). However, below we discuss some of the key consents that may be required.
Pipeline Works Authorisation
Under the Petroleum Act 1998, a Pipeline Works Authorisation (PWA) is required for the construction, modification and continued use of an offshore pipeline. The PWA names the parties that hold the PWA (i.e. are a "holder") or that are a "user, operator or owner" of the pipeline (note that a party can have more than one role). In accordance with the terms and conditions of a PWA, the holder of the PWA must apply to the regulator, the OGA, before making any changes to the "holder, user, operator or owner" information. Where there is to be change in the operator or owner on an asset deal, the OGA will want to satisfy itself that the incoming owner/operator will have appropriate standing. This is linked to the legal requirement that the OGA exercises its powers in accordance with the MER UK Strategy (the Maximising Economic Recovery Strategy for the UK).
Health and Safety Executive and OPRED
Again, in the context of an asset deal, the approval of the Health and Safety Executive, which administers the safety regime applying to pipelines, may also be required, and this regulator plays an important role in ensuring that pipelines are operated safely. The Offshore Petroleum Regulator for Environment and Decommissioning (OPRED) will also need to be consulted. For example, a permit issued to the operator of a pipeline under the Offshore Petroleum Activities (Oil Pollution Prevention and Control) Regulations 2005, may not be transferred to a new operator without the consent of OPRED.
The Crown Estate
Where a pipeline has been laid within 12 nautical miles of the coast, there will usually be a Crown Estate lease in place. As a condition of the lease, the consent of the Crown Estate will need to be obtained if there is to be a transfer of that lease.
Third parties and stakeholders
Before an asset sale can proceed, in most instances the consent of various other third parties including any joint venture partners of the existing owner, as well as other users of the system (depending on the terms of use), will be required. It is important to identify and engage with such third parties and any other stakeholders as early as possible in the transaction, to ensure that any potential "sticking points" are identified and resolved. Where there is to be a change in operatorship of the pipeline, the employees of the existing operator may be transferred to the new operator under the Transfer of Undertakings (Protection of Employment) Regulations 2006 – the so-called "TUPE" regime.
Carving out the midstream business
It is important on any midstream deal where there is an existing upstream link to ensure that the midstream assets are appropriately carved out from the integrated upstream and midstream business. This may involve putting in place new long-term transportation agreements, agreements of joint venture partners at the upstream to execute the carve-out and also to put in place specific decommissioning security arrangements in relation to the midstream assets (as distinct from the integrated business).
Decommissioning liabilities
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 attaches particularly to offshore pipelines. The UK Petroleum Act 1998, which governs oil and 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 a wide range of people, including former owners and associated companies, 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.
Conclusion
While UKCS midstream transactions are complex, the new ownership model in the UKCS business is now well established through transactions that have been completed in the sector and remains an area of focus for investors looking at the midstream infrastructure space. It is likely to be a theme that sees further development in the future.
This is an updated and expanded version of an article first published in April 2018 in Financier Worldwide Magazine.
