Industry could save billions by spinning off late-life assets into ‘bad banks’
Oil producers in UK waters would save up to $7.5 billion in total by spinning off late-life assets into a separate decommissioning company, global management consultancy Oliver Wyman has declared.
The company would take the form of a syndicate that owns the physical end-of-life assets and performs removals, Oliver Wyman said. It based the idea on the “bad-banks principle” deployed in response to the Swedish banking crisis in the early 1990s and the US sub-prime mortgage crisis in the late 2000s, Nic Singleton, Energy Specialist at Oliver Wyman and co-author of the report, told DecomWorld.
Creation of a bad bank in the North Sea would see operators identify and segregate “good” assets from “bad”, with the bad assets to be acquired by a separate company or set of companies. The bad or “toxic” assets in this case are fields that are nearing end of life or have ceased production.
By clearing the balance sheet of non-performing assets, the operator has less liabilities on its books and becomes more attractive to shareholders. As a result, the industry can afford to focus on exploration and production for longer and without the distraction of decommissioning conversations, Singleton said.
North Sea the perfect incubator
The UK Continental Shelf (UKCS) is a perfect candidate for this strategy due to its declining reserves, aging infrastructure regulation and high costs of production. The bad-banks scheme has been rapidly implemented in past examples, which is ideal for the North Sea basin because time is critical, according to Singleton. He said, “The longer you leave it, there are costs associated with mothballing assets, including the increased risks of decreasing integrity. If you can come up with a solution that works, then why not take out unproductive and costly infrastructure now?”
According to Singleton, potential benefits to the strategy include: greater protection against decommissioning liabilities in the event of a major accident; reduction of operational risk during decommissioning; and it serves as a form of tail-risk hedging, meaning the creation of a position within a portfolio to protect against downward market pressures.
Singleton evolved the bad-bank idea during DecomWorld’s Decommissioning and Abandonment Summit in Houston in 2015, where he challenged industry experts about the extent to which they were prepared to engage in collaboration.
Although the scheme would involve financial engineering to improve profitability, he said pooling together in this way would also enable operational improvements in the decommissioning stage. He listed increased purchasing power across the supply chain, knowledge-sharing improvements, better information planning and scheduling of activities, reduction in duplicated skills, and improved financial control and transparency as potential benefits. These factors were used as a basis for Oliver Wyman’s calculation that the industry could remove up to 30% of current decommissioning costs.
Singleton highlighted improved learning and knowledge sharing as contributors to the scheme’s success. Presently, he said, players are apprehensive to be the first mover on decommissioning as there is a competitive advantage from learning from the experiences of others.
Focusing on core competencies
Andy Brogan, Global Oil & Gas Transactions Leader at EY, told DecomWorld that he agreed economies of scale and reduced decommissioning costs could be achieved by establishing some cohesion between bigger UKCS players. He said the fragmentation of decommissioning ownership contributes to a significant proportion of marginal costs.
Setting up a bad bank for the purpose of decommissioning would require the recruitment of individuals with specific expertise in that field, Singleton said. He noted that a number of operators have been relying on part-time resourcing to help with their decommissioning needs and alternating between the two – neither concentrating on producing nor decommissioning.
While Singleton believes a successful North Sea future rests upon the bad-banks strategy, Brogan said a “bigger bank of experience” around topside abandonment is more likely to save the region. He said there is no quick remedy to the “super- mature” North Sea, unlike Singleton’s claim of speedy bad-banks implementation. But Brogan added that a steady track record would over time increase decommissioning knowledge and reduce costs.
Brogan believes there is an “initial hump” relating to the relatively high margin of error and the variance in cost predictions which must first be tackled before engaging in risk and liability transactions. The greater the ability to forecast, the more comfortable insurance companies – for example – will be with understanding the economics of an asset transfer. It is difficult to find traction with liability-transfer strategies, he said, because “there have been various attempts to sell portfolios of late-life assets but as yet we don’t have a truly visible player who is willing to be a consolidator”.
However, Singleton was confident the idea would find support, and he said Oliver Wyman has already “devised some models on how the assets be grouped together”.
Other commentary on the how the bad-banks scheme was implemented in 2009 has largely attributed the success of this strategy to the fact it had government support – and both Brogan and Singleton agree with this view.
While the bad-banks scheme does not aim to prop up flagging revenues, Singleton argued that the cost-saving opportunities by allowing companies to focus on their core competencies and diversify their risk is the exact innovation idea that the region needs to survive the downturn and to reach the desired goal of maximizing long-term economic recovery from the UK Continental Shelf.
By Sayo Rotimi