Contract risk balancing pivotal to future decommissioning market
North Sea players need to develop a less polarised approach to contracting if they are to smooth the way for decommissioning in the coming decade, say industry analysts.
By Sam Phipps in Edinburgh
Limited North Sea decommissioning activity so far has tended to be weighted too heavily in favour of either the operator, via lump sum deals, or the contractor, with “cost plus”.
With only about 7% of infrastructure removed to date, activity will step up considerably in the next five years. An estimated £3.8bn is due to be spent, according to Oil & Gas UK’s 2010 Decommissioning Insight. It forecasts a further £5.4bn outlay before 2020, and total expenditure of at least £26bn by 2040.Better contracting strategies and models will therefore be crucial if this process is to be achieved efficiently, safely and to the benefit of all parties – and in such a way that momentum can build throughout the supply chain.
Independent research by the Robert Gordon University (RGU) in Aberdeen and Accenture, with input from Decom North Sea – the new industry forum – as well as Oil & Gas UK and other stakeholders, has highlighted a range of contracting models that could be applied.
“It’s an emerging market, a young market, and we are trying to shape relationships by making sure a negative character doesn’t become inherent,” said Deji Awodiji, an MBA oil and gas student from RGU who presented the findings at a major decommissioning conference in Dunblane in October.
“That is why collaboration is so important and we are seeing an overwhelming interest in it.”
Alignment of drivers needed
Five operators, a representative number of contractors (Tier 1, 2 and 3), tax consultants, government agencies such as the Department for Energy and Climate Change (DECC), legal experts and academics all contributed.
“Operators largely prefer lump sum, contractors ‘cost plus’ because they are very risk averse. Different organisations have different perceptions of, and reactions to, risk and these affect the contracting strategy,” Awodiji said.
It is vital to align “objectives, beliefs and actions” among operators and contractors, he said.Four main factors drive the choice of contracting strategy and model in the UKCS (United Kingdom Continental Shelf) decommissioning industry, the researchers found: experience, capacity, capability and risk.
Key issues include the limited level of experience so far; location (North North Sea, Central North Sea or Southern North Sea), including water depth and distance from shore; and project complexity – environmental factors, age of installations and size of platform.
But when it comes to value drivers other than health and safety, operators and contractors reported different priorities. For instance, environment, cost and timing ranked slightly higher for operators than contractors, whereas technology, and reputation and performance were more pressing for contractors.
“There needs to be alignment of all those drivers,” Awodiji said.
Risk balancing crucial
A huge disparity in average financial strength between operators and contractors must also be taken into account.
In order to stop loading all the project risk onto the operators or contractor, four key contracting strategies were outlined: cost containment, gainshare, total cost of ownership and alliances.
Cost containment is closest to the cost plus end of the spectrum but with incentives/caps on the expense incurred by the contractor. This can be achieved by, for instance, only allowing 50% of indexed cost rises or agreeing year-on-year price reductions to incentivise efficiency.
With gainshare, both parties risk a portion of project cost on agreed outcomes, with a potential swing of up to 20%. Here the upfront effort to define key metrics is vital – whether they be safety, cost, time, economics etc.
Total cost of ownership has a fixed price basis, like lump sum, but with a mechanism for the contractor to improve margins through innovation or improved delivery. This way the operator might see greater benefits in terms of reduced risks or better HSE performance. It has been summed up as “pay more to get more”.
Mark Smith, analyst at Accenture, said these potential alternatives could be applied across the life cycle of a decommissioning project, sometimes in combination.
“Lump sum and cost plus are very polar in the way they apportion risk. They are not always appropriate in developing the level of relationship that will lead to the investment we are seeking in the supply chain.”Strategic alliances to shape market
Delegates at the conference heard how alliances between contractors, under a single arrangement with the operator, could have an increasingly important role to play in delivering decommissioning.
Complementary skills and capabilities could thus benefit the entire market, reducing total cost and improving efficiency. “The one-off nature of projects can be smoothed with a portfolio of projects shared by a number of contractors,” Smith said.
On the other hand, certain obvious caveats were sounded, including how the alliance partners would work in practice, which would take the lead, how liabilities would be apportioned and revenues shared.
“From the operator’s point of view, one plus one can equal three if the alliance works properly, and it can also benefit the contractor,” said Bob Buskie of Sparrows.
“But there has to be an element of trust and openness. You could get friction in the supply chain if a major player is left out,” he said. “Big alliances can change the balance of power. Operators also really want to ensure they are stable, that they will last for the duration of the project, particularly one that takes years.”
Will Rowley, group analyst at Acteon Group, said liability containment was a major risk for suppliers of all sizes. “The opportunity from North Sea decommissioning just about outweighs the risk at the moment.”
Better ways of contracting are therefore going to be absolutely crucial if the market is to take off.
As Alex West, director of decommissioning and business expansion at Wood Group Ltd, said: “We have to put in the hard work upfront. We can’t be lazy about setting contract terms because that’s a recipe for having fights later.”
NUTSHELL:
Depending on the author, there are just about four stages in oil and gas exploration activity: Exploration, Development, Production and Decommissioning; others may view them as the geological and geophysical survey, exploration, development & production and decommissioning phases. Decommissioning is sometimes overlooked, however it is sometimes the difference between a technical success and a commercial success in exploration activity. Decommissioning involves a total removal of pipelines and platforms, sinking them or total abandonment. Each of these options must be incorporated into exploration ventures in order to determine the net present value of each project. Decommissioning has huge implications for the environment as well. In more regulated and developed markets, decommissioning is a significant consideration for determination of authorizations, project viability and contract terms. As such, it is little wonder why the United Kingdom Continental Shelf (UKCS) is taking proactive measures to enhance practice in the industry. What steps are being taken in your country to ensure that decommissioning is properly managed?
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