Perspectives

Contentious matters in the Energy and Resources sector: Don't be left stranded

Governments are under pressure to tackle climate change by reducing emissions and shifting investment to clean energy. With the focus now on renewables and sustainability, the energy sector will need to consider the implications of a shift away from fossil fuels. Companies in the sector may want to reconsider their investments and contractual arrangements, as well as the extent, and value, of any stranded assets that they have.

What’s it worth?

The International Energy Agency defines stranded assets as “those investments which have already been made but which, at some time prior to the end of their economic life, are no longer able to earn an economic return”.

A recent FT article reports that energy producers would have to write off over half of their fossil fuel reserves as stranded if governments attempted to restrict the rise in temperatures to 2°C , increasing to 80 percent under a 1.5°C target. Companies in the sector are reportedly looking at multi-billion dollar impairments. The ramifications of these impairments may well include adverse stock market reactions and contractual breaches.
 

Waste it or use it?

Energy companies may want to plan for their next steps; when should they begin to minimise ongoing expenditure on assets which are no longer seen as economically viable; and, when should they exit or stop renewing ongoing contractual arrangements?

Such disruptive changes come with risks that energy companies should be aware of when charting their route, such as:

  • Unmaintained, stranded assets due to cutbacks in expenditure may begin to pose a risk from an asset integrity or environmental compliance standpoint;
  • Disputes may arise between parties because of differing views on the appropriate levels of investment and development plans committed to state regulators;
  • In circumstances where there are joint operators, or multi-party licenses, there may be divergent views on the necessary costs and the economics of these assets, particularly during the “lighthouse” or decommissioning phase of an asset, where operators continue to incur costs but will generate no revenue;
  • Governments may seek to exercise relinquishment clauses in license agreements in order to encourage, or ‘push’, operators to either invest or exit the agreement so that they can award the license to other (potentially lower-cost) operators, triggering bilateral investment treaty disputes; and
  • Disputes between nation states and operators arising from the desire by states reliant on the expert of fossil fuels to maximise investment and production in the short term, in order to achieve higher returns before energy transition takes off.
     

The cost of cost sharing

Cost sharing arrangements often make commercial sense, with companies minimising their expenditure and exposure by sharing facilities, or production costs, either between assets or asset owners. But what if an asset is only viable when the costs are shared across other assets up and downstream and what if one of the assets is no longer economically viable? Disputes may arise when:

  • operators of new (undeveloped) fields keep production volumes ‘hostage’ to negotiate better processing tariffs/ fees;
  • operators of exploration licenses upstream of stranded or sub-commercial assets may lose access to critical infrastructure; or
  • parties are not aligned on how to interpret the contractual clauses and the calculation of the costs to be shared.
     

Don’t be left stranded

Energy companies may want to think about how they value their asset portfolios and make an assessment about which assets are likely to earn an economic return and which should be divested.

Changes of circumstance are always likely to increase the occurrence and complexity of disputes between parties. To learn more about how our dispute resolution specialists and industry experts can support your business or clients at all stages of dispute resolution please contact Matt Brewer and Timothy Johnson.

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