Contracting for collaboration

Accordingly, 2018 looks like it may well be the year that many collaborative discussions, plans and projects are put into action.

In order to stay at the top of their game in the UKCS, many supply chain companies will need to revisit terms and conditions and, more significantly, the approach to payment mechanisms included in these agreements.

Ultimately the key element to be decided in all collaborative engagements is the apportionment of risk.

And this is where the contracting approach becomes key to an effective collaboration.

Prior to the Oil and Gas Authority-mandated requirement to collaborate, many of the larger suppliers to the UKCS had sought to provide operators with more flexible commercial models.

These approaches looked to the long-term objectives of a project rather than a simple supply and payment structure, and frequently included the supply company taking on some additional level of risk.

As collaboration has become more commonplace, and even expected in relation to some projects, this approach has been taken on board by an increasing number of supply chain companies regardless of size and scale.

Moreover, there are increasing incidences of groups of supply chain companies working together either under one headline supplier or in a syndicate or consortium approach.

Risks and rewards

Irrespective of whether there is one supplier offering a holistic solution or a consortium of suppliers proposing a joint offering, it is vital the parties to the collaborative arrangement understand their risks.

In such arrangements, the operator will seek to pass all risk to the headline supplier or consortium group and then leave them to allocate risk among themselves and any subcontractors or affiliated companies.

Accordingly, many collaborative project agreements are seeing a shift away from the standard ‘knock-for-knock’ regime, which has been inherent to UKCS contracting for many years.

This has been replaced by a bespoke risk allocation mechanism where full responsibility for the project is passed on to the supplier together with all risk until such time as the project is completed or handovers are staged at specified milestones.

The usual mutual indemnity structure may still be applied among the consortium or as between the headline supplier and its subcontractors but equally, depending on the work commitment or engagement of such parties, the liability may be allocated on a non-mutual basis which reflects the project contract.

Given that risk allocation has moved away from the usual industry standard for most collaborative projects, it is not unexpected that there has been a similar shift from the usual payment on completion of work model.

Obviously, accepting higher risks should reap greater potential rewards.

In this new world of collaborative enterprise, supply chains are stepping up to receive some benefit from the oil fields they help bring online.

It is now not unusual to see contracts with payment mechanisms that cross-refer to a royalty or net profit interest in resulting production, or that include an element of deferral with uplift to allow payment once production is flowing.

Such terms provide added incentive to the supplier as they represent a significant investment in the project being undertaken — if there is no completion, there can be no payment.

This structure requires significant consideration and review by the relevant supplier or consortium.

Primarily, the project must be analysed to determine if the operator has a true prospect of a producing field at the end of the work.

Even if production is likely, the supplier will also need to consider if the rate of return under the uplift or royalty is sufficient to offset the costs of the project.

In some cases, suppliers want the ability to showcase capability and indicate a willingness to collaborate so the level of return is of less importance, but coverage of costs should always be verified.

This requires additional legal and commercial review, obtaining of technical advice (to verify the viability of the project) and likely a greater need for management approvals to the contracting process.

It is vital that the supply chain determines how to address these issues now to avoid the contracting process becoming overly drawn out or delayed.

A further aspect of contracting in this manner is the possibility that a supplier could end up on the hook for decommissioning costs under the terms of the licence underlying the project.

Where a production-based royalty is agreed, the operator and any other licensees require the approval of the Oil and Gas Authority, as essentially the licensees are agreeing to give away a share of production value before that production has been realised.

In line with section 34 of the Petroleum Act 1998, anyone who has an interest in infrastructure attached to a UKCS licence could be asked to contribute to its decommissioning costs.

As the supplier has provided the work and put the infrastructure in place in order to receive production there is an argument, albeit tenuous, that such suppliers could be caught by these provisions. This is currently untested but equally it has not been rejected by the Oil and Gas Authority as a possibility.

Structure and sharing

A key element to effective collaboration is ensuring that the structure of the collaborative enterprise is appropriate. Typically, between the operator and the suppler or consortium group this will be a straight supply of services and right to payment arrangement notwithstanding that it may look a little different to the usual terms.

That’s not say that there would never be a form of joint working initiative between a supplier and operator, just that it is less common.

Some form of joint working arrangement will definitely be required to underpin the arrangements between the members of any consortium or the supplier and its subcontractors.

This will outline their rights in, responsibilities for and specific attributes that are being brought to the project.

This type of arrangement could be in the form of a new company, established as a special purpose vehicle solely for the work required in the specified project and managed pursuant to a joint venture agreement.

Alternatively, if the work required is less tangible — for example in relation to operating systems software — the coordination of the supply chain could be managed by a simple sharing and development agreement relating to each party’s respective intellectual property contribution.

There are many ways and forms of contract that can be used to narrate these collaborative relationships, the important issue for all supply chain companies is selecting the right structure which —

• Clearly identifies each party’s contribution

• Outlines the responsibilities being undertaken by each party

• Allocates the appropriate risk and reward mechanism

Collaboration is likely to be a concept which will be inherent to UKCS projects for the foreseeable future.

Supply chain companies are live to this, and are seeking to investigate and instigate collaborative opportunities. The key contracting focus for the supply chain now, to be ready for this, is to review the contracting practices currently in place and make sure that there are new terms, new strategies and new internal policies and procedures which allow for collaboration with ease.