The insurance market issues various third party guarantees on behalf of energy exploration and production operators in the oil and gas sector. Many of these guarantees cover both onshore and offshore decommissioning obligations, and are referred to as surety bonds or surety guarantees issued by sureties or surety companies.
While contractual requirements are usually in place for the decommissioning of assets, oil and gas operators always maintain the primary responsibility. Surety guarantees can be used as an alternate form of collateral (security), freeing up cash that would usually be required under a traditional letter of credit (LOC) or bank guarantee (BG).
For those operators interested in improving their cash flow as their assets approach end of life, or as they adopt strategic plans to accelerate their energy transition, decommissioning surety guarantees could be a security option worth considering.
Prior to 2000, many upstream assets were operated by the oil majors. In the North Sea, for example, decommissioning security was typically provided via a parental guarantee (PCG) if the operator’s external credit rating met the decommissioning security agreement (DSA) requirements. However, as oil majors shift their focus, the number of independent or junior operators has been increasing. For these types of operators, a PCG is not typically acceptable to joint venture partners or the regulatory authority. Often, bank guarantees (BGs) or letters of credit (LOCs) are the primary form of acceptable security and in some cases, these LOCs are cash-collateralized, in part or in full.
This has resulted in the need for new approaches to satisfy DSA requirements in a way that doesn’t:
As new DSA’s are formed, and with encouragement from relevant authorities, alternative forms of security are being accepted to support investment in “late-life” assets in the North Sea.
Traditionally, decommissioning security typically took two forms:
Generally speaking, the issuer of the LOC/BG or PCG is required to be “A rated” by an external ratings agency such as S&P and/or Moody’s; in some cases the minimum rating may need to be higher than “A”, including “AA” under certain DSAs.
Historically, some insurers supported junior operators or start-up oil companies by offering surety guarantees that would sit-behind the LOCs. These surety markets were relatively sparse and rarely provided sufficient capacity to release all of the existing cash collateral.
However, some surety markets have increased their underwriting sophistication. What was a purely credit-driven approach has evolved into one where asset value, projected longevity, and economic viability of the specific assets or energy field(s) are taken into account. This asset-based underwriting approach aligns more closely with the asset-backed lending approach used by banks. It can be useful where the financial condition of the company does not support the decommissioning surety guarantees. When the surety underwriter has assurance of the longevity of the asset(s), it may support surety guarantees based on its evaluation of the asset’s quality and expectation that the asset(s) will survive an insolvency event.
In some circumstances the company issuing the guarantee may require the operator to post cash collateral to a “sinking fund”. This fund builds over time as the assets approach end of useful life.
If the DSA has requirements for an LOC/BG or PCG that would significantly impact the cash or financial position of an operator, then a surety guarantee could be a viable option. Surety guarantees are typically issued in favor of regulatory agencies, trustees, or other entities under joint development agreements (JDAs) or in favor of the sellers of the assets being acquired.
Net present value fluctuates with commodity pricing, so it is important to provide underwriters with stress test information, demonstrating your ability to manage through a pricing downturn. It is also important to provide a comprehensive decommissioning plan, schedule, and sources of funding for the required decommissioning costs.
The surety underwriter will generally require:
Other information that may aid in a more favorable outcome includes a third party reserve report and/or investor presentation(s).
If the release of cash collateral, or the freeing up of bank credit lines could be beneficial to your business, then a surety guarantee should be considered.
If you would like to understand more about using surety guarantees to support the decommissioning of your assets, please contact your Marsh advisor or email firstname.lastname@example.org.