Gassled in the Supreme Court: parallels (and cautionary tales?) in the UKCS

The Supreme Court of Norway has confirmed the State’s wide discretion in exercising its regulatory authority and upheld the validity of the Norwegian regulator’s decision to reduce tariffs for the transportation of gas. The Court’s decision has been summarised in our previous Law Now (available here). Here, we consider whether parallels can be drawn between the Norwegian example and similar challenges encountered in the regulation of the UKCS. In both systems there is a balance to be achieved between, on the one hand, upholding national energy policy that seeks to maximise recovery and revenue from oil and gas fields and, on the other, regard for the commercial interests of other stakeholders, such as infrastructure owners. The Gassled judgment highlights the tension that can arise when those interests conflict.

Background

The world’s biggest offshore system for the transportation and processing of gas is owned by ‘Gassled’, a joint venture established in 2003 with the encouragement of the Norwegian authorities. It is owned in part by the Norwegian state and in part by private companies. Nearly all Norwegian gas sold to the United Kingdom and Central Europe is transported through the Gassled system. The tariff paid by third parties for shipment through the network is set by regulation (the “Tariff Regulations”). In 2013, the Norwegian Ministry of Petroleum and Energy (the “MPE”) amended the Tariff Regulations, reducing the tariffs Gassled owners were able to charge for new contracts from 1 October 2016 and thereby substantially reducing Gassled’s future income. Four Norwegian companies with ownership interests (but no shipping interests) in Gassled of a combined 45% (the “Appellants”) argued that the amendment of the Tariff Regulations was invalid and that the State was liable for the loss of revenues they incurred.

The Decision on Statutory Authority

Before the Supreme Court, the Appellants contended that the amendment of the Tariff Regulations (i) went beyond the scope of its legal basis and that, in any event, (ii) it interfered with the Appellants’ right to enjoy their possessions under the European Convention on Human Rights Protocol 1 Article 1. The latter argument will be discussed in a further Law Now.

The Court dismissed the Appellants’ argument that the MPE had lacked statutory authority – largely because it disagreed that the legislative provision identified by the Appellants was the sole basis on which the MPE could amend the regulations. Instead, it found that the regulator had complied with the legislative framework and acted within the scope of its (wide and discretionary) powers.

Reasonable Profit

Though ultimately unsuccessful, the Appellants submitted that the Norwegian Petroleum Act (the “Norwegian Act”) section 4-8 subsection 2 was the only legal basis on which the amendment could be made. That subsection provided that the MPE may:

“stipulate tariffs […] to ensure that projects are completed with due regard to concerns relating to resource management and that the owner of the facility is provided with a reasonable profit taking into account, among other things, investment and risks” (our emphasis).

It was argued for the Appellants that the MPE should have assessed whether the tariff adjustment was consistent with this “reasonable profit” requirement. At first instance, the argument was rejected by the District Court: the amended Tariff Regulations would provide the Appellants with a “reasonable future return”, which was all that was required by the Norwegian Act. On appeal, it was held that the MPE had thoroughly considered the promotion of “best possible resource management” and whether the “owner can expect a reasonable return on invested capital”, thereby satisfying its statutory obligations.

Consideration of what might be a party’s right to a reasonable return is not relevant only in the Norwegian industry. In the UKCS, the MER UK Strategy created a legally binding obligation on industry to take the steps necessary to secure that the maximum value of economically recoverable petroleum is recovered. The Strategy includes a number of safeguards intended to ensure that this obligation does not discourage investment. One key safeguard provides that there is no obligation to make an investment or fund activity where there will not be a “satisfactory expected commercial return” (“SECR”). According to the MER UK strategy, SECR is “an expected post-tax return that is reasonable having regard to all the circumstances including the risk and the nature of the investment (or other funding as the case may be) and the particular circumstances affecting the relevant person.” For more on SECR generally, see our previous Law Now (available here). Both the SECR definition and the Norwegian Act require an assessment of what is a “reasonable” return in light of investment and risk.

The method for calculating tariffs under the Infrastructure Code of Practice on Access to Upstream Oil and Gas Infrastructure on the UK Continental Shelf (“ICOP”) also reflects the risk/reward principle: ICOP provides that tariffs ought to be “fair and reasonable”, ensuring that “risks taken are reflected by rewards”.

Rate of Return

Whilst “reasonableness” is a consistent theme across both jurisdictions, the difficulty is in determining what exactly that term means. In the circumstances of Gassled, the Supreme Court started from the position that the fact the tariffs were to be based on return implied a principle that, as a starting point, the owners were to earn back their invested capital in addition to a reasonable return, but not more. The Supreme Court found that “the starting point was […] a real return throughout the licence period of around 7 percent before tax”. After considering at some length the history of and background to the formation of Gassled and other enactment of the Tariff Regulations, it was held that the Appellants knew and accepted that the MPE was authorised to reduce the tariffs if the real return exceeded 7% of the invested capital. That had been identified as a maximum rate of return in various Propositions to the Storting in connection with the Zeepipe network in the late 1990s, the principles for which were then applied as other networks were established.

In comparison, the SECR requirement does not prescribe a particular rate of return – indeed the OGA is at pains not to do so: the SECR guidance explicitly states that it “does not seek to […] set any new tests as to what should be considered economically recoverable petroleum, or set the rate of return for projects or investments”.

Nevertheless, it is foreseeable in both jurisdictions that a company may find itself in a position where unhindered exploitation of its assets would yield a certain rate of return, and yet the regulator may expect that company to accept a lower rate of return – not necessarily unprofitable, but nonetheless lower than that company’s typical internal hurdle rate for return on investment.

Relevance of Policy and Guidance

In coming to its decision, the Norwegian Court interpreted the words of statute but equally had regard to policy and reports of the regulator. In fact, it was these policy documents that had always stipulated that the real return on total capital for Gassled investors should be around 7%. It is therefore clear from the Court’s focus on the MPE reports that a regulator’s policy and guidance can be of great significance, even where it has no de facto legislative weight.

The OGA has itself been prolific in the production of documentation, with over sixty publications released since 2016. However, it is only the MER UK Strategy which is elevated to binding legal status in accordance with the Petroleum Act 1998. The Norwegian judgment, however, demonstrates how non-binding guidance might inform the court’s view of the understanding and intentions of the legislative and the parties when considering a dispute of this nature.

Costs Incurred

The Appellants went on to make one final argument: that the MPE had no basis on which to completely disregard the costs the companies had incurred in acquiring interests in Gassled. The Court found to the contrary: that, whilst the MPE had the opportunity to consider those costs when setting the tariffs, it was not bound to do so. The Supreme Court went so far as to say: “It is hard to understand why entirely commercial transactions carried out by the owners to realise profit or release capital should influence the tariff level or in fact limit the Ministry’s regulatory authority to adjust the tariffs”.

Companies entering into commercial negotiations would therefore be well advised to keep one eye on the potential effects of any regulatory changes on rates and costs. These deals are not being done in a vacuum; parties should not look solely at the negotiating factors within the four walls of a boardroom. There is no guarantee that the regulator will have regard to the terms entered into between the parties when considering its wider policy approach – despite the fact that the overall framework will nevertheless have direct effect on those individual stakeholders.

Comment

The decision demonstrates the Norwegian State’s ability to actively regulate the framework in order to maximise resources and revenue from oil fields. It confirms the discretion afforded to the Norwegian state in exercising that power, even where the interests of other stakeholders may be adversely affected. Notably, despite the Appellants’ claimed NOK 34 billion loss, it was thought by the Court that the tariff adjustment had not affected them particularly harshly.

In reaching their view, it seems the Court was influenced by the facts that (a) the cost of construction of the infrastructure had been recovered; (b) the owners knew the tariffs were based on return and could be adjusted; and (c) the new tariffs only applied to new contracts – capacity had already been booked under existing arrangements conducted under the higher tariffs.

The ethos emphasised by the Court was that the transport system for natural gas should contribute to good resource management to encourage exploration and investment in the infrastructure. In that way, the Norwegian focus is the same as in the North Sea, being a variation on one theme: encouraging continued investment and maximising the recovery of hydrocarbons.

The judgment reinforces the principle that “profit is earned from the fields and not the infrastructure”. It is not clear that the UK regulator shares the same view. Unlike in Norway, the state does not have any ownership interest in the UKCS infrastructure. The OGA has encouraged various new investment structures since its inception, including arm’s length or separate ownership of infrastructure by non-traditional owners, backed by private equity finance. For those new approaches to work commercially, it is necessary that the infrastructure can be treated as a separate profit centre in its own right, rather than (as has traditionally been the case) an adjunct to core production business. Indeed, increasingly in the UKCS we are witnessing private equity companies and midstream owners purchasing infrastructure in order to generate profit; it is no longer the case that all infrastructure is in the hands of upstream companies.

With a regulator more ‘hands on’ than its DECC predecessor, encouraging “right assets in right hands” it will be interesting to see how active a role the OGA may take in managing resources when considering potential investments, including separate treatment of infrastructure in the North Sea.