Scotland's Independent Expert Commission on Oil and Gas: report

5. Regulation: Governance and Licensing

Key Messages:

• The emphasis of future regulation should be on high quality, proactive stewardship - the new Regulator must utilise a combination of regulatory powers, persuasion and incentives.
• There is a need for a change to the way in which oil and gas companies operate within the basin. At a corporate level there should be a shift to a new paradigm of complementarity and mutual advantage.
• If voluntary and incentivised stewardship does not deliver, further licensing obligations and statutory powers for the Regulator should be considered in support of achieving maximum TVA.

Existing Regulation

1. The Commission agrees with the Wood Review that the current model of regulation in the UKCS is considerably under-resourced. As a consequence, it is our view that the regulatory framework has not been pro-active or as influential as it could have been.

2. The current Regulator is also considered to have had a limited role in shaping fiscal policy. As such, the current Regulator is viewed as detached from critical decisions which shape tax rules, or the development of new allowances or other fiscal mechanisms - all of which could enhance the longevity of the UKCS, boost investor confidence, and provide sustainable value to the economy.

3. It is the Commission's view that the regulatory regime must recognise the increasing diversity of operators and the move to smaller, more marginal fields with greater emphasis on collaborative industry approaches. This highlights the need to reduce bureaucracy and remove obstacles to collaborative development.

4. Wood stated that the " fundamental licensing model by which the UK monetises its offshore oil and gas resources is the right one" and that it is the regulatory body which is " struggling to perform a more demanding stewardship role" in an operating environment which has changed significantly in the last two decades.

5. Industry recognises the need for partnership working but it does not often behave in ways conducive to achieving this outcome. This has been exacerbated by post Macondo litigation.

6. Wood suggests that the current "'light touch" regulatory regime is not sufficient in managing the future of the UKCS. Instead, there is a requirement for licence holders to commit to MER principles, working on agreed Cluster Field Development Plans and committing to shared infrastructure, with regulatory power to encourage collaboration.

7. The Commission fully supports the Wood Review assessment of the governance model applying in the UKCS, and the solution: the creation of a new arm's length Regulator for the UKCS with increased powers to enable effective high quality, proactive stewardship for the delivery of the MER strategy.

The New Regulator

8. There is broad industry agreement that the current framework is under-resourced and a stronger, more proactive regulator, would be welcomed. The Norwegian model of a regulator has been cited as a more effective model of stewardship - with the data and expertise to engage with industry, and the strength and expertise to encourage operators to collaborate for the good of the industry as a whole.

9. It is the commission's view that the new Regulator's role must utilise a combination of coercive regulatory powers, persuasion and incentivisation. Government must set the parameters for the implementation of this strategy in the context of TVA; taking responsibility for its achievement.

10. The assessment of what is 'economic' recovery must be reviewed in light of potential TVA. Proactive stewardship by the new Regulator must not only tackle the impediments to investment but also assist Government in ensuring the maximisation of TVA through providing advice in relation to the necessary investment in, and development of, skills, technology and innovation.

11. As a result of this new regulatory model, responsibility for licensing is likely to be further devolved from central government. It is important to recognise the challenges in ensuring the appropriate level of capacity which facilitates prudent stewardship of UKCS licences. The distinction of the levels of responsibility between Government and the new Regulator must be explicit, and distinct efforts will be required to ensure any duplication of effort is minimised.

Recommendation 1: The over-arching strategy of MER must be implemented by the new Regulator, inclusive of the whole industry, and viewed in light of the ultimate goal of achieving maximum TVA.

Box 5: The new Regulator

• The Commission recognises the influential role which Statoil and Petoro AS play in the Norwegian oil sector, and acknowledges the prevalence of National Oil Companies in many other oil and gas provinces. In considering future policies for the UKCS the Commission has adopted a non-ideological view in suggesting that the role of a strong regulator could replicate some of the key responsibilities often entrusted to National Oil Companies and bestow some of the benefits.
• National Oil Companies tend to be designed to act as commercial companies but will also perform regulatory functions on behalf of the Government.
• Significant direct equity investment in the UKCS by a new National Oil Company ( NOC) would inevitably be expensive, and in the current and prospective budgetary position of the Governments of the UK/Scotland, this would be difficult to justify. However, in relation to the Commission's proposals, National Oil Companies internationally adopt valuable roles other than equity participation.
• They tend to play a leadership role with respect to the province exploration strategy, R&D and technological innovation more widely. In some cases they also advise Government on technical and commercial factors impacting upon basin performance.
• The Commission does not propose the establishment of a National Oil Company in the UKCS. However, it believes that the new Regulator, equipped with the enhanced powers advocated within this report and within the Wood Review, can effectively undertake many of these functions and generate the associated benefits for the industry and for society. This must be accompanied by cost efficiency, minimal bureaucracy and with the full cooperation of the industry.

Cultural Change

12. There is a need for a change in the way oil and gas companies operate within the basin. While it is critical that the benefits which come from competition are retained and encouraged, it is also important that a new paradigm of complementarity and mutual advantage is fostered.

13. In terms of legal complexity, the Wood Review cites the UK as being " one of the most difficult and adversarial legal and commercial basins in the world", characterised by " risk aversion to the detriment of value creation" and industry is called on to lead a change in culture through greater adoption of standardised agreements, processes and procedures. The European Offshore Safety Directive calls for clarity around liability and compensation, and may therefore assist in the development of such standard approaches.

14. The UKCS presents a complex scenario for entrants in terms of the Regulatory and Licensing regime, a factor which raises the cost of entry and impedes investment. If the licensing regime is to operate swiftly, seamlessly and without delay in a complex world without 'overzealous legal' constraints, then a strong, well-resourced and informed regulatory regime is required.

15. With the changing competitive landscape in the UKCS, characterised by the entry and increasing influence of a mix of large subsidiaries, new small to medium sized players and emerging NOCs, an ever greater variety of corporate strategic objectives are becoming manifest. These companies will be key to the future of the UKCS and informed stewardship must acknowledge the differing motivators behind investment decisions.

16. The starting point for alignment begins with the establishment of coherent operating hubs within the five regions of the UKCS - SNS, CNS, NNS, WoS and IS. Only then will behaviours shift from driving unique competitive advantage in which only a few players benefit, to an environment that promotes cooperation and mutual advantage.

17. This shift is fundamental to accessing the potential remaining 24 Bboe and includes challenging a number of current operating practices which include:

• The current mechanisms for managing ongoing base operations (production operations, maintenance and inspections for facilities and pipelines) and their related supply chains with a change in focus to sharing and creating economies of scale across operating centres;
• The need for pooling of well management and drilling resources to ensure sufficient market capacity to meet the needs of small to medium scale operators whilst recognising the increased obligations and liability exposure arising from the 2010 Macondo incident;
• The balance in the type of fixed (platforms) and mobile Floating Production, Storage and Offloading ( FPSO) infrastructure pathways to the market;
• The ownership and management of arterial pipeline systems and the tariffs charged;
• The introduction of technologies from reservoir to export that extend access to resources and the life cycle of facilities as well as innovative design technologies; and
• The need for the relationship between operators and contractors to change from one which has been historically adversarial to one where the supply chain is positively encouraged to come forward with innovation and technologies to provide solutions to the challenges currently facing the UKCS, contributing to the achievement of MER and therefore generating maximum TVA.

Attracting Investment: Licence Measures

18. The current process for obtaining licences is regular and frequent rounds, rather than ad hoc awards. This approach, with the related publicity, concentrates the attention of explorers and produces the maximum response.

19. Currently a block is awarded for a four-year period after which 50% is relinquished. The remaining 50% can be kept for another four-year period after which it is relinquished unless a field development is in prospect - which permits the development area to be kept for an 18-year period.

20. These arrangements produce an appropriate balance between the realities of undertaking the work and the national need to encourage expeditious exploration. For frontier areas the relinquishment terms reflect the difficult operating environment such as in WofS, where six year exploration, and six and nine year development terms are offered.

21. Within this context there are a number of specific issues which licensing policy set by Government, and licence monitoring and implementation by the new Regulator, should seek to address:

• Access to Data

22. Expeditious exploration involves the ready acquisition of seismic and well data. Much data already exists, but it is not always made available to new explorers.

23. The acquisition of new data can be very expensive and the Wood Review has suggested that licensees should collaborate to share these costs, particularly in relation to frontier and relatively new play areas. The Commission supports this and suggests that the new Regulator seeks to facilitate collaboration on this basis as part of its responsibilities.

24. The Commission also believes there may be merit in a state contribution being made to seismic studies in new play areas - where there would be a wider national benefit from enhanced knowledge of the exploration potential. The new Regulator should investigate further the national costs and benefits of doing so, and it should take steps to ensure that the existing licensees fulfil their obligations to ensure that other explorers can obtain ready access to data in accordance with licence terms.

• Stewardship

25. Given the clear need to increase exploration activity the new Regulator should give fresh consideration to the optimal balance between the exclusive rights of an existing licensee and the national benefit from wider and readier access.

26. In terms of Maximising Economic Recovery the new Regulator should have powers to set expectations in terms of recovery by licence holders and to impose sanctions where these expectations are not met.

• Cluster developments/Collaboration

27. The Wood Review recommended that the Regulator be given the power to call companies to account when they adopt an 'unreasonable' position in relation to industry collaboration. It cites the good example of industry collaboration on Health and Safety as a model for other forms of collaborative working. However, it should be recognised that industry itself has identified that collaboration, without an imperative such as low prices, can be difficult to achieve.

28. With smaller companies playing an ever more central role in maximising UKCS potential this further drives the need for a collaborative environment to ensure all parties can play their part in the basin's future.

29. Currently DECC assesses and approves all field development plans. This includes significant incremental projects, which have acquired increased importance in recent years. The Wood Review suggests that the Regulator's role should be enhanced to include the development plan for a field, and to consider the benefit of a cluster of developments, incorporating the economies of scale from sharing a common processing hub and/or pipeline, for example.

30. The Commission is supportive of this proposal. However, its success depends on much more effective collaboration than has been seen in recent years. For new licences a commitment to collaborate could be set as an obligation, but many relevant licences will be existing, and there may be legal difficulties constructing and enforcing such an obligation which would require to be overcome.

31. In its stewardship role, the new Regulator should be able to influence the development plans for a cluster of new developments as well as activity in the mature phases of field life.

32. One way of promoting communal developments is to realign equity interests to enhance the financial harmony among licensees.

• Production Efficiency

33. Under the present Stewardship Initiative relating to mature fields DECC is able to press operators to enhance their production efficiency with the possibility of requesting a change of operator or even selling an equity interest in the event of non-compliance.

34. The Commission supports a substantially enhanced role for the new Regulator with respect to production efficiency. This would include proactive interventions to a greater degree than has happened in the past. The potential national gains, enhancing MER and TVA, from enhanced production efficiency justify a more proactive role.

• 3rd Party Access to Infrastructure

35. This is an issue which has needed to be addressed for a long time, with examples of protracted negotiations and even failures to reach agreement. Whilst DECC now has powers to become more proactive in determining terms and conditions it has preferred that agreements are reached by negotiation.

36. It is clear to the Commission that a more proactive involvement by the new Regulator is needed to speed up the process in some cases and to determine terms when no voluntary agreement is in sight. The realignment of equity interests among the asset owners and potential users to harmonise financial interests could again be used by the new Regulator to facilitate agreements.

• Impact of licensing measures

37. The evidence gathered by this Commission has reinforced industry recognition of the need for effective regulation of the UKCS in areas impacting upon licensing, operation and decommissioning. However, any regulatory change should be clearly set out and communicated swiftly in order to minimise confusion, disruption and uncertainty in planning.

38. All the proposed duties for the new Regulator constitute a significant increase in extent and depth of responsibilities from the existing situation and should be seen within the context of MER and TVA.

Recommendation 2: The licensing regime should aim to achieve ambitious targets for MER as well as the higher aspiration of maximum TVA.

Stability and Predictability

39. This report has emphasised the importance of the need for predictability and stability in both the regulatory and fiscal regimes in the UKCS.

40. The effect of frequent changes, and, in some cases, a lack of prior consultation by Treasury, has earned the UKCS a reputation for fiscal instability, damaging the competitiveness of the province and inhibiting new investment. This has damaged investor confidence in the past, and has resulted in decisions being made for short-term gain which have a negative impact in the longer term.

41. As part of a move to re-balance the relationship between the industry, the Regulator and Treasury, much closer collaboration than has been seen in the past is necessary.

42. The Commission notes the Scottish Government's commitment to formal consultation prior to future reforms to the policy framework and this is welcomed as a means to avoiding or mitigating any negative impacts on investment or production.

43. This formal consultation must be meaningful and it must be undertaken well in advance of any proposed change being announced. Consultation with industry should be carried out as part of this process with the new Regulator acting as the facilitator.

44. Decision making must also be firmly based upon the principles of MER and TVA, enabling an assessment of the degree to which a measure is likely to impact upon economic recovery of oil and gas in the UKCS and the extent to which factors considered to be impeding or encouraging exploration, investment and production, for example, also have an impact on the wider economy.

Recommendation 3: The new Regulator should have a formal right of consultation on fiscal or regulatory issues which could have an impact on investment or production in the UKCS.

Recommendation 4: Licence terms could be worth investigating as a means of ensuring greater certainty for operators investing in the UKCS, through incorporating a commitment to meaningful consultation with the Regulator and industry on any regulatory or fiscal changes and through formally placing MER and TVA as central to those considerations.

Constitutional Change

45. In the event of a Yes vote, the new Regulator should operate within a single regulatory regime with dual government control. With the vast majority of oil and gas fields likely to be within the Scottish portion of the UKCS in the event of independence, the natural conclusion would be for the new Regulator to transfer predominantly to the control of the Scottish Government upon independence. It also makes practical sense for the same Regulator to serve the rUK portion of the UKCS under an arrangement of shared competence.

46. The Regulator would in this case work to both the Scottish and the rUK Governments, and would provide the stewardship function for all areas of the UKCS in accordance with the policies set by the two governments. Initially those policies are likely to be the same or very similar, however, with different geological and economic features and challenges, policies are likely to diverge to a certain extent over time.

47. The Commission has recommended that the Regulator should have a formal right of consultation in relation to fiscal or regulatory issues, which could have an impact on investment or production in the UKCS. This should apply equally to decisions made by a Scottish and an rUK Government.

48. It would be appropriate for clear governance arrangements to be set to ensure swift decision making and as far as possible that policy implementation and maintenance is coordinated. The Regulator should have separate teams working on each jurisdictional area, as well as the geologically different regions of the UKCS, with the right expertise in place.

49. These teams should share skills and knowledge and collectively advise both Governments on the impact of any policy proposals - with a view to maintaining complementarity as part of the Regulator's formal right of consultation.