With proven oil & condensate reserves of 36 billion barrels and at current production levels of 2.1 million barrels per day, Nigeria is expected to deplete its oil reserves in 46 years. The practical reality of the waning trajectory of oil production makes the discourse on decommissioning and abandonment costs germane to the Nigerian oil and gas industry.
Decommissioning, which is the general term for returning an oil production site to its pre-lease condition at the end of the useful life of the oil asset, can be a costly exercise for the companies involved and can also be challenging for the government, in terms of enacting effective regulations to enforce remediation and restoration of the environment.
In some other jurisdictions with more mature oil and gas basins, decommissioning has become a costly challenge requiring direct financial intervention by the government and creation of incentives for operators to continually improve and optimise decommissioning performance. For example, the decommissioning costs for removal of 600 fixed installations and plugging and abandoning of 7,000 wells in the rapidly maturing North Sea basin is estimated at US$150 billion. Regardless of the cost challenges posed by decommissioning of oil and gas installations, various international conventions require coastal states to exercise their sovereign rights on the removal of disused and abandoned installations and facilities within their continental shelf and exclusive economic zone. The most recent of these international conventions is the 1982 United Nations Convention of the Law of the Sea (UNCLOS III), which came into force in 1995, and prescribed the application of generally accepted international standards on the removal and abandonment of offshore platforms impeding coastal navigation.
In furtherance of the UNCLOS III, the International Maritime Organisation in 1989 issued the Guidelines and Standards for the Removal of Offshore Installations and Structures on the Continental Shelf and Exclusive Economic Zones, as a guide to member-countries on offshore decommissioning. While these international conventions are deemed legally non-binding, they constitute a recommendation for government and operators in the oil and gas industry.
In Nigeria, the Petroleum Act mandates the implementation of an abandonment programme approved by the Director of Petroleum Resources for the decommissioning of any soon-to-be abandoned oil field. The guidelines for the abandonment program and decommissioning of oil and gas facilities is further provided in the Environmental Guidelines and Standards for the Petroleum Industry in Nigeria (EGASPIN) issued by the Department for Petroleum Resources. In this article, we would examine important considerations on decommissioning that should be of concern to the industry and the Nigerian government.
Should buyers of producing oil assets be concerned about decommissioning obligations?
Within the last decade, the Nigerian upstream sector witnessed significant transactions involving the sale of interests in oil licenses. Some of these transactions were concluded in the time of high oil prices and in some instances involved asset transfers from International Oil Companies with long years of carrying on exploration and production activities in Nigeria, to smaller indigenous companies with limited experience in the upstream sector. Expectedly, decommissioning obligations and the potential liabilities are also transferred to the new holder of the license.
As the oil fields reach the peak of their production cycle, there are concerns that the holders of such assets may not be able to discharge their decommissioning obligations, given the enormous cost involved and the current cycle of lower oil prices. This is further complicated by the reality that the full extent of the decommissioning work to be done may not have been fully known at the time of the asset transfer, and the accurate decommissioning costs may not have been factored into the negotiations. This is in line with a recent report "Preparing for the next wave of offshore decommissioning" authored by the Boston Consulting Group, where it was noted that most companies only have 5 – 10% of their asset retirement obligation estimates predicated on fully engineered studies. Thus, the unrealistic estimates for projected cost for decommissioning is responsible for the unpreparedness for actual decommissioning of oil installations and platforms.
Are there enough incentives to mitigate rising decommissioning costs?
The Nigerian tax system does not provide enough incentives for optimising the impact of decommissioning costs on companies operating in the oil and gas industry. For accounting purposes, when a company acquires a long-term asset and has an obligation for remediation and restoration at the end of the useful life of the asset, the International Accounting Standard (IAS 37) "Provisions, Contingent Liabilities and Contingent Assets" requires the recognition of a provision based on the estimated cost of dismantling oil and gas assets such as rigs and platforms when there is a future liability. Based on the requirements of IAS 16, "Property, Plants and Equipment" entities are required to capitalise the provision alongside the initial cost of such asset. The provisions are measured at the present value of management's best estimates of the expenditure required to settle the present obligation as a result of past events. The increase in the provision due to the passage of time is recognised as interest expense in the income statement.
"Decommissioning, which is the general term for returning an oil production site to its pre-lease condition at the end of the useful life of the oil asset, can be a costly exercise for the companies involved and can also be challenging for the government, in terms of enacting effective regulations to enforce remediation and restoration of the environment."
However, the Nigerian tax laws do not allow the tax deductibility of any provision/ estimate for decommissioning or cost of abandonment, except when incurred or when such an expense is set aside in a funded sinking fund. In practice, the finance cost recognised with respect to the unwinding of the decommissioning provision is not tax deductible. Also, companies are unable to claim capital allowances on the decommissioning provision capitalised as part of the fixed asset. The actual amount incurred is to be treated as tax deductible when the decommissioning activity finally happens.
Given the capital-intensive nature of oil and gas operations and the consequent requirement of funds to finance other investments, it becomes a business challenge for an oil company to leave idle its cash in a sinking fund, to support a decommissioning exercise that may be years away. The situation may even be complicated further at the point when the cost is finally incurred, as the company may have little or no revenue to offset against the decommissioning cost. In essence, the Nigerian government appears to be taxing decommissioning costs for companies operating in the Nigerian oil and gas industry, thus making the country potentially unattractive for future investments in its maturing oil and gas basin.
Decommissioning activities and operations is fast evolving into a thriving global industry, capable of breeding a new ecosystem of economically viable supply chain companies. Thus, the Nigerian Government ought to recognise the potentials inherent in decommissioning activities and should put in place decommissioning strategies to assist operating companies in optimising their decommissioning costs and reduce the risk of future default on decommissioning obligations. It is also incumbent on the industry and government to collaboratively work on innovations that can drive efficient and cost-effective decommissioning capabilities for the country. In this regard, government and industry may set up a 'Decommissioning Fund' similar to that established by Scottish Government, whose aim is to support cost reduction efforts on retrieval and disposal activities in order to improve the Scottish onshore and offshore decommissioning market. Furthermore, government must work out modalities for granting reasonable tax deductions on decommissioning provisions made by oil companies.
The Nigerian government may also adopt the United Kingdom approach of allowing companies to retrospectively apply the balance of decommissioning costs that could not be offset against current revenue, as a way of incentivizing investments into the country's oil and gas sector.
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