UK regulatory regime governing Offshore Gas Storage

September 2008 Contents

Introduction 3 Current Regulatory Regime 4 The Petroleum Act 1998 4 Use of the Sea-Bed and associated Geological Features: The Crown Estate 4 Safety regulations 4 Environment 5 Other consents 5 Connecting to the Grid: physical requirements 5 Connecting to the Grid: the Uniform Network Code Gas Transporter Licence 5 Third party access (“TPA”) to offshore gas storage 6 Exemptions 6 UK offshore gas storage precedent: the Rough facility 6 Building a Third Party Access Exemption Case 7 ‘Open Season’ procedure 7 Future reforms 9 The Energy Bill 2008 9 Storage in non-hydrocarbon features 10 Issues for gas storage developers to consider 11 Introduction

This note provides an overview of the regulatory regime governing offshore gas storage in the UK. This note does not attempt to advise and should not be relied upon in relation to a particular course of action. CMS Cameron McKenna LLP would of course be delighted to so advise, upon instruction. This note contains copyright material and may not be reproduced or distributed without permission.

Whilst the Gas Act 1986, Town and Country Planning Act 1990 and other provisions have certain application for onshore gas storage facilities (depending on type), the UK government has acknowledged that the current regulatory framework for the offshore storage of natural gas is unclear and was not intended to cover the range of storage activities now contemplated. Whilst the Energy Act 2004 extended provisions to cover offshore storage facilities, to address the present lack of clarity the government is implementing a new regulatory regime under the Energy Bill 2008 designed specifically to cover offshore gas storage.

In summary, under the new regime, UK offshore gas storage (whether in depleted hydrocarbon fields or salt caverns etc) will generally require:

• a Crown Estate lease; and from the Department for Business Enterprise and Regulatory Reform (“DBERR”): • a Gas Unloading and Storage Licence (“GUSL”) • a Coast Protection Act consent.

In addition, certain Health and Safety Executive requirements will apply; and associated pipelines will be regulated by DBERR’s Pipeline Works Authorisation Unit. In addition:

• Third party access (and exemptions) will remain regulated by the Office of Gas and Electricity Markets (“Ofgem”).

UK regulatory regime governing offshore gas storage September 2008 3 Current regulatory regime

No single piece of legislation explicitly covers offshore gas and Safety Executive for the purposes of the Offshore storage activities and consents may be required at present Installations (Safety Case) Regulations 2005. In its role as the under some or all of a number of pieces of legislation statutory regulator of health and safety, the Health and Safety including: the Petroleum Act, the Food and Environment Executive (“HSE”) has wide-ranging powers of inspection, Protection Act 1985, the Coast Protection Act 1949; and the enforcement and ultimately prosecution under the Health and Transport and Works Act 1992. Significant provisions of these Safety at Work Act 1974. Certain other safety related and other regulations are discussed further below. provisions may also apply to a particular storage operation such as provisions relating to safety zones around installations, under the Petroleum Act. The Petroleum Act 1998 At present, the Petroleum Act 1998 applies to offshore gas These arrangements should not be substantively affected by storage in depleted fields, even if used solely for storage (as the government’s future proposals (see section 4 below), opposed to continuing production). although DBERR has stated that “some minor consequential adjustments may be needed to ensure full consistency with the Therefore the development of a depleted gas field into an offshore new regulatory framework.” gas storage facility is currently governed by the relevant existing Production Licence, together with certain provisions of the Gas Pipelines Act 1986 (as detailed later) where relevant. Pipelines running to and from gas storage facilities are regulated under the Pipelines Safety Regulations 1996, which It should be noted that gas storage in non-hydrocarbon features applies to onshore pipelines in Great Britain and to those in (such as salt caverns) is not generally regulated under the Petroleum territorial waters and the UK Continental Shelf. The pipeline Act1 although the Food and Environment Protection Act 1985 operator must ensure that the construction of a pipeline is in (“FEPA”) provides a short-term licence regime for placing objects accordance with Health and Safety Executive requirements. (such as well head platforms) in the sea environment. Environment Use of the Sea-Bed and associated Geological Features: The Crown Estate The development of an offshore gas storage facility will have to comply with those provisions of UK, EU and international Developers need to be granted exclusive rights to use the law that provide for the protection of the marine environment. geological features in question for gas storage; The Crown DBERR have stated that any future applications for offshore Estate can currently grant leases in an area of the seabed gas storage facilities under the new regime will be subject to a within 12 nautical miles of the UK’s territorial sea limit. It is similar degree of environmental scrutiny as exists at present. possible that rights could be asserted under the United Nations Environmental controls should be similar to those of FEPA, and Convention on the Law of the Sea 1982 in areas of the (post Marine Bill) the Marine Act, so that there is consistency continental shelf beyond the UK’s territorial waters, although of environmental protection across sectors. at present the position beyond the 12 mile limit is unclear. The currently applicable UK domestic legislation protecting the marine environment includes FEPA (which is, however, subject Safety regulations to a number of exemptions and exclusions in relation to oil Offshore2 and gas activities and installations); the Offshore Petroleum Offshore gas storage facilities are also subject to the Production and Pipelines (Assessment of Environmental Effects) requirements of the Health and Safety at Work Act 1974 and Regulations 1999; the Offshore Petroleum Activities (Conservation its subordinate regulations. In particular, no facility may of Habitats) Regulations 2001; the Offshore Combustion operate without a safety case which is accepted by the Health Installations (Prevention and Control of Pollution) Regulations 2001; and the Offshore Chemicals Regulations 2002.

1 Note later discussion of application of Petroleum Act/Gas Act to third party access. 2 For onshore safety regulations, a gas storage facility may require consent from the relevant Hazardous Substances Authority (usually the planning authority) under the Planning (Hazardous Substances) Act 1990 and the Planning (Hazardous Substances) Regulations 1992. Safety issues during construction and operation of the site are also regulated under the Borehole Sites and Operations Regulations 1995 and the Health and Safety at Work Act 1974, both of which are overseen and enforced by HSE.

4 UK regulatory regime governing offshore gas storage September 2008 Any developer of an offshore gas storage facility will also have provisions are in addition to or in substitution of Sections I and to act in compliance with two key pieces of international J, which govern entry and exit requirements respectively. For legislation: the Convention of 1972 on the prevention of the purposes of the UNC a “Storage Operator” is the person marine pollution by dumping of wastes and other matter and (or several persons jointly) operating a gas storage facility. the 1992 OSPAR Convention for the Protection of the Marine Environment of the North East Atlantic. A number of EU A Storage Operator must enter into a Storage Connection Directives will also be relevant. The purpose of this note, Agreement (which constitutes the Network Entry Agreement however, is not to set out in detail the rules covering the and Network Exit provisions) with the relevant pipeline operator environmental aspects of offshore gas storage, but rather to for the location at which the stored gas must enter the NTS. flag key issues and legislation for further consideration. This agreement details the conditions necessary for the gas to flow, and sets out the detailed commercial information agreed between the parties, based on Section R of the UNC. Other consents Depending on the nature of the gas storage facility, certain Gas Transporter Licence other consents may need to be obtained including under the Coast Protection Act 1949. Local planning authority consent Depending upon the gas storer’s level of involvement throughout may also be required, particularly if the facility requires the the storage value chain, and competition restrictions on development of any onshore infrastructure. integrated storage and transportation operators, the operator of an offshore gas storage facility may require a gas transporter licence under the Gas Act 1986. The obligation is imposed Connecting to the Grid: physical upon any persons conveying gas through pipes to any requirements premises, or to a pipeline system operated by a licensed gas operator (subject to certain exceptions and exemptions). Most gas held in storage will at some point need to flow into the National Grid’s National Transmission System (“NTS”), and therefore will be governed by the Uniform Network Code (“UNC”) (as detailed below).

Connecting to the Grid: the Uniform Network Code The UNC comprises a legal and contractual framework to supply and transport gas in Great Britain. It has a common set of rules for industry players which aim to ensure that competition can be facilitated on level terms. It governs processes such as the balancing of the gas system, network planning and the allocation of network capacity.

For the purposes of offshore gas storage, Section R of the UNC will apply, which sets out provisions as to the terms on which users of the system may off-take gas from the NTS for injection to gas storage facilities, and deliver gas withdrawn from storage facilities to the NTS. Section R also regulates the entry of stored gas with foreign origins on to the NTS. These

UK regulatory regime governing offshore gas storage September 2008 5 Third party access (“TPA”) to offshore gas storage

The Petroleum Act 19983 (which predominantly relates to • if all of the following requirements are met: offshore) and the Gas Act 1986 (which predominantly relates – the facility will promote security of supply; to onshore4) provide the current UK framework for third party – the level of risk is such that the investment to construct access to gas storage facilities.5 These implement the Gas the facility would not or would not have been made (Third Party Access) Regulations 2004, which, amongst other without the exemption; things, transpose into UK law the requirements of EU Directive – the facility is or is to be owned by a person other than 2003/55 Concerning Common Rules for the Internal Market in the gas transporter who operates or will operate the Gas, by requiring compliance with a negotiated TPA access pipeline system; regime and prohibit certain discrimination between storage – charges will be levied on users of the facility; users. Under these regulations the owner of a gas storage – the exemption will not be detrimental to competition, facility is obliged to offer capacity in the facility to third parties the operation of an economically efficient gas market or unless authorised not to do so under one of the relevant the efficient functioning of the pipeline system; and exemptions detailed below. There is also a voluntary “Code of – the Commission of the European Communities is, Practice on Access to Upstream Oil and Gas Infrastructure on or will be in the opinion of Ofgem, content with the UK Continental Shelf” published by the UK Offshore the exemption. Operators Association which offers guidance in relation to If Ofgem reaches a decision to grant an exemption, this must negotiating infrastructure TPA which although is stated not to be notified to the European Commission, which then has two apply to LNG importation terminals, is not so expressly months to request the decision’s amendment or withdrawal, disapplied in relation to offshore storage facilities.6 if appropriate. Exemptions Exemptions may be granted for an indefinite or fixed period, An exemption from the TPA requirements may be applied for but may be revoked at any time if circumstances occur that under either s.17C-E of the Petroleum Act 1998 or s.19A and give rise to the need to amend or revoke the exemption. As 7 B of the Gas Act 1986. As both statutes contain similar discussed later, where exemptions were granted under the exemption provisions and similarly define their application to gas Market Definition Limb: storage facilities generally, DBERR has confirmed in our ongoing discussions, the confusion as to which statute will apply, “in Ofgem’s view, there is a general trend to increasing particularly in relation to non-hydrocarbon storage facilities such as competition in the gas storage market. Ofgem considers that it offshore salt caverns. In either case, regulation is similar and initial would be unlikely that such an exemption would be revoked.”8 applications should be made to Ofgem who will either determine the appropriate statute to apply on a case by case basis, or in UK offshore gas storage precedent: the Rough facility complicated cases, will use powers provided under the Treaty of There is at present only one offshore depleted field gas storage Rome and relevant EU legislation to issue specific regulations. facility in the UK: Rough, off the east coast of Yorkshire, We understand that so far, regulatory authorities indicate the operated by Centrica Storage. Most existing (and planned) UK Petroleum Act will be applied to offshore salt caverns for example. gas storage facilities have received TPA exceptions (other than Hatfield Moor (Scottish Power) and Rough (Centrica Storage) A TPA exemption may be granted by Ofgem in relation to a newly which are both depleted fields. Importantly, Centrica Storage developed gas storage facility for either of the following reasons: did not apply for a TPA exemption for the Rough facility, instead accepting the conditions imposed upon it by Ofgem • firstly, on the basis that the use of the facility by other and the Competition Commission. As such, there has not been persons is not necessary for the operation of an an application published in the UK for an exemption from the economically efficient gas market (“Market Definition TPA requirements for an offshore gas storage facility. Limb”); or

3 Note: see s.17 Petroleum Act 1998. 4 See later discussion relating to application of Petroleum Act and Gas Act offshore in relation to third party access. 5 See also s10 Pipe-lines Act 1962 (c.58) re. third party access to pipelines (but note that this will soon be amended by the Energy Bill 2008) 6 The Code does not apply to access to NTS, interconnectors or LNG import terminals. 7 The Energy Act 2004 extended these provisions to cover offshore storage facilities 8 As per Ofgem’s letter in relation to the effect of the Second EU Gas Directive on storage regulation dated 25 November 2004.

6 UK regulatory regime governing offshore gas storage September 2008 Upon the acquisition by Centrica from Dynergy of the two Building a Third Party Access Exemption Case companies that owned and operated the Rough facility and its The regulatory and commercial landscape has changed since associated assets, the Competition Commission recommended Rough with the application of the Second EU Gas Directive certain statutory undertakings regarding Centrica’s behaviour and the Secretary of State for Trade and Industry’s recent as owner of Rough in order to safeguard an economically conclusion of “the clear national need for new gas storage efficient and competitive gas market. The most important of infrastructure”, together with the Energy Bill 2008. these required Centrica to: Recent TPA exemptions have been granted in relation to the • sell Rough’s full capacity on non-discriminatory terms, Market Definition Limb (referred to at 3.3 above). Whilst Ofgem retaining the existing Storage Services Contract (“SSC”); has intentionally not set specific levels in relation to market share, • auction all capacity remaining unsold no less than 30 days pricing or otherwise in order to enable flexibility as the before the start of each storage year, with no reserve price competitiveness of the industry evolves, recent TPA exemptions by • not participate in the primary sale process but reserve no Ofgem were given to (onshore) facilities which generally held less more than 20 per cent of Rough’s existing nominal capacity than 20%9 of the relevant market share, both in terms of size of for itself in the first year (2004/05) falling to 15 per cent capacity and deliverability/flexibility over short, medium10 or over five years and remaining at that level thereafter: this is longer term periods.11 Any major storage development should to give Centrica an incentive to invest in expanding Rough’s additionally consider how to counter the potentially discriminatory capacity, in that Centrica would be able to retain effect that granting a TPA exemption could have against incremental capacity for its own use Centrica’s Rough facility, and equally the commercial implication • maintain legal, financial and physical separation between its of Rough potentially being able to apply for TPA exemption/ storage business and all other parts of the group; ensure amendment of its existing undertakings, in a more competitive that no commercially sensitive information arising from the environment. Projects capable of incremental development (such operation of Rough is passed to other parts of Centrica; as linked salt-caverns) may also consider when to apply for and make any disclosure of information relating to the exemptions in relation to the entirety of a project. storage operations to all market participants simultaneously • facilitate the efficient operation and development of the However, whilst size is clearly an important factor, it may act in secondary market in Rough capacity a project’s favour in terms of generally lower deliverability12, • offer at least 20 per cent of Rough’s capacity on annual which appeared to be a major factor in, for example, the contracts; capacity should also be offered on a range of other exemption granted by Ofgem on 25 October 2007 to SSE durations and with the possibility of fixed or indexed pricing Hornsea Ltd under s19B of the Gas Act 1986, relating to the • arrange for an independent review of compliance with all Aldborough salt cavern gas storage facility. Ofgem concluded undertakings by Centrica’s Audit Committee, with annual that the relevant product market for this facility is the flexibility reports to the Office of Fair Trading and the Office of Gas market (given 4,550 Gwh of space with deliverability of 421 and Electricity Markets. GWh/day, as split between joint venture partners) and Both the Competition Commission and Ofgem considered at geographic market is Great Britain and which noted: the time that divestment of the assets was a possible remedy if “Ofgem has calculated the market share…based on its expected Centrica was not prepared to give the full set of undertakings future capacity [for three years]…The measure that we have that the Commission recommended. The market definition used in this instance is deliverability. This appears to be the most applied by the Competition Commission in the case of Rough, appropriate measure for comparing …with other sources of gas has continued to be used by Ofgem. in the market definition. Total available space and injectability are also important…however they are not directly comparable with other sources of gas within the flexible market definition such as IUK imports and Beach Flex…”

9 According to a review of recent published Ofgem decisions. 10 Ofgem stated (in decision dated 5 July 2005 re: Caythorpe Gas Storage Limited) that Humbly Grove, Welton, Aldbrough and Byley and Caythorpe are regarded as medium term storage facilities. 11 Ofgem has stated (in decision dated 5 July 2005 Re. Caythorpe Gas Storage Limited) that a short duration facility is where total storage duration is less than ten days; medium is ten or more days but less than 30 days; and long is where the total storage duration is equal or greater than 30 days. 12 Although incrementally operated facilities like linked salt-caverns may be able to operate at large scale and high deliverability.

UK regulatory regime governing offshore gas storage September 2008 7 The Aldborough decision also noted that significant new gas ‘Open Season’ procedure import capacities are changing the competitive landscape, Increasingly, regulatory authorities are suggesting that developers namely the Langeled pipeline and BBL Dutch-UK interconnector. of large-scale gas network infrastructure initiate an ‘open season’ Although fixed or indefinite exemptions may be granted, TPA procedure for the initial stages of the infrastructure development. exemptions are generally granted for an indefinite period (with Indeed Ofgem has alluded to the relevance of whether capacity a right to re-open). Public consultations responses requesting will be marketed on an ‘open season’ basis and/or whether Ofgem to impose fixed terms or times to reconsider a decision effective secondary trading and anti-hoarding mechanisms will to grant a TPA exemption have been requested by Ofgem. We be in place (i.e. use it or lose it (UIOLI) arrangements). are not aware of any recent exemptions being revoked, but The open season stems from Article 5 of EC Regulation we do note Ofgem correspondence encouraging enforcement 1775/2005 on conditions for access to the natural gas of conditions that were imposed when exemptions were transmission networks, and is essentially a European granted, but which were not yet implemented. Ofgem has Commission-created process designed to assess market demand previously stated its reluctance to revoke exemptions granted for the infrastructure and the capacity involved, and attempts to under the Market Definition Limb. tender and allocate that capacity on a “transparent and non- The Aldbrough decision also refers to Ofgem’s 2005 decision discriminatory basis”. An open season process is currently on the proposed treatment under s.19A of the Gas Act 1986 overseen by the European Regulators’ Group for Electricity and of gas storage facilities with split ownership and noted: Gas (“ERGEG”), with implementation up to national regulatory authorities. It should be noted that the open season is not “It is appropriate to accept exemption applications from more technically a legal requirement (it is not mentioned in Regulation than one owner provided that effective operation separation 1775/2005) but a series of guidelines and working groups exist is achieved”, on the area. Furthermore there is no set way of conducting an open season; it is often undertaken by the developer with input implying there may be benefit in bringing in joint venture from the regulatory authorities. partners in terms of diluting the effect of size / deliverability with regard to market share analysis. What this means in practice for the developer of a gas storage facility is that capacity is essentially marketed and booked in the Ofgem’s decision of 5 July 2005 in relation to the Byley salt early development stages, in the context of an ongoing dialogue cavern gas storage facility again considered maximum flexibility between the developer, the market, the national regulatory in relation to the market definition, in addition to total storage authorities and, to a lesser extent, the European authorities (the space, but also took into account the deliverability duration (7 Commission and ERGEG). The entire open season procedures days) in the content of the owner’s storage portfolio. Ofgem generally take between seven months and one year. also stated in its decision that it is appropriate to consider the whole flexibility market, not just traditional gas storage. From our discussions with ERGEG it is clear that an open season is an increasingly common precursor to gaining a TPA In addition, Ofgem stated in their 25 November 2004 exemption (though it does not guarantee that an exemption publication on the application of the Second EU Gas Directive, will be awarded). A typical example would be that the that any gas storage TPA exemption application should generally developer agrees with the regulatory authorities that 50% of include an appropriate competition analysis. Although Ofgem capacity will be booked via an open season, and the remaining does not detail what constitutes an appropriate analysis, it does 50% may be granted a TPA exemption, although models are refer to a previous consultation by way of example. considered on a case by case basis.

An analysis of European and UK competition restrictions should be conducted for new developments but is not substantively considered in this note.

8 UK regulatory regime governing offshore gas storage September 2008 Future reforms

As noted above, the current legislative regime was not The proposed regulatory regime designed for the range of offshore gas supply infrastructure The Energy Bill 2008 sets out the overarching structure of the that the market is seeking to develop, and does not refer proposed regime. We are in regular contact with explicitly to these activities. Therefore the Government is representatives from DBERR and are currently liaising in introducing new legislation for a simpler consents procedure, relation to the development of the specific, practical involving three determining authorities: framework that will underlie this structure. The following is a • The Crown Estate, who would issue the geographically summary of some of the key proposals so far: bound lease for the use of the seabed Relationship between the GUSL and The Crown • DBERR, who would issue a Gas Unloading and Storage Estate Lease Licence (“GUSL”) for offshore gas storage, and a Coast Protection Act consent A lease from The Crown Estate will be geographically bound • HSE, who would ensure health and safety on gas storage and will allow intrusive exploration within the licensed areas. developments, as with existing oil and gas developments. A condition of the lease will be for the lessee to apply for a GUSL from DBERR; this should be awarded without recourse In addition, Ofgem will continue to regulate third party access. to any competitive requirements, provided the lessee fulfils DBERR’s technical and environmental criteria.

The Energy Bill 2008 Whilst it is understood that it is intended to match the The Government is implementing these proposals in the duration and geographical extent of a GUSL with that if its Energy Bill 2008, which is currently at the committee stage in corresponding lease, there is no guarantee that any grant of a the House of Lords. lease by The Crown Estate would automatically result in DBERR issuing a corresponding GUSL, even if criteria are The Energy Bill, once enacted, should enable the Crown to purportedly met. DBERR is able to withhold a GUSL if it has claim sovereign rights for the storage of gas within its good reasons for doing so (for example, environmental reasons). exclusive economic zone13, thereby extending its ability to grant leases from the existing 12 nautical mile limit of the UK’s Terms and conditions of the GUSL territorial waters, to a maximum of 188 nautical miles within The proposed terms and conditions of the GUSL include: the UK’s continental shelf. This is to be known as a “gas importation and storage zone”. • an obligation to retain the gas within defined geographical boundaries The Energy Bill, once enacted, should also implement the • an obligation for the operator to protect the marine GUSL, and makes it a criminal offence (among other activities) environment from pollution, and to undertake licensed to store gas or convert a natural feature into a place for gas activities in a way that does not interfere with other uses of storage without a licence, or to fail to comply with certain the seabed (e.g. consult with and maintain communications terms of the licence. with fishing interests, provide Ministry of Defence with notice of installation movements and seismic surveys and As part of simplifying the consenting processes for offshore gas maintain and install underwater beacons to Ministry of storage and Liquefied Natural Gas unloading projects, the Defence specifications) Energy Bill disapplies the requirement on developers to • an obligation to report to DBERR any incidental discovery of separately apply for a licence under the Food and Environment hydrocarbons when drilling without a Petroleum Production Protection Act 1985 (c.48) to inject gas into the seabed, except Licence (“PPL”) where functions under that Act are exercised by the devolved • an obligation to submit a Gas Development Plan to DBERR administrations in Scotland, Wales or Northern Ireland. on the location, design and capacity of the facility.

13 Under Part V of UNCLOS, states can claim rights within an area, known as the exclusive economic zone, which forms part of the area of the continental shelf and extends from the edge of the 12 nautical miles limit of the territorial sea for a further distance of 188 nautical miles. Within this area, the coastal state can claim exclusive sovereign rights over all natural resources, including storage space under the seabed. Under Chapter 1 of the Energy Bill the UK will claim rights relating to the unloading and storage of gas.

UK regulatory regime governing offshore gas storage September 2008 9 The licence conditions appear very similar to those found in a probable that DBERR will set out specific thresholds on their Seaward Production Licence; this is understood to be a website. If the amount of hydrocarbons is below the threshold deliberate policy which allows the dovetailing of the two then the application process would be similar to that described licences, and also replicates a process that is already well- in 4.11 above (i.e. a Lease from The Crown Estate is applied known to the industry. for, then a GUSL).

Storage in hydrocarbon features: PPL Holders Storage in non-hydrocarbon features Current holders of PPLs who wish to undertake offshore gas A potential developer wishing to use a non-hydrocarbon field storage activities in hydrocarbon features in the area within their (e.g. a salt cavern) for offshore gas storage will only need to Licence would simultaneously approach DBERR’s Licensing and apply for a lease from The Crown Estate and a GUSL, both as Exploration Development Branch and The Crown Estate. If The described above. If the lease and subsequent GUSL are awarded Crown Estate awards a lease then a GUSL should subsequently the developer must submit a Gas Storage Development Plan be sought from DBERR. If a GUSL is awarded, then the PPL will for approval of the facility. be extended to cover the active storage life of the facility (which will also be the same length as the Lease and GUSL). Decommissioning Part IV of the Petroleum Act 1998 (following minor amendment The next step would be to submit a Gas Storage Development by the Energy Act 2004) will be applicable to gas storage Plan for approval of the facility itself, together with a revised Field facilities. However we intend to remain in ongoing discussions Development Plan (these can be submitted as one document). with DBERR regarding how exactly the new regime will deal with issues around continued/postponed decommissioning Storage in hydrocarbon features: Non-PPL Holders requirements under existing production licences. In addition, Any potential developer hoping to use a hydrocarbon (i.e. DBERR issued a consultation paper on 30 June 2008 on the depleted field) feature for offshore gas storage that is not detail of the UK’s proposed regulatory framework for Carbon currently covered by a PPL will generally need to apply for a Capture and Storage. Perhaps the most significant outstanding Licence and a GUSL in one of DBERR’s oil and gas licensing issue is that developers are unlikely to accept liability for rounds. Certain initial exploratory works (e.g. with no drilling storage site leakage in perpetuity. deeper than 350 metres) are permitted under Exploration licences. The work programme submitted to DBERR as part of Costs and Taxes the exploration period will include a commitment to obtain a A fee will be payable to The Crown Estate, as well as certain Crown Estate lease within four years from the start of the application fees; DBERR is currently working on the pricing and Licence. The geographical extent of the GUSL will be the same methodology of these fees. At present the government has as the Petroleum Licence until The Crown Estate awards a made no statements regarding the tax treatment of gas stored lease; following this the GUSL will relate to the geographical offshore under the new regime. It is, however, understood parameters of the lease. The usual technical and environmental that the position is being reviewed and that the government is checks would still have to be run on the operator under the actively considering options to incentivise potential developers. Licence if drilling activities are envisioned. Therefore one of the main differences to the process for a PPL holder is that the Third Party Access lease is applied for after a GUSL is awarded. It should be noted that the proposed regulatory regime does not at present significantly impact on the TPA requirements Note that if the amount of hydrocarbons present in the enforced by Ofgem, and as discussed above in section 3. geological feature in question is such that the Secretary of State is satisfied that “the amount of petroleum which exists in its natural condition in the relevant stratum is so small that it ought to be disregarded”, a PPL will not be required. It is

10 UK regulatory regime governing offshore gas storage September 2008 Issues for gas storage developers to consider

Tax • How long will capacity contracts be? This note does not address tax issues. In addition to income, the • Are any strategic partners anticipated beyond remaining tax treatment of the project’s capital and operating expenditure field partner(s)? (including cushion gas) may be crucial to increased profitability. • Do field partners wish to be involved/invest? If not, are We have for example recently worked on European storage they aligned as to COP? facilities where finance and taxation authorities were • What are the tax and regulatory assumptions? approached for indications on interpretation or rulings as to Has production tax been levied on cushion gas? treatment of cushion gas for example which included: • What strategy for third party access exemptions, tax and other incentives has it developed? • arguments for storing state-owned gas as strategic reserves • Where will the cushion gas be coming from (domestic in the facility and providing cushion gas as a side-effect or foreign sources) and what is the duration of supply (rather than buying cushion gas commercially) contract if any? • not levying production tax on domestically sourced cushion gas • Will single or multiple entities own/lease cushion gas, from another field on the basis of moving gas from one field to operate storage and market capacity? another without producing for consumption (with commercial • Will any depleted field be left with non-produced reserves arrangement for transfer of benefit of such tax relief) as cushion gas? • treatment of cost of cushion gas (and other capex / opex) • Has it considered commercial models that later enable as deductible from income tax (and intra-group offsetting). working volumes to replace some cushion gas? Analogous discussions with tax authorities in relation to capex Although the Energy Bill is well advanced, its interpretation by and other deductions against income and other taxes may also regulators in the context of previous non-binding precedents be crucial to economic viability. makes continued informal contact with the regulators advisable. We remain in regular contact with relevant Commercial Considerations regulators and would be happy to keep developers informed of interpretative and other developments, including in relation We believe there are a range of commercial structures to to relevant statutory instruments as they are implemented. consider from those where the relatively high risk of long term cushion gas supply is aligned with relatively high capacity If you would like any further information or have any queries marketing returns, to those with lower risk and return tolling please contact: type arrangements, in each case with different financing options. Bob Palmer Gas storage developers may also consider the following: DDi +44 (0)207 367 3656 M +44 (0)7831 248 814 • What is its commercial model and risk/return profile? E [email protected] • Will entire capacity be developed at the same time or incrementally? Humphrey Douglas • What is the targeted storage capacity market/seasonal DDi +44 (0)207 367 3054 cycle rate? M +44 (0)7881 511 489 • Is it targeting the UK market only or intending to build E [email protected] contractual nexus and price arbitrage options to European customers? • Does it wish to trade/retain storage capacity and if so what percentage? If you would like to subscribe for our award-winning • How many capacity customers are envisaged? Energy and other legal update service, please subscribe to • Will capacity be marketed on an “open season” basis? www.law-now.com

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