Walter Oil & Gas UK LLP v Waldorf CNS (II) Limited

EnQuest, as the Host Operator under the TPOSA bills itself, as Shippers Operator, for the totality of the charges that have to be paid by the Shippers (i.e., itself and Waldorf) under the TPOSA.

EnQuest separates out the 50% of the TPOSA charges for which Waldorf is liable in respect of the Scolty production and then invoices Waldorf for that part by including Waldorf’s 50% share of the relevant TPOSA charges in the monthly statements issued under the JOA.

Waldorf then pays that amount to EnQuest along with other JOA expenses in respect of the relevant month.

The costs of installing and commissioning a new pig launcher on the Kittiwake Platform (the “KUP Settlement Installation Costs”).

The costs of operating that pig launcher (the “KUP Settlement Operating Costs”).

for production services invoiced by EnQuest in its capacity as “Host Operator” of the Kittiwake Platform to EnQuest in its capacity as “Shippers Operator” within the meaning of and pursuant to the TPOSA. Such tariffs comprise a “Crude Oil Tariff” charged pursuant to Clause 6.2 of the TPOSA in the period up to December 2020, and “Costs Share Costs” charged pursuant to Clause 8 of the TPOSA since January 2021 (the “TPOSA Tariffs”); and

for transportation services charged pursuant to Clause 7 by EnQuest in its capacity as “Pipeline Operator”, to EnQuest in its capacity as “Scolty Crathes Operator” within the meaning of the SC KUPTA (the “SC KUPTA Tariffs”).

The first arises in relation to all the Disputed Costs charged pursuant to the TPOSA (excluding the ETS Tariffs), the SC KUPTA and the KUP Settlement. The issue is whether those costs are charged to Waldorf by “third parties which are not Affiliates of such party for such services” within the meaning of the Deed, such that they are Deductible Costs (the “Third Party Issue”).

The second issue of construction is whether the Send or Pay Charges are costs of “the processing, transportation, dehydration, compression, recycling or any other similar cost or expenses incurred in making RCO or RO as the case may be ready or available for market or transporting same to the point of sale” within the meaning of the Deed and therefore, Deductible Costs (the “Send or Pay Issue”).

The third issue of construction is whether the KUP Settlement Installation Costs are costs of “the processing, transportation, dehydration, compression, recycling or any other similar cost or expenses incurred in making RCO or RO as the case may be ready or available for market or transporting same to the point of sale” and therefore, Deductible Costs, or whether they are a capital cost of infrastructure for the production and transportation of petroleum from the Block and therefore not a Deductible Cost (the “KUP Settlement Issue”).

The final issue of construction is whether ETS Tariffs are within the definition of “Tax” in the Deed and if so, whether they are the kind of Tax which is a Deductible Cost (the “ETS Issue”).

Waldorf contends that the TPOSA Tariffs and the TPOSA Send or Pay Charges, together with sums incurred pursuant to the SC KUPTA and the KUP Settlement, are Deductible Costs because they are charged to it by EnQuest, and EnQuest is a third party which is not an Affiliate of Waldorf within the meaning of the Deed.

Walter disputes that these are Deductible Costs because they are charged by EnQuest in its capacity as operator of the Kittiwake Platform and the KUP, to itself as Operator of the Block and/or on behalf of EnQuest and Waldorf as the Grantors, who are jointly and severally liable for them. Walter contends that since EnQuest is one of the Grantors, these costs are not charged to the Grantors, the Agent or the Operator “by third parties who are not Affiliates of such party for such services”, and they are therefore not Deductible Costs.

The definition contemplates that the same legal persons may pay amounts which fall to be deducted in different capacities: the Grantors, “Agent (acting in its capacity as such)” who will be one of the Grantors under clause 2.1, and the Operator, who may well once again be one of the Grantors (and in the JOA which was entered into not long after the Deed, was confirmed to be CMNS (now EnQuest)).

It is necessary to look at the amounts paid by that relevant person in the relevant capacity, and ask what amount has been paid to third parties “who are not Affiliates of such party” – i.e. the paying party – for “such services” (i.e. those to which the payment relates). That party-by-party approach is reinforced by the definition of Affiliate, which similarly contemplates a party-by-party analysis (“‘Affiliate’ means in relation to a party, a subsidiary or holding company of that Party”).

Here the relevant payment has been made by Waldorf to EnQuest, who it accepted is not an affiliate of Waldorf.

Ms Campbell’s reliance on the boilerplate in clause 1.6 – “unless the context otherwise requires, references to the singular shall include the plural and vice versa” – does not assist. It is the compendious expression “such party” which is key here, “such” being a well-known interpretative prompt when placed in front of a noun to indicate that it is a particular person, time, place or thing in the qualified term which is being referred to, as indicated elsewhere in the clause.

The fact that the Shippers are jointly and severally liable to the Host Owners (and thus EnQuest and Waldorf for the other’s share qua Shipper of transportation and processing charges) does not change the outcome. The focus of the definition of “Deductible Costs” is on “actual amounts” “paid” and “charged” and which are “incurred in respect of RCO and/or RG”.

It is said that Walter might have no visibility as to any ownership interests in the Kittiwake Platform. However, there are inevitably aspects of “Deductible Costs” which may require some form of enquiry – for example the allocation of “amounts … not incurred in respect of RCO and/or RG specifically”. If these is a dispute, clause 6.4 provides for an expert determination process with an express obligation to provide information. Clause 3 of the Deed also contains an audit right.

Mr Davies KC’s construction distinguishes between amounts not paid on an arms-length basis, and of which the relevant Grantor or the group of which it forms part is a beneficiary, and payments made on an arms-length basis by one Grantor to the other for a service provided. That is a distinction which is readily understandable from a commercial perspective.

By contrast, Ms Campbell’s construction places far too much weight on the identity of the Host Operator from time-to-time. Ms Campbell did not shrink from the conclusion that if EnQuest was the Host Operator with only a 1% stake as Host Owner (or indeed none – there seems to be no requirement in the TPOSA that the Host Operator is a Host Owner), none of the costs charged to Waldorf could be deducted, but if Dana was the Host Operator, all the costs could be passed on even if EnQuest owned 99% or 100% of the Kittiwake Platform.

This is so even though the obligations arising on the “Host” side under the TPOSA are placed on the Host Owners and the Shippers, not the Host Operator and the Shippers’ Operator (Clauses 3.1, 6.1, 13.1, 13.2 and clauses 17.2 and 17.3), with the two Operators acting on behalf of the respective groups.

The definition of “Deductible Costs” and the operation of the Deed provide other protections for Walter, such that it is not necessary to give this part of the definition a wider reach to address that concern – costs deducted must be “as may be reasonably required to be paid” and the Agent will be paying the same charges for their own 48.5%. interest as for the Royalty Interest Petroleum.

Clause 2.1 contemplates that only one of the Grantors would be Agent for the sale of the entire 3% of Royalty Interest Petroleum. In that scenario, the Agent would have to carry all of the transportation costs under the TPOSA if the other Grantor was the operator for the Kittiwake Platform (thereby both subsidising the other Grantor’s share of Walter’s interest and making payments to that other Grantor from which it would benefit). It seems unlikely that the parties could have envisaged the agency operating in so unequal a way.

It was said that Waldorf’s construction involved inconsistency in the treatment of the Grantors because EnQuest could not deduct the amounts it paid qua Shipper. However, to the extent that this is the case, it is because EnQuest had made that payment to itself and derived profit from doing so, and Waldorf has not. The difference in treatment reflects the difference in circumstances.

An issue arises as to whether EnQuest’s role as Host Operator should prevent it passing on the TPOSA costs referable to Dana’s 50% interest in the Kittiwake Platform. Neither party showed any great enthusiasm for me deciding that point. It is possible to formulate a case that only the amount received by EnQuest qua Host Operator on behalf of EnQuest qua Host Owner should be excluded from deduction, not that received by EnQuest qua Host Operator on behalf of Dana qua Host Owner. But, whatever the answer to this question, it provides no justification for Waldorf being unable to deduct a payment it has made, none of which is payable to itself or an affiliate and from which it derives no profit.

It is said that, in effect, Waldorf is trying to pass onto Walter some element of EnQuest’s profit (qua Host Owner). However, I do not accept that the definition of “Deductible Costs” is to be interpreted by reference to the issue of whether the cost being passed on is one which involves a profit element for a non-affiliate of the payer. Even if that was the case, that goal would not be served by Ms Campbell’s construction, which would involve Waldorf being unable to deduct the payment even where EnQuest had made no profit because it was the Host Operator but not a Host Owner, yet being able to pass on the entire amount even if EnQuest had received the entire profit element where the invoice was rendered by Dana as Host Operator.

Finally Ms Campbell said the clause was intended to address those cases where the Agent could control the costs (in the sense, presumably, that the Agent could try and get a better deal or refuse to pay). However, the extent of any control by Waldorf as Shipper under the TPOSA of the price to be paid for transportation and processing services is limited, and no greater when the invoice is rendered by EnQuest than when it is rendered by Dana.

Pursuant to Clause 6.1 of the FPS TPA, the Shippers Group is to pay Ineos a Transportation Tariff payable per “Barrel” of “Shippers Production” delivered for transportation through the FPS.

Pursuant to Clause 6.4 of the FPS TPA however, the Shippers Group is obliged to pay for a minimum of 85% of the Firm Maximum Quantity or “FMQ” (being the maximum amount the Shippers were permitted to send pursuant to the FPS TPA in each Contract Year), whether or not it is actually sent such an amount through the FPS (the “Tariff Minimum Quantity”).

Pursuant to Clause 6.4(c) of the FPS TPA, the difference between the Tariff Minimum Quantity and the quantity actually delivered during any Contract Year is referred to as the “Tariff Shortfall Quantity”.

Pursuant to Clause 6.4(d) of the FPS TPA, a “Tariff Shortfall Payment” (referred to in this skeleton as the FPS Send or Pay Charge) is payable on the Tariff Shortfall Quantity, calculated by multiplying the tariff payable pursuant to Clause 6.1(a), by the Tariff Shortfall Quantity.

The concept of “Deductible Costs” involves a blunt and to some extent crude process of identifying what is paid “for” the identified matters. That is suggestive of a direct link between the charge and the service received, rather than embracing all costs incurred in achieving a desired end. To take and update Lord Hoffmann’s hypothetical “domestic example” in Charter Reinsurance Co Ltd v Fagan [1997] AC 313, 391-92, if a husband brings home new trousers, and his wife asks “what did you pay for them?”, the answer would not naturally embrace not simply the price of the trousers but the petrol consumed driving to the shops to purchase them, and the costs of parking.

That conclusion derives some support from the contemplation that the costs will be “incurred in respect of RCO and/or RG”, or at least there will be a proportion which can properly be said to be so incurred. The more diffuse the link between the costs and the transportation and processing of Royalty Interest Petroleum, the more complex the process of identifying which costs (or proportion of costs) are referable to the Royalty Interest Petroleum will be.

As Ms Campbell submitted, the Send or Pay Charges are not costs of the transportation of Royalty Interest Petroleum within the meaning of the Deed: they are costs incurred only to the extent that petroleum (including Royalty Interest Petroleum) is not transported through the FPS.

It is significant in this regard that the Deed contemplates that there may be costs born by the Grantors in relation to “the storing, handling, transporting, treating or marketing of production from the Block” which cannot be recovered from Walter, even in respect of the Royalty Interest Petroleum. Clause 4.1 of the Deed provides that “without prejudice to the right of the Grantors to deduct the Deductible Costs from the Gross Proceeds, Grantee shall not be or become liable or responsible in any way for … any liabilities incurred in or in connection with …. the storing, handling, transporting, treating or marketing of production from the Block.”

Clause 4.1 provides that the FMQ which the Shippers Group is entitled to tender for shipment is set out in Exhibit IV at the start of the FPS TPA, but with provision for subsequent adjustment.

By 30^th September in each year, the Shippers’ Group is to specify its bona fide best estimate of the FMQ for each Quarter of the following Contract Years for the expected duration, failing which the Exhibit IV rates apply.

The Shippers Group also have an entitlement, but not an obligation, to serve a notice specifying their best estimate of the FMQ for each Quarter over the remaining life of the agreement (save for the Quarter in which the notice is served and the next quarter), such notice to be served on the last working day in each quarter. There is scope for Ineos to object to such FMQ nominations.

Against that background, the liability to make “Send or Pay” payments (which arise when less than 85% of the FMQ is shipped) is effectively dependent on the accuracy of the FMQ submissions made by the Shippers Group and/or any revisions of them, having regard to all their requirements for the FPS (not simply those relating to the Block). If a charge which arose in these circumstances was one which could be passed onto Walter, a clearer communication of this intention in the Deed would be expected.

EnQuest as Pipeline Operator pursuant to the SC KUPTA was to invoice the Scolty Crathes Group for the KUP Settlement Installation Costs, and the Scolty Crathes Group was then required to make payment to EnQuest;

EnQuest as Pipeline Operator pursuant to the SC KUPTA was to invoice the Scolty Crathes Operator for the KUP Settlement Operational Costs, with the Scolty Crathes Group making payment to the Pipeline Operator.

First, they are paid in settlement of a claim in respect of losses suffered by the KUP owners and brought against Waldorf. The concept of “Deductible Costs” does not readily lend itself to amounts paid to settle Waldorf’s liabilities arising from the shipment of off-specification product. This appears to fall more naturally in the carve-out in clause 4 of the Deed by which Walter “shall not be or become liable or responsible in any way for … any liabilities incurred in or in connection with … the storing, handling, transporting, treating or marketing of production”.

Second, the KUP Settlement Installation Costs involve a capital contribution to the KUP. The working life of the equipment installed is not clear, but it has no necessary connection with the period of time over which Royalty Interest Petroleum would be transported through the KUP (and the use of the KUP is not limited to transporting the life of product from the Block, but extends to other blocks which may have different operational lives). Once again, the difficulties in allocating some element of those costs to the Royalty Interest Petroleum, and the fair allocation of those costs over the life of the KUP, weighs against the suggestion that they constitute Deductible Costs.

The EU emissions trading scheme (the “EU ETS”) was established in 2003 pursuant to Directive 2003/87/EC (the “Directive”). It operates on a “cap and trade” principle, by which a cap is set on the total amount of greenhouse gasses which can be emitted by persons subject to the scheme. Over time the cap on permissible emissions has been reduced, and the types of infrastructure affected by the EU ETS has expanded.

Pursuant to Article 4 of the Directive, operators of any installation affected by the EU ETS are required to hold a greenhouse gas emission permit requiring them to, amongst other things, surrender allowances equal to the total emissions of the installation, on an annual basis.

Allowances may be acquired on issue, either free of charge or for payment at auction pursuant to Article 10; or subsequently, by trading pursuant to Article 12.1.

Pursuant to Article 12.3 of the Directive, each September the operator of each installation is to surrender allowances equal to the total amount of emissions from that installation during the preceding calendar year. If they fail to do so, a penalty is imposed by the relevant Member State pursuant to Article 16.3, calculated by reference to the amount by which the emissions from the installation exceed the allowances surrendered.

The EU ETS was effective in the UK until 31 December 2020. From 1 January 2021 the UK emissions trading scheme (the “UK ETS”) was established by the Greenhouse Gas Emissions Trading Scheme Order 2020 (No. 1256 of 2020). The UK ETS is materially the same as the EU ETS, though allowances between the two schemes cannot be directly transposed or traded.

“imposed directly or indirectly in respect of the Royalty Interest and/or the Royalty Interest Petroleum and/or the Net Proceeds thereof, or the assets, income, dividends or profits of the Grantee (without regard to the manner of collection or assessment and whether by withholding or otherwise)”;

“by any governmental, semi governmental or other body authorised by law to impose such Tax”; and

“levied in respect of the production of all Royalty Interest Petroleum produced from the Blocks, the transportation of that Petroleum and the processing and initial storage of that Petroleum at any terminal”.

Walter submits that, to the extent that the ETS Tariffs comprise the costs of purchasing allowances from other operators, these are not “imposed by” any governmental or semi-governmental body: they are paid to private parties.

However, the EU / UK ETS requirement of “allowances” is, in my assessment, a “fee or other charge” imposed by a “governmental, semi-governmental or other body authorised by law”. The fact that such allowances can be purchased from other holders in a secondary market as well as acquired from the relevant authority does not, in my view, take them outside the words “imposes directly or indirectly” which are broad in scope.

I agree that there would be an unappealing element of happenstance if the question of whether the cost of the allowances constituted a Tax depended on whether they were acquired directly from a governmental body or indirectly through a purchase in the secondary market.

Walter submits that they are not, because they are imposed on the operators of infrastructure to which they apply, by reference to the level of emissions from the infrastructure which they operate, not imposed on particular amounts of petroleum produced, or on the proceeds of such petroleum.

Waldorf contends that “production from the Block could not take place without paying for the relevant emissions permits”, which has the effect that the “in respect of” test is met.

I accept that it can be said that the words “in respect of” allow for a wider nexus than the word “for” in the second limb of the definition of Deductible Costs. However, while the second limb contemplates the allocation of some smaller part of a greater whole to the Royalty Interest Petroleum (“if such amounts have not been incurred in respect of RCO and/or RG specifically, such proportion as the quantity of RCO or RG bears to the total quantity in respect of which such amounts have been incurred”), there are no such words in the first limb.

That omission, in my view, means that limb (a) of the Deductible Costs definition requires a tax which, in its operation, is more directly linked to the production or treatment of the Royalty Interest Petroleum than a tax on the operation of third party infrastructure through which it is transported.

I have concluded, therefore, that the sums paid by Waldorf under clause 6.6 of the TPOSA are not a relevant “Tax” for the purposes of the Deductible Costs provisions in the Deed.