Operating in the crosshairs

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Operating in the crosshairsJune 2015

2 MINTER ELLISON RUDD WATTS – OPERATING IN THE CROSSHAIRS

PAGE

How are you feeling? 3

Is New Zealand’s offshore off-limits? 4

Health and safety in New Zealand is under the microscope 5

What’s the fracking problem? 6

Thermal fuel: Using the tools in the new toolbox 8

NZ – Pohokura Offtake – appeal confirms High Court judgment 9

Minter Ellison Rudd Watts 10

For more information about Minter Ellison Rudd Watts please visit www.minterellison.co.nz

© Minter Ellison Rudd Watts June 2015

Contents

3 – MINTER ELLISON RUDD WATTSOPERATING IN THE CROSSHAIRS

Two years ago, the impending drilling seasons over the summers of 2013/14 and 2014/15 were seen as a great opportunity for New Zealand to give the exploration sector a real boost from significant activity and from expected success.

Offshore, success has only taken the form of additions to proved and probable reserves within existing mining permits; while onshore what were hoped to be low cost operations have been adversely affected by lower oil prices.

New Zealand’s attractiveness in the context of worldwide exploration opportunities has been adversely affected by these factors as reduced returns have not yet been matched by reduced exploration costs. Yet New Zealand’s exploration terms are seen as relatively attractive and the New Zealand government continues to strongly support and promote exploration. Whether wider public support for the industry is waning or not is both a question and a challenge for the industry. The industry is in the spotlight – or, as we see it – “in the crosshairs”.

The articles in this publication address some of the factors which are worrying to those undertaking exploration or production in New Zealand. As lawyers, we can’t solve the technical issues that explorers face, but we continue to have confidence in the ability of companies to obtain the required licences and approvals to carry out exploration activities in New Zealand effectively, safely and (hopefully) successfully.

How are you feeling?

The bold hopes for the New Zealand exploration sector over the last two years, if not dashed, have been dampened – by lack of new discoveries and, for some, by a belief that the operating environment is getting harder.


Following the failure of Trans-Tasman Resources and Chatham Rock Phosphate to obtain required consents, questions have been raised about the ability of future offshore projects to be consented and whether New Zealand’s updated environmental legislation strikes the right balance between environmental protection and economic development.

Do the recent decisions by the Environmental Protection Authority (EPA) really indicate that new oil, mineral and gas activities in New Zealand’s offshore waters are off-limits? We think not. Our view is that novel projects in new locations will always have challenges. While all offshore projects will have some degree of uniqueness, the two mineral mining projects had particular characteristics that won’t apply to all projects.

Projects will always need compelling experts who are confident that there is adequate data to rely on to make a decision. The recent decisions reinforce that; partly as a general principle and also partly because the legislation raises the question specifically.

Demonstrating adequate information is easier when there is an activity that is similar, which has been established, and where there is scientific information available about how the

ocean and marine ecology operates in the area. In this way

new activities could expand incrementally from locations with

known or analogous data. Where there are new areas with little

or no known scientific information, environmental studies will

need to be started at a date earlier than when most project

leaders feel comfortable. Being late with data gathering may

result in uncertainty about the environmental data, debate

about whether the data available is adequate (with differing

expectations about what is reasonable information to gather)

and an inclination of the EPA to decline applications for those

reasons.

It is also essential to have a strong convincing explanation

about the controls that can be put in place to robustly avoid,

remedy or mitigate the potential adverse effects of the activity.

This is particularly the case where the adverse effects on the

environment and existing interests will be significant.

While addressing concerns about adequacy of information and

controls can involve additional expenditure, projects that focus

on these areas are more likely to obtain the consents needed to

operate offshore.

Is New Zealand’s offshore off-limits?

Oil companies are starting their engagement with the EPA in circumstances which are hopefully less controversial than those raised by the two declined applications. OMV received marine consent for its 2014 development drilling programme and STOS has recently appeared before an EPA appointed Decision-Making Committee for the hearing of its application for a 35 year marine consent for its operations in the Māui field.

The failure of two high profile projects offshore to get the necessary environmental consents has shocked and confused investors in offshore developments.


Health and safety in New Zealand is under the microscope

Establishing that you have taken all practicable steps to ensure the health and safety of your employees is in focus. High risk industries must act now.

In the wake of the Pike River tragedy, there has been an unprecedented focus on how to keep workers in this country healthier and safer. With a new regulator in our midst – WorkSafe NZ – and new legislation to be enacted this year, the ante has been significantly increased.

Getting health and safety right is now more important than ever. WorkSafe NZ’s annual report for 2013-2014 reveals there were over 11,000 health and safety assessments, coupled with over 1120 health and safety investigations. Another 57 investigations focussed on energy safety. There also were 117 prosecutions at a success rate of 82%.

Not only are these numbers sobering but new law slated for enactment later this year will provide an even broader platform for investigations and prosecutions. For the first time in the health and safety space, directors and officers will be required to exercise due diligence and must be able to establish that they have done so. Around board tables and in senior management meetings across the country, this reform is getting close scrutiny.

Health and safety leadership will no longer be an option but an absolute requirement. Figuring out exactly how they will meet this new duty is a key question for directors and officers to ask themselves before the new law arrives and the prospect of prosecution grows.

The stakes are particularly high in sectors like the energy industry. Subject to scrutiny by the High Hazards Unit of WorkSafe NZ, the industry is a focal point of regulatory interest. New regulatory regimes are being implemented and the Unit itself has grown in staffing size. This is coupled with WorkSafe NZ’s plan to have more than 200 inspectors by next year. With occupational health now also receiving more attention, the scope of investigations should also be expected to grow.

Simple reacting to health and safety incidents is becoming past behaviour. Anticipating issues and pro-actively managing them is the way of the future. The stakes are getting too high not to approach the issues in this way.


What’s the fracking problem?The onshore oil and gas industry in New Zealand is expanding.

An increasing number of wells are being drilled in Taranaki

and the amount of gas and oil extracted in the region is rising.

Exploration for oil and gas has also spread into the East Coast

Basin. This expansion is connected with the productivity that

hydraulic fracturing (‘fracking’) yields, and the Government’s

push to develop the industry.

The purpose of fracking is to extract previously inaccessible oil

and gas from the earth’s crust. It involves the injection of fluid

containing sand and chemicals at high pressure to fracture

rock. As fracking technology has developed in New Zealand

and overseas, concerns about its environmental impacts have

emerged. The practice is generally not publicly popular. In some

countries, including France, Bulgaria and some parts of Australia

and the United States, the practice has been banned.

The regulation of onshore fracking in New Zealand is currently

determined by local authorities, with the potential for diverse

approaches – sometimes driven by local interests rather than

science.

New Zealand is attempting to create a sensible and nationwide approach to fracking.

In New Zealand the Parliamentary Commissioner for the Environment (PCE) has released two reports centred around public concern about the increasing use of fracking. Generally the PCE’s reports are not alarmist about the use of the technique. What she found was that “fracking is safe if it is properly regulated and managed” and that less concern was needed about the activity itself than the ability for regulators to systematically respond to the increased use of the technique.

The PCE gave six key recommendations to the Government to reduce concerns about fracking and improve regulation of the industry. These included developing a national policy statement to give clear direction to regional and district councils on how to deal with the activity in policy statements and plans, requiring New Zealand Petroleum and Minerals to assess the adequacy of public liability insurance cover held by operators, and amending health and safety regulations to require inclusion of environmental protection in the assessment of well design by the High Hazards Unit.

The regulation of onshore fracking in New Zealand is currently determined by local authorities, with the potential for diverse approaches – sometimes driven by local interests rather than science.


While the PCE’s recommendations are not legally binding, they

can be particularly influential on central and local government

and can signal future changes to environmental regulation. For

instance, the National-led Government is proposing reforms

to our environmental legislation which are consistent with a

number of the PCE’s recommendations, including more specific

direction about how environmental matters could be addressed

consistently across the country.

In preparation for the potential centralisation of fracking

regulation, the oil and gas industry may wish to prepare a ‘think

piece’ to form a basis for any future Government consideration

on national standards about fracking. Then, if centralisation

of environmental decision-making does arrive, the industry

can address any industry issues in the same way as was done

for cellular sites with the National Environmental Standard for

Telecommunications Facilities.

Oil and gas operators should be aware of ‘anti-fracking’ litigation overseas

As the public debate continues and the legislative framework

for fracking evolves further, New Zealand oil and gas operators

should be aware that the heightened interest in fracking may

come with an increased risk of litigation.

Overseas examples show that ‘anti-fracking’ groups as well as individuals are willing to use a wide range of legal avenues to attempt to stop fracking operations. The types of claims are broad: constitutional law, health and safety, personal injury, human rights and indigenous rights claims have all been seen in anti-fracking disputes. These tend to reflect the nature of the legal systems in each country.

Local fracking bans in the United States have led to a series of lawsuits seeking to overturn state decisions on the basis that any ban is unconstitutional and pre-empted by state law. There have also been a number of claims to environmental authorities concerning allegations of environmental or health effects. Perhaps unsurprisingly, there are examples of damages being awarded to persons claiming that onshore fracking programmes have adversely affected their health.

In Australia and Canada, activist groups have been threatening to bring claims for land access and compensation and breaches of indigenous rights in so far as the activity affected the claimants’ ability to access sacred sites and practice their culture.

The Canadian courts have also been grappling with health and safety litigation relating to fracking, including a claim in Alberta against the provincial Environment Ministry for allegedly failing to properly investigate water contamination.

While these types of claims would likely play out very differently in the context of New Zealand’s legal regime, the “noise” created by them could be seen as useful by those seeking to frustrate any approval process, or the earlier establishment of local policies and requirements.


Fuel contracts immediately following the Maui redetermination were pretty inflexible and ‘swing’ was limited to water and the coal stockpile. Talk of the impending ‘gas cliff’ that we saw 10 years ago drove an increased focus on upstream exploration and even importing LNG was considered. Long-term ‘take or pay’ gas contracts were seen by some as desirable, but could cause gas buyers not insignificant financial pain where the contracted quantity was not taken. And then the tables seemed to slowly turn as we didn’t fall off the cliff – what was the future demand and supply for gas? It was those uncertain times that seemed to drive large fuel users, particularly the large electricity generators, to look at the tools in their tool box.

The addition of large producing fields, including Kupe and Pohokura, the change in generation mix (and owners of that

mix), and some innovative and strategic thinking have all led to

more tools in the toolbox. The successful commissioning and

use of gas storage for Contact and the success of Methanex

and its resulting desire for gas are also two factors that seem

to have enabled greater flexibility in the gas market. These

factors have all contributed to a greater range of gas contracts

in the market with respect to term, volume and flexibility of

supply.

The wholesale gas market is more flexible and diverse than it

was 10 years ago. We will watch with interest the impact of the

gas spot market and proposed market-based MPOC pipeline

balancing regime on an increasingly flexible and liquid market.

The past decade has seen a major shift in the use and predicted supply of thermal fuel. Predicting long term thermal fuel use and supply, in relation to gas in particular, has been the subject of much debate over this period with companies taking quite different strategic approaches to their fuel books.

Thermal fuel: Using the tools in the new toolbox


Todd Pohokura Limited (Todd) brought the case against Shell

Exploration NZ Limited (SENZL) and OMV New Zealand Ltd (OMV). The case concerns the interests of each of them in offtake from the

Pohokura gas field.

The case had at its heart challenges by Todd to the validity of

offtake rules, nominations protocols and annual work programmes

and budgets. These were implemented by the joint venture’s

Operating Committee on the majority votes of SENZL and OMV

over opposition from Todd.

Todd advanced a number of claims, the central claims being:

That the ‘Offtake Regime’ was passed invalidly and in breach of the

Pohokura Joint Venture Operating Agreement (JVOA).

• Todd claimed that, absent unanimous agreement on gas

balancing arrangements, Todd’s entitlement under the JVOA

was to a share of ‘total production available’, as determined by

maximum technical production capacity at the field.

• SENZL and OMV argued that it is within the Operator’s remit

under the JVOA to set an annual rate of production that is less

than maximum technical capacity, and to implement rules to

address how the parties are to take and dispose of their shares

of what is actually produced. They argued that it would make

no sense, in a situation where gas balancing arrangements have

not been agreed, for the JVOA to require that the field produce

at maximum technical capacity every day. They argued that

the entitlement of each of them under the JVOA is to their

NZ – Pohokura Offtake – appeal confirms High Court judgment

The judgment will be important in establishing the entitlements of joint venture gas producers operating pursuant to a JVOA, but where no gas balancing arrangements are in place.

Judgment of the Court of Appeal has been released in an important case concerning the entitlements of joint venture gas producers operating, without agreed gas balancing arrangements, under a joint venture operating agreement.

equity interest share of actual production, and that Todd’s entitlement to that was not affected in any way.

• Todd also argued that the Offtake Regime breached the Commerce Act 1986. Todd alleged that SENZL and OMV had colluded to restrict the amount of gas produced from the field in a way that was anti-competitive and harmful to Todd.

• SENZL and OMV argued that Todd was not prevented unconditionally from taking gas in excess of its entitlement to a share of production – but in order for Todd to do so there needed to be gas balancing arrangements in place. They argued that the ‘Offtake Regime’ was not anti-competitive in either its purpose or effect, that it facilitated production by prescribing mechanisms necessary to govern offtake that were not in the JVOA, and that the ‘Offtake Regime’ had not prevented Todd from selling more gas.

The case went to trial in the High Court in 2010. In July 2010, the High Court ruled in SENZL and OMV’s favour on all causes of action and dismissed Todd’s multi-million dollar damages claim. Todd appealed the High Court judgment.

The appeal was heard in September 2014. The Court of Appeal judgment dismissing the appeal was released recently.

The most interesting aspect, for this audience, of the Court of Appeal’s reasoning is its strident confirmation of the High Court’s approach to the interpretation of the JVOA and the parties’ entitlements to a share of “total production”.

The Court of Appeal confirmed that the natural and ordinary meaning of the words of the provision in the JVOA governing the right and the obligation to take in kind, is that they refer to petroleum that has been produced from the field and is available to be distributed to the individual parties.

The Court dismissed Todd’s argument - that the words refer to what is available to be produced from the field if the facilities are run at their maximum capacity - on a number of grounds, essentially find that this argument was inconsistent with the wider contractual framework, and the role and place of the Operating Committee as the supervisor of joint operations (of which production is obviously a key one).

On the Commerce Act argument, the Court also found for SENZL and OMV, finding:

• Todd’s argument that there was a contractual obligation that required the plant to be operated at maximum capacity has already been rejected. Once that point is reached, it is plain that some mechanism was necessary to govern the basis on which parties took gas which is jointly owned until it passes into individual ownership. That is the role of the offtake documents, and there is a fundamental difficulty in the way of describing them as anti-competitive. They are the necessary machinery by which gas is produced from the Pohokura field, and is then conveyed to the parties for sale into the market. On this basis, the Operating Committee’s decisions about annual production levels are decisions that enable or facilitate production, rather than limit it.


For more information about Minter Ellison Rudd Watts please visit www.minterellison.co.nz

© Minter Ellison Rudd Watts June 2015

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Operating in the crosshairs