Oilfield Cost Overruns [PART 2]: How do operators protect from exposure to oilfield service company

Introduction

Part 1 of this series established that the non-operators (investors) cannot be protected from the good faith cost overruns of the operator and thus any protection against cost overruns must be clearly addressed by the operator in the well service contract. That is to say, liability must stay with the oilfield service company.

At this point, an important factor to note is Article 16.2 of the AIPN 2002 well services contract. This clause attributes the responsibility for the acts of subcontractors to the well service company (Referred to as “Contractor” within the contract) and ultimately, the operator will take responsibility for the contractors’ actions as far as the investor group is concerned.

This clause establishes a straight line of responsibility all the way from a subcontractor on the ground to the investor group. This section will cover some of the mechanisms the operator can use to protect itself (and by extension the investor group) from liability for cost overruns.

Mechanisms used by the operator to protect from liability from cost overruns

The first mechanism that the well services contract requires an all-inclusive charge or total cost charge that shall remain fixed for the term of the contract. This provision shifts the liability for costs outside of that fixed amount to the oilfield service company[1] and is the core protection for the operator.

However, it is important to note that the cause of a cost overrun is an essential factor. The contract provides that the operator will pay for cost overrun during a suspension of operations by the JOA members[2], cost increases as a result of legislative changes[3] or as a result of an approved change order by the operator[4]. In these instances the operator or JOA members are responsible or chiefly liable for the cost increase.

The second element in protecting the operator from cost overruns is insurance. The model contract provides for the procurement and maintenance of insurance at the expense of contractor (or the contractor and the company).

Although insurance for cost overruns directly are difficult to come by, if the cost increase in this case is as a result of e.g. the damage to an aircraft used in the operations or collision of a vessel used, then insurance taken out against those activities specifically will lighten any financial burden. Insurance is the responsibility of the oilfield services company.

However, simply acquiring insurance isn’t enough, the proceeds of that insurance must be pledged to the operator to protect it. Prior to the commencement of work, a waiver of subrogation can be obtained by the oilfield service company from their insurer, in favor of the operator[5].

Lastly, indemnification is a key mechanism for protection. A standard approach taken by parties is for the oilfield service company to indemnify the operator for any claims by any members of the contractor group[6].

Although there are a variety of considerations and specific items to indemnify for (e.g. cost overruns below/above a certain amount or third party claims) the overarching principal remains that each party will indemnify the other for activities it takes responsibility for.

What the parties agree to as far as indemnification is concerned will be addressed during contract negotiations. Suffice it to say that, this mechanisms protects the investor group from any claims for consequential losses or damages including but not limited to loss of earnings from the service company.

It is clear that there are mechanisms in place to keep liability for certain costs with the oilfield service company. Negotiation will reveal the extent to which the insurance and indemnification provisions can protect the operator but one thing is for sure: the operator is not automatically liable for any increases in cost that the oilfield service company encounters.

It is important to note that there is another side to this coin. The oilfield services company will also endeavor to protect its own financial interests. To see how oilfield service companies protect themselves you can read another article I wrote titled “How do Oilfield Service Companies protect themselves from financial risk: A look at the 2002 AIPN Model Well Service Contract”

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About the Author

Zach Kauraisa holds an LLM in International Oil and Gas Law and Policy from the Centre for Energy, Petroleum, Mineral Law and Policy. He is currently a Candidate Attorney at Koep & Partners in Windhoek Namibia. For inquiries, email: kauraisaz@gmail.com

Clauses of the AIPN Model Well Services Contract

[1] Schedule 3. Part 1 – basis for charges. Section 1.2.

[2] Article 6.2.4

[3] Article 11.2.5 Alternative 2 and Article 11.5

[4] Article 12

[5] Article 14.5

[6] Article 13