American Oil and Gas Reporter - November 2015 - 68

SpecialReport: Finance & Logistics
timate win-win. As infrastructure owner,
ArcLight clearly would benefit from additional volumes and revenues. In exchange, the parties agreed that LLOG and
its partners in the producer group would
receive certain capacity rights during the
early years of production and fee credits
associated with new tiebacks, reducing the
all-in cost of their anchor production and
also enhancing the economics of new regional development that they would have
the right to bring to Delta House.
Since this was not the typical model for
deepwater hosts, the parties recognized the
distinct advantages of creating a truly independent, common carrier-oriented facility, particularly in the active subregion of
the Mississippi Canyon where Delta
House is located.
Perhaps most importantly, these principles engendered mutual trust and strong
communication between the parties, without which the novel, complex, multiparty commercial structure for Delta House
could not have become a reality.
The Solutions
The three primary phases of the project-construction, operations, and abandonment-each presented unique challenges in
a context where no creditworthy entity
could provide sufficient guarantees to
the system. Instead, as an essential element
of the Delta House transaction, the oil and
gas reserves were used as "collateral" to
support the producers' various obligations.
Of course, such an approach is not without its challenges-notably, the quantity and
economics of reserves often are unique to
the eye of the beholder.
As a result, in addition to detailed reserve analysis by ArcLight working in
close coordination with LLOG, the creative design and use of ancillary structures
was required in order to make the transaction work. Consequently, the transaction
included several key features.
The parties formed project companies to own the FPS and the pipelines, as
well as all associated contracts. The financing arrangement required that the producer group invest a minimum amount of equity in the project companies. This investment would align incentives between
ArcLight and the producer group, and also
serve as an additional source of collateral should the producers fail to fulfill certain performance obligations. LLOG was
designated the project manager during the
construction and installation of the facilities, and on achieving first commercial

68 THE AMERICAN OIL & GAS REPORTER

production it became their operator. This
allowed LLOG to retain management
control, within agreed-on limits, over
project design, execution and operation,
while ensuring that LLOG-and, through
the joint operating agreements, the producer group-retained certain key regulatory
and leasehold obligations.
Second, to construct the facilities, the
parties agreed on a project completion
budget for the FPS and the pipelines that
excluded the subsea production infrastructure, which would remain the producer group's sole responsibility. This budget included significant contingencies. ArcLight committed to fund all the budgeted
facility completion costs, less the amount
corresponding to the percentage of the project companies retained by the producers.
Pursuant to the production handling
agreements, the FPS and pipeline fees
would be ratcheted down in a manner proportionate to the amount by which the actual costs were less than budgeted. Conversely, if the actual costs were to exceed
budget, the producers would be obligated
to fund those overruns.
In order to secure this funding obligation, the producers agreed to forfeit both
their investments in the facility project
companies as well as their working interests in the reserves, should they not provide the required overrun funding. This
represented a significant and valuable
commitment on the part of the producers
to ensure that any potential overruns
were fully financed. As a result, ArcLight was able to eliminate key risks in
infrastructure financing; namely, project
completion and capital cost overruns.
The producer group, meanwhile, receives
the full benefit of cost savings relative to
budget, while also retaining significant
control over project execution with LLOG
as project manager.
Concomitant with the infrastructure
financing, the producer group also contractually agreed to execute development
plans associated with the wells and subsea
facilities that would anchor the Delta
House project. While a significant amount
of development work had been performed
prior to closing the ArcLight transaction,
the development plans outlined concrete,
ongoing milestones and timelines to ensure
the reserves dedicated to the FPS would be
fully developed and ready to produce by
the time the facilities were commissioned.
Given the reserve-based nature of the
tariff structure, this was a critical element
of the financing arrangement. Similar to

the capital cost overrun arrangement, to secure these performance obligations, each
producer agreed to forfeit its working interests if it failed to timely fund the development plan. This prospect of forfeiture,
together with the previously sunk upstream
investment and the successful results
from the appraisal drilling, gave ArcLight sufficient comfort that producers
would honor their commitments to develop and produce the anchor reserves.

Allocating Risk, Reward
In addition, the production handling and
transportation agreements contained a
number of key provisions that carefully allocated risk and reward among the parties.
The producer group agreed to retain principal responsibility for all facility operating costs, insurance requirements, major
work and repair costs, and the funding of
abandonment reserves.
This cost allocation was important
because it enabled the parties to focus the
tariff negotiations more squarely on aligning investment return with reserve realization and production. The FPS and the
pipelines utilized different tariff structures.
With significantly higher capital costs and
more operational complexity, the FPS warranted more attention by the parties, and
its commercial arrangements employed
some more nontraditional features.
For example, while the pipelines incorporated a fixed fee as part of the tariff
structure, the fees for throughput on the
FPS were wholly variable. The FPS tariffs included four tiers, whereby fees
would decline on the realization of certain
benchmarks tied to cumulative production
from the anchor fields and the aggregate
amount of net revenue earned by the infrastructure owners.
The first tier was set at a very high level (compared with traditional processing
fees) to ensure that ArcLight quickly recovered its capital and derisked its investment
even in cases where reserve performance
dramatically underperformed expectations. The final tier was set at a level that
would represent one of the most favorable
host facilities rates in the deepwater Gulf.
This was an essential trade-off for the
producers; if the reserves were as large as
they believed them to be, they would benefit from highly attractive long-term production economics. In addition, they
would be able to use this advantaged pricing for certain other new developments that
they had the right to bring to Delta House.
Importantly, net revenues from third-par-

American Oil and Gas Reporter - November 2015

Table of Contents for the Digital Edition of American Oil and Gas Reporter - November 2015