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Is the UK Government an ‘old fossil’ in protecting the downstream oil market?23 September 2021

The Downstream Oil Resilience Draft Bill 2021 – introduction and implications

Background

The Downstream Oil Resilience Draft Bill 2021 (the “Bill”) was presented to the UK Parliament in June 2021. This followed a consultation by the Department for Business, Energy and Industrial Strategy (BEIS) on fuel resilience measures which was conducted in 2017¹. A keen reader will note that in the past four years a number of defining events have taken place, including Brexit and the Covid-19 pandemic, which have profoundly changed the UK’s energy landscape and sharply increased the emphasis on energy transition and decarbonisation. One may question therefore whether the consultation undertaken during 2020/2021 would have led to the same outcome and, conversely, whether the outcome of that consultation should be taken as a blueprint for legislative changes today.

The downstream oil sector in the UK comprises over 200 companies involved in the refining, importing, storage, distribution/transportation and marketing of petroleum products, such as petrol, diesel, and aviation and heating fuels. The explanatory section of the Bill sets out that this sector continues to play a key role in UK energy security, supplying products that are vital to the UK’s economy and way of life, as well as providing employment to a significant part of the population. It also states that oil-based fuels are currently the UK’s main source of energy for transport (96%) and supplied over 44% of its final energy demand in 2019.

"Although the Bill anticipates a transition to a decarbonised economy to reduce demand for oil-based fuels, hard to electrify sectors like aviation, road freight, marine and heavy industries are expected to retain a significant need for oil fuels. "

Although the Bill anticipates a transition to a decarbonised economy to reduce demand for oil-based fuels, hard to electrify sectors like aviation, road freight, marine and heavy industries are expected to retain a significant need for oil fuels.

According to the outcome of the consultation, the UK market for petroleum products is a mature one facing both changing patterns of demand and high levels of global competition. This has apparently created:

  • fragmenting supply chains with major oil companies, which used to run vertically integrated well-to-pump operations, divesting themselves of categories of assets or outsourcing some operations; and
  • relatively high utilisation rates and closures of spare or uneconomic capacity. For example, currently there are six UK oil refineries, down from a high of 19 in 1975, and the number of filling stations has declined from around 18,000 sites in 1990 to 8,400 now.

The consultation also found that, despite these developments, the sector seems to be managed efficiently, flexibly and effectively in ensuring continuity of fuel supply but accidents, severe weather, malicious threats, industrial action and financial failure present significant supply chain disruption risks. The effects of Brexit and Covid-19 represent additional uncertainties.

The need for regulation

There is currently no central authority or regulatory body that oversees the UK mid/downstream oil sector and the Government’s powers to monitor market security, supply risks, support industry to improve supply resilience and protect it against risks of disruption are only available for use during an emergency or crisis situation.²

The consultation also revealed that there was little co-ordination between individual suppliers’ efforts to ensure their own resilience and no mechanism to share burden across the sector or with Government.

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"The consultation also revealed that there was little co-ordination between individual suppliers’ efforts to ensure their own resilience and no mechanism to share burden across the sector or with Government. "

However, the resulting issues are considered to be more of a regional than national nature and short-term rather than mid/long-term as UK supply chains are very dynamic and can adjust to disruption.

The new powers

In response to the consultation, the industry called for a light-touch approach to measures. The Bill is, therefore, stated to be designed to provide Government with tools to address these vulnerabilities in the downstream fuel supply sector by introducing preventative, in preference to remedial, measures whilst at the same time minimising the impact on market dynamics and competitiveness.

The Bill, as currently drafted, gives the Secretary of State for BEIS a number of powers to achieve these goals:

1. Directions

Under Part 2 of the Bill, the Secretary of State may direct an industry participant (by individual written directions or by passing delegated legislation) to take certain measures to improve resilience and keep critical infrastructure running.

Example measures include acquiring and installing specific equipment or carrying out specific work at the industry participant’s own expense or imposing a time limit or a requirement for some action that must be complied with at specific intervals. Directions may also include requests to refrain from certain actions.

Directions may only be imposed by notice and following suitable market consultation and must be limited in time.

This power may be exercised in relation to persons conducting downstream oil activities with a capacity in excess of 500,000 tonnes or owning downstream oil facilities with capacity in excess of 20,000 tonnes, per calendar year.

2. Information

Part 2 of the Bill also gives the Secretary of State the power to request information from downstream oil sector players in relation to their activities to allow potential disruptors to be identified early and crises managed effectively.

The duty to supply information extends to information about incidents that pose a significant risk (referred to by section 10 of the Bill as ‘notifiable incidents’) of, and circumstances that may create, supply disruptions.

The general duty to supply information upon the Secretary of State’s request exists in relation to persons conducting downstream oil activities, or owning downstream oil facilities, with a capacity in excess of 1,000 tonnes; the duty to report notifiable incidents applies to activities and facilities with capacity in excess of 500,000 tonnes.

3. Restriction on acquisitions/control test:

Part 3 of the Bill introduces a new power for the Secretary of State to require persons acquiring important levels of control in significant infrastructure in the downstream oil sector (referred to by section 16 of the Bill as ‘qualifying acquisitions’) to seek the Government’s prior written consent. This new power allows the Secretary of State to refuse or restrict such an acquisition unless it passes the ‘Ownership/Control Test’, that is, the relevant acquiror is found to be sufficiently financially stable and operationally and technically fit for the task. Under section 22(3), in reaching its decision, the Secretary of State may also consider the desirability of securing continuity of supply of crude oil-based fuel and the likely influence that the applicant will have on the relevant business.

A ‘qualifying acquisition’ may be one of three types, that is, an acquisition of (i) an interest (whether legal or beneficial) or (ii) shares or rights, in a ‘qualifying asset’ that causes the value of the interest held by the acquiror to be more than 25% of the value of that asset or (iii) shares or rights that result in the acquiror holding – directly or indirectly – more than 25% of the voting rights in the ‘critical asset-owning company’.

A company falls within this provision if the value of any interest it directly or indirectly holds in the ‘qualifying asset’ exceeds 25% of the total value of that asset. An asset is a ‘qualifying asset’ if it is located in the UK and in the calendar year prior to the acquisition was used to store, handle, transport by road, convey by pipe or refine or otherwise process crude oil of more than 500,000 tonnes. Operations in relation to crude oil that has not yet entered a refinery or terminal in the UK, including upstream operations, are excluded.

4. Financial assistance

Part 5 of the Bill grants the Secretary of State a power to provide financial assistance in any form and on such terms (including financial threshold and terms of repayment, with or without interest) that the Secretary of State considers appropriate to ensure the downstream oil sector’s resilience and continuity of fuel supply.

Contravention of requirements

The failure to comply with the relevant directions, requests or restrictions made or imposed by the Secretary of State or the provision of false or misleading information constitutes an offence which on summary conviction carries a prison sentence of up to twelve months or a fine or both.

CONCLUSIONS

We consider this Bill to be noteworthy for several reasons:

"Now that Brexit has given the UK Government the ability to implement such powers, some may question whether it wants to be seen to be actively legislating to protect UK interests in relation to the mid/downstream oil market by introducing regulatory powers and particularly by providing financial support to that market."

  • Traditionally, the mid/downstream oil market in the UK has not been regulated due to previous analyses concluding that the market was sufficiently competitive – this Bill indicates a change of direction;
  • The Bill is designed to protect the mid/downstream oil market³ against the background of an increasing number of companies that have decided to divert their attention away from that market and embrace the UK Government’s (other and apparently conflicting) stated goal of energy transition⁴ based on its legal obligation to achieve carbon neutrality by 2050⁵, by diversifying and often considering an outright sale or at least a reduction in their exposure to oil-related businesses. It seems that the UK Government is now concerned that energy transition, which is already taking effect, may actually cause a reduction in domestic oil product supply sources, which may be exacerbated by supply source limitations connected with Brexit;
  • Interestingly, although the powers under Part 3 of the Bill to restrict acquisitions in qualifying assets mainly relate to a requirement of the financial and technical capacity of any potential acquiror having to be sufficiently robust, in deciding the response to a consent application the Secretary of State may also consider ‘the desirability of securing continuity of supply of crude oil-based fuel and the likely influence that the applicant will have on the relevant business’. The latter follows an increasing theme of the Government seeking to protect control of national critical infrastructure against foreign investment and is in line with the recently adopted National Security and Investment Act 2021 (see here for more on this);
  • Another interesting feature of the Bill is the Government’s power to protect the mid/downstream oil market by providing financial assistance to ensure the sector’s resilience and continuity of fuel supply. Such financial support would likely have been caught by EU State Aid rules which were of course abolished in the UK in the wake of Brexit. This type of financial support may eventually have to comply with the new UK subsidies regime that is being adopted (the Subsidy Control Bill 2021) and is based on the UK’s commitments under the UK-EU Trade and Cooperation Agreement; and
  • Once Parliamentary approval has been granted, including any changes which may be made, the Bill will come into force on a date the Secretary of State will set by regulation. Of course, even when passed into law, these powers may never (need to) be exercised and it remains unclear if the UK Government considers these powers likely to be used. Alternatively, now that Brexit has given the UK Government the ability to implement such powers, some may question whether it wants to be seen to be actively legislating to protect UK interests – here in relation to the mid/downstream oil market – by introducing regulatory powers and particularly by providing financial support to that market. This could be seen as the UK Government sending a mixed message between, on the one hand, its focus on decarbonising the entire oil & gas value chain to support the UK’s 2050 carbon neutrality obligations and its latest resolve to reduce the reliance on fossil fuels to lower the country’s exposure to volatile fossil fuel prices⁶ and, on the other hand, this latest proposal to give subsidies to the oil-based (i.e. fossil) fuel market. It is also unclear how these subsidies would sit within a comprehensive strategy on the replacement of fossil fuels with hydrogen and other green fuels (see here for more information on the UK’s hydrogen strategy), and what message such financial support would send, particularly at the eve of COP26.

[1] Department for Business, Energy & Industrial Strategy. Downstream Oil Supply Resilience: Proposals to strengthen the resilience of fuel supply to UK consumers. October 2017
https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/652539/Downstream_oil_consultation_document.pdf
Please also see the full government consultation page at https://www.gov.uk/government/consultations/downstream-oil-supply-resilience
[2] Such powers include those set out in the Energy Act 1976, Offshore Safety Act 1992, Civil Contingencies Act 2004, Enterprise Act 2002.
[3] See Downstream Oil Resilience Bill, Legislative Scrutiny. 12 July 2021 available at: https://committees.parliament.uk/work/1323/downstream-oil-resilience-bill/
[4] See Policy paper COP26 Energy Transition Council – Summary Statement. 7 December 2020, available at: https://www.gov.uk/government/publications/cop26-energy-transition-council-summary-statement
[5] By virtue of section 1 of the Climate Change Act 2008, as amended in 2019. available at: https://www.legislation.gov.uk/en/ukpga/2008/27/section/1
[6] See UK Business Secretary Kwarteng plans more gas crisis meetings. 19 September 2021, available at: https://www.spglobal.com/platts/en/market-insights/latest-news/electric-power/091921-uk-business-secretary-kwarteng-plans-more-gas-crisis-meetings

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