OT22002 - Interest and Financing

OTO Approach

In looking at any financing arrangements, and particularly where the lending/borrowing is not at arm's length, Oil Taxation Office will have regard to what would have happened under good banking practice. Over the years many agreements, painstakingly negotiated between oil groups and the banks, have been seen and the office has extensive experience about the background to, and course of, these negotiations. Equally the office is well informed on the packages which eventually emerge.

This Manual does not include extracts from papers and speeches at conferences etc which have been used from time to time to give some indication as to what a bank might, and might not, be prepared to consider. However, from the flow of information available on the subject Oil Taxation Office is conscious that bankers have not dropped their guard, and, particularly in view of oil price volatility, remain vigilant.

The possible need for comparisons is touched on again in the following pages but at this point several useful general comments can be made.

First, exploration activity has been, and continues to be an unacceptable risk. A bank will therefore not normally lend to finance exploration and companies have to carry on exploration and appraisal activities from their own resources. Some of the recent North Sea Study Occasional Papers issued by the Department of Economics, University of Aberdeen have continued to confirm that exploration etc remains high risk.

Second, experience shows that a bank is unlikely to focus exclusively on one set of figures or relationships etc to the exclusion of all other criteria. On the contrary, a bank will look at a range of factors and projections, and it will require a minimum level of satisfaction in all areas.

Third, many agreements negotiated with banks involve ongoing constraints, regular reporting and periodic review arrangements. OTO has to take an initial position on loans when they are first presented. But the Inspector should at least be aware of any ongoing requirements and exactly what they are, in case, in mirroring banking practice, tax positions also have to be reviewed.

The above should not be read as implying that the terms of all third party loan arrangements from a bank or a consortium of banks are necessarily and automatically acceptable if they satisfy any other relevant tests eg Section 494. Certainly much third party borrowing will be acceptable. But consider the position where a group negotiates a global facility. There might then be some elements in the UK/North Sea leg or legs of the package which would not be acceptable if the lenders had been dealing with the UK/North Sea in isolation ie the downside is compensated by non-UK/North Sea aspects. When looking at new arrangements Inspectors will wish to be clear whether they are part of a wider lending/borrowing agreement and whether there is a "back to back" element.