News

Acquiring downstream petroleum assets – the business of buying risk

16.10.2014

The Australian petroleum industry is going through a period of significant change. Small volume refineries – inefficient in world terms – have closed down. Demand for fuel in Australia shows no signs of abating, and our reliance on imported fuel has grown. There is a strong business appetite for securing volume and exploiting economies of scale in the distribution and sale of petrol products.

Investment in downstream petroleum assets has become a more attractive prospect, with the Australian Competition and Consumer Commission recently stating that the wholesale sector has become the most profitable in the Australian downstream petroleum industry[1]. It is no surprise then to see the increase in merger and acquisition activity presently underway, by operators and wholesalers, large and small[2].

The successful acquisition and operation of downstream petroleum assets turns on minimising risk and maximising reward. Buying a petroleum depot, or storage facility, or a group of petrol stations or diesel stops is accompanied by the general kinds of risks that most businesspeople are familiar with, as well as a host of risks that are specific to the type of asset concerned.

These specific risks include environmental and land contamination liability. In this Focus on Energy and Resources, Ann Jovanovic and Christopher Hewitt look at the risks and liabilities inherent in acquiring a downstream petroleum asset in Australia, and how they can be identified and managed.

Sellers want to walk away cleanly… especially if the site is dirty

In any land or business purchase it is essential that the purchaser knows and understands the features and risks of the asset. There is nothing inherently wrong with acquiring land or assets that have associated risks and liabilities, and precious few assets have no potential risk or liability. “Taking risks” can be a way to make more money. However, the risks and liabilities first need to be identified and understood so that the prudent purchaser can make an objective assessment of the value of the asset. This is particularly germane to purchasers of downstream petroleum assets because of the industry practice of transferring existing risk and liability with the land and assets.

Most contracts for the sale of a downstream petroleum asset are on an “as is, where is” basis, meaning that the land is being sold in its present condition with any historical environmental liabilities and contamination issues attached. In practice this means that the purchaser is accepting liability for all environmental and contamination liabilities, even if the liabilities arose prior to the transfer of the land or asset. This is why we talk about “buying risk”. Indeed, the face price of the asset will often be reduced to take account of the historical environmental and contamination risk that is being transferred to the purchaser. The onus is on the purchaser to make an accurate assessment of the condition of the asset and its associated environmental and contamination risks. After the land or asset is transferred, the vendor will walk off into the sunset and the purchaser will be left holding the land and all the attached liability.

This makes proper due diligence critically important to the purchase of any downstream petroleum asset. In our view, a standard and superficial “box ticking” exercise is a poor due diligence process that wastes both time and money without giving real comfort to a purchaser. An astute and targeted due diligence process will identify real risks and liabilities, and will create commercial negotiating opportunities for a well-advised purchaser. The due diligence process should establish the foundation for the negotiation of risk allocation and mitigation between the parties. It should be conducted before the prospective purchaser of the petroleum asset finalises contractual negotiations (especially on price, as “discoveries” definitely impact on value). However, if this is not possible then due diligence must be provided for in the letter of offer or heads of agreement, and the purchaser must allow themselves a right to walk away from any contract if due diligence is unsatisfactory and the seller is unwilling to adjust its commercial position.

Due diligence is often used as a general term to describe all manner of technical, operational, environmental, legal, accounting, financial and taxation investigations. While all of these enquiries have a legitimate role, for purchasers of downstream petroleum assets it is the environmental and contamination investigations that must be a priority.

Why should you be concerned about the state of your property?

A prospective purchaser of petroleum assets in Australia must navigate a network of environmental legislation and regulations. Australia’s environmental and contamination laws are coordinated at the State and Territory level, and there are significant differences in the obligations and liabilities imposed by those laws. Some jurisdictions are highly prescriptive in relation to how parties manage environmental and contamination risks associated with downstream petroleum assets. Other jurisdictions give parties more discretion to allocate the risks themselves.

For example, in New South Wales the new Protection of the Environment Operations (Underground Petroleum Storage Systems) Regulation 2014 specifically deals with underground petroleum storage systems, including how to manage environmental contamination associated with such systems. A prospective purchaser of potentially contaminated land in NSW must liaise with multiple State Government agencies – the Office of Environment and Heritage, the Department of Planning and Environment, planning consent authorities, and the NSW Environment Protection Authority (“EPA NSW”). These enquiries will include detailed searches of several public registers maintained by EPA NSW, including the Protection of the Environment Operations Act 1997 (NSW) public register, the Contaminated Land Public Record, and the Dangerous Goods Register.

In Queensland the primary environmental regulator is the Department of Environment and Heritage Protection, which has two public registers that deal with contaminated land – the Environmental Management Register (“EMR”) and the Contaminated Land Register (“CLR”). By searching the EMR and the CLR, a prospective purchaser can identify whether land has been subjected to reported contamination or used for a “notifiable activity” – an activity that has the potential to cause land contamination as identified in the Environmental Protection Act 1994 (Qld). Almost inevitably, a downstream petroleum activity will come within the scope of one of these two categories.

A registration of land on the EMR is not as drastic as a CLR registration. EMR registration usually indicates contamination with a lower risk to humans, animals and the environment. Relevantly, an EMR listing does not necessarily mean the site needs to be cleaned up, rehabilitated or that the current land use must stop. But what if the site is on the CLR? A listing on the CLR means that scientific investigations have confirmed that the land is contaminated and that the level of contamination is causing or may cause serious environmental harm. The practical (and commercial) impact of this is that there are likely to be restrictions on the management and use of the land. A listing on the CLR is a red flag to a prospective purchaser. A prudent purchaser should obtain the detailed site investigation report and investigate whether there is a remediation notice or site management plan in place. These documents will provide critical information about permitted land uses, the conditions applying to use or development of the land, the management of environmental harm, and any remediation requirements.

In Queensland, a seller must give prior written notice to the purchaser of any EMR or CLR listing of the land concerned. The notice must provide details of any site management plan. This requirement overrides any contractual term to the contrary. The contaminated land provisions under the EPA are currently being reviewed by the Queensland Government in an effort to streamline development requirements on contaminated land sites. We anticipate changes in the near future that may affect those who want to undertake construction or development activities on contaminated land.

Each State and Territory imposes liability – including financial penalties – on those who mismanage contaminated land. For example, in Queensland, it is an offence for any person to willfully contravene a site management plan, which attracts a maximum penalty of $189,560.25 or two years imprisonment. This means the perpetrator in Queensland would be directly liable. In some other jurisdictions, such as Western Australia, responsibility to manage or remediate contaminated land can be transferred under the contract, subject to regulatory approval[3].

Next – the negotiation table

By the time parties are ready to negotiate the contract terms and conditions, the purchaser should be aware of the risks and liabilities that are attached to the downstream petroleum land or asset. Alternatively, if a contract of sorts is already on foot, the purchaser must ensure that it is appropriately “conditional”, with a pathway for the purchaser to exit the transaction if the due diligence reveals unanticipated risk and liability.

Contract negotiations are about allocating risks and liabilities. As with any negotiation, a purchaser should be prepared to compromise. But there are limits – some risks are just too onerous, and not even price adjustments will create an acceptable balance. Good due diligence gives better opportunities to negotiate more favourable terms. A seller (especially a major seller) of a downstream petroleum asset will push hard to dispose of all environmental and contamination risk and liability, so that the seller can walk away with a clean slate when the transaction is complete. This could expose a purchaser of the petroleum asset to more than what they bargained for if there are inadequate protections, and disclosure obligations, in the contract. On the positive side for the purchaser, the seller’s desire to walk away is often stronger than its desire to maintain an unrealistic price.

It should be remembered that searches of government registries will only identify contamination and environmental problems that have been reported or discovered. If a prospective purchaser of the petroleum asset suspects there is contamination on the property, it would be wise to conduct a private environmental audit to allay (or confirm) those suspicions. In any case, well considered and drafted seller disclosure obligations are essential to protect a purchaser and minimise risk.

There are a number of risk reduction mechanisms that a prudent purchaser should consider:

  • guarantees, disclosures and warranties from the seller
  • division of liability under the contract – who is responsible for what after the sale
  • indemnities, which will include issues relating to consequential loss, environmental liability, land contamination and others[4]
  • breach, termination and compensation provisions if a seller fails to provide sufficient disclosure of risks.

Commercially-focused drafting of these provisions will help to minimise the risk exposure for the purchaser of a downstream petroleum asset. The positive flow-on effects – such as improved insurability and fundability of the land and assets, and shared remediation costs – can be the difference between project success and failure.

For more information, please contact Christopher Hewitt or Ann Jovanovic on +61 7 3367 6900 or christopher.hewitt@moulislegal.com or ann.jovanovic@moulislegal.com

This memo presents an overview and commentary of the subject matter. It is not provided in the context of a solicitor-client relationship and no duty of care is assumed or accepted. It does not constitute legal advice.

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[1] ACCC, Monitoring of the Australian Petroleum Industry (December 2013) p185
[2] Ibid
[3] Section 30 Contaminated Sites Act 2003 (WA) – a written agreement to transfer liability for remediation of a site also requires written approval by the CEO of the Western Australia Department of Environment and Conservation.
[4] In some jurisdictions (such as in Western Australia) parties can contract out of contamination liability. In other jurisdictions (such as New South Wales) this is prohibited.