Walter Oil & Gas UK LLP v Waldorf CNS (II) Limited

Whether a cost is deductible under an overriding royalty deed depends on the language of the deed, rather than a broad characterisation of the transaction. Costs charged to a payer by a non-affiliated third party may qualify even where the same entity is involved in the wider operating arrangements in another capacity. A deductible service cost ordinarily requires a direct link between the charge and the processing or transportation of royalty petroleum. Send-or-pay liabilities and capital contributions to infrastructure lacked that link. Emissions-related charges were not deductible as Tax under the deed, but were deductible as processing costs where directly calculated by reference to the volume processed.

The claimants and defendant disputed the proper construction of a 2005 deed granting a 3% overriding royalty interest in petroleum produced from a North Sea block. The parties brought cross-applications for summary judgment under CPR 24.3, accepting that the construction issues could finally be determined on the applications.

The disputes concerned whether charges under transportation and processing agreements, send-or-pay liabilities, costs under a settlement concerning pipeline infrastructure, and emissions trading charges fell within the deed’s definition of Deductible Costs.

1. Third Party Issue. The relevant question was whether the amount was paid by the relevant person, in the relevant capacity, to a third party that was not its affiliate for the services in question. The deed contemplated that the same legal person could act in different capacities. Waldorf’s payments to EnQuest therefore satisfied the third-party requirement, notwithstanding EnQuest’s other roles and the parties’ joint and several liabilities. The TPOSA Tariffs and SC KUPTA Tariffs were deductible.
2. Send-or-Pay Issue. The phrase requiring costs to be paid “for” processing or transportation indicated a direct link between the charge and the service received. Send-or-pay charges arose because a minimum quantity was not transported, and depended on estimates of the group’s wider requirements. They were not costs of transporting Royalty Interest Petroleum and were not deductible.
3. KUP Settlement Issue. Installation costs paid to settle liabilities concerning off-specification product were capital contributions to pipeline infrastructure. They had no necessary connection with the period or quantity of Royalty Interest Petroleum transported and were not deductible. Operational costs were accepted to be service costs; the third-party objection failed for the reasons given on the Third Party Issue.
4. ETS Issue. Emissions allowances constituted a fee or other charge imposed by a body authorised by law, even where acquired through a secondary market. However, the tariffs were not a relevant Tax under limb (a), because that limb required a more direct connection with the production or treatment of Royalty Interest Petroleum. They were nevertheless deductible under limb (b): the charges were calculated by reference to the volume of crude processed and were sufficiently directly referable to the processing service.
5. The parties were directed to draw up an order reflecting the four construction conclusions.