The Energy: Oil and Gas guide provides expert legal commentary on the key issues for businesses involved in the oil & gas sector. The guide covers the important developments in the most significant jurisdictions.
Last Updated: August 09, 2019
Oil and Gas Market Developments
The past year has been a challenging one for the oil and gas industry. Although oil prices have in general been at acceptable levels, after steadily increasing during most of 2018, they plummeted at the end of 2018 and have shown substantial volatility since then, with major geopolitical events (including the collapse of production in Venezuela and Libya, sanctions on Iran, and rising tensions in the Persian Gulf) battling with global economic news (trade wars and economic cooling) and rising non-OPEC production to influence prices up and down at various times during the year. OPEC continued to maintain a reasonable degree of success in maintaining production discipline through its pact with Russia and other non-OPEC producers, which has probably spared the industry from a substantial price decline.
This price-volatility, and somewhat lower oil prices on average than in the majority of 2018, have brought challenges to the M&A market, where smaller players have struggled to reach deals and contingent pricing clauses tied to oil prices have come back into vogue.
Adding to the pressure on the US upstream M&A market has been the US capital market’s loss of patience with many shale producers’ poor or absent net cash-flow to shareholders. Pressure by large shareholders for capital discipline and more returns to shareholders has reduced the enthusiasm of many independent producers for new acquisitions. Those that have made significant acquisitions have been punished in the markets by falling share prices, further discouraging activity.
The international upstream M&A market has perhaps been less negatively impacted, as some material strategic upstream acquisitions have taken place during this period, although, once again, the number of deals was limited.
Difficult capital markets have compounded the problems of the independents, as other sectors have offered better returns and have seen more interest from investors. As a result, some independents in the US have returned to 'drillcos' (participation deals with investors), production payments, royalty sales and other forms of fundraising that do not rely directly on the capital markets, or on still-cautious energy lenders.
Despite some of the challenges in the US market, US production has continued to increase, with the United States now achieving the status of the world’s largest oil producer, a milestone that ten years ago few ever expected to see. This change is having, and will continue to have, geopolitical as well as market impacts.
As one bright spot for the US market, the majors have returned. Majors came back into the market as buyers, starting in 2018, most prominently Chevron’s proposed acquisition of Anadarko and BP’s acquisition of BHP Billiton’s onshore assets. Following several years of largely sitting out the market or selling assets, the majors are looking for growth opportunities to replace depleting large fields elsewhere. For most of the majors, it appears that US shale is a major centre of focus. As shale plays, particularly in the Permian Basin, have moved to full manufacturing mode, where economies of scale and large acreage plays that allow very long laterals provide better rates of return, and global deals with service-providers offer cost advantages, these shale plays are now perfectly suited for many of the advantages the majors bring. It would not be surprising to see more proposed large-scale acquisitions by this group.
Midstream and downstream M&A deals were more active than the upstream market, including one blockbuster major non-US M&A deal, Saudi Aramco’s roughly USD69 billion deal to acquire SABIC and another USD35 billion deal in which Marathon Petroleum acquired Andeavor. However, reductions in crack spreads have recently signalled challenges for downstream M&A as well.
Offshore exploration and development is another area in which the majors have continued to focus new efforts, particularly the US Gulf of Mexico and Brazil, as well as offshore Africa. An outlier going forward is likely to be Mexico, where a ramp-up of current activity based on previously awarded contracts masks a general suspension of further contract awards by a new government that is sceptical of foreign investment.
The liquefied natural gas trade has finally seen several final investment decisions (FID), including major projects in Mozambique and Mauritania/Senegal, Golden Pass in the US, LNG Canada (the first Canadian liquefaction project), and others. Numerous potential LNG liquefaction projects globally are racing to declare FID in order to supply a perceived 2022 – 2026 window of opportunity in the LNG market. There is a real risk of a new LNG glut, given the large number of proposed projects and the fact that most new projects will have some share of their output that is not contracted to end-users and will be sold on a short-term or spot basis. Certainly, some of the proposed liquefaction projects will not materialise, at least not in this cycle. Projects sponsored by majors and other large portfolio traders who are not constrained to wait for long-term contracts to launch construction, as well as those promoted by sovereigns such as Qatar who desire to proceed for strategic reasons, have a clear advantage in the current market. Existing plants are also competing, both through expansions and through backfill arrangements in which gas is supplied by nearby fields, often on a tolling basis, to offset declining production in the fields originally supplying those plants. Existing plants offer developers of new gas reserves a materially lower cost to bring their gas to market than a greenfield LNG project. Finally, it is worth noting that the LNG market has been directly impacted by the current trade wars, as Chinese tariffs on US LNG and the general level of tensions between the US and China have led to an almost complete elimination of Chinese purchases of US LNG, and a withdrawal of Chinese interest in funding US projects. There is much talk of a trade deal that would lead to substantial Chinese purchases of US LNG, but that refrain has been heard before and, thus far, such a deal has proven hard to reach.
US gas continues to be on a very different, lower-priced, path than gas in much of the rest of the world. As this introduction noted last year, ever-growing associated gas supplies created by growing shale-oil production and constraints on pipeline takeaway capacity in some basins have driven prices ever lower. This year, the Waha (Permian Basin) gas price has been negative several times; gas has become a waste product to be disposed of by those without adequate pipeline access. As a result of this phenomenon, and growing natural gas liquid supplies driven by the same causes, the US petrochemical and refining industry continues to be a story of growth, largely aimed at this point at the global export market.
One of the biggest ongoing influences on the industry has nothing to do with oil and gas markets directly: climate change. Pressure on the industry is coming from a multitude of directions, including political and legal changes (such as greenhouse gas controls, taxes and reporting requirements, and downstream requirements, such as increasing automotive fuel-efficiency standards and electric vehicle mandates), activist investors (who have supported resolutions to require company disclosures of alleged stranded resources, targets for greenhouse gas reductions, and other climate-related matters), lawsuits by governmental units and others seeking compensation for costs of climate change, and withdrawal by some lenders and insurers from the oil and gas markets, or portions of them, in the face of pressures from their own activist investors. In addition, opponents of oil and gas development have increasingly sought to attack and delay or defeat pipeline and other midstream projects required to bring oil and gas resources to market. The industry is promoting natural gas as an environmentally friendly 'transition' fuel, but the climate change-related headwinds to new oil and gas development look likely to increase.
A lurking risk likely to rise to greater prominence next year is the risk that the United States will undergo a major shift in energy policy following the 2020 election, should the Democratic candidate win the Presidency. A number of leading Democratic candidates have threatened to revoke oil industry tax benefits, ban hydraulic fracturing, and enact stringent environmental requirements, all of which would have a major impact on US industry. It is hard to assess the likelihood of any of these actions materialising at this point, but they represent a political risk on which the industry is increasingly focused.
Impact on the Legal Business
Legal work on development of new projects has continued at a reasonable pace, though not nearly at the levels that were typical during the boom in work earlier this decade. LNG work and offshore work, in particular, have continued a healthy but slow recovery. This work continues to be spread globally, with Southeast Asia, Africa, Brazil and the Gulf of Mexico being among the most active spots. In addition, downstream projects in the US continue to be active, with a focus on terminal projects that can export crude oil, natural gas liquids and other products of the shale revolution. A number of refinery and petrochemical projects have been launched in the Middle East, also on the basis of cheap feedstock.
M&A work, in contrast, has slowed substantially, as companies focus on capital discipline. North America has seen the biggest collapse in activity, if a handful of very large transactions are excluded. Private equity buyers have become more hesitant, as they no longer perceive the ability to make a quick exit from the market.
With the slow-down in capital markets, related legal work in that area has also diminished significantly, now that various master limited partnership roll-ups and corporate conversions have been completed in the United States. Creative financing work, included issuance of preferred shares and 'off balance-sheet' financings such as drillcos and production payments, are keeping some lawyers busy.
Regulatory work continues to grow at a rapid clip, with sanctions and trade related advice in high demand, as well as securities' expertise in dealing with activist shareholders and environmental advice on greenhouse gas issues, including methane emissions.
Litigation work in the environmental area remains another strong growth area, with governments and non-governmental organisations bringing litigation to try to stop fossil fuel projects on a number of grounds. Trade and investment-related claims have also been active, as predicted last year. Not all of this activity has been in contested proceedings, as companies have also required legal assistance in seeking administrative exemptions from various tariffs impacting the industry.
Except for the regulatory and litigation bars, we appear to be in a period of perhaps more sluggish, and turbulent, waters for those in the legal profession working in the oil and gas sector, with fewer but larger M&A deals and the gradual wind-down over the next couple of years of a substantial amount of legal work from this round of LNG projects. Here’s to hoping that at least some of these projections, like some of those from last year, turn out to be wrong, but this time, on the upside.