The Energy: Oil & 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 December 11, 2018
Oil and Gas Market Developments
The biggest development over the past year has been the fairly rapid recovery of oil prices to the USD60s and USD70s, levels at which the industry gradually has been able to resume new investment, particularly outside of the United States. This development came about through a combination of OPEC’s success in maintaining production discipline through its pact with Russia and other non-OPEC producers, aided heavily by the collapse in production in Venezuela and Libya, and a strong world economy which, together with lower prices during 2016 and 2017, fuelled demand growth. The success of this effort is all the more remarkable in the face of additions of over one million barrels per day, annually, from growing US shale production.
The role of the Permian Basin in west Texas and eastern New Mexico in that shale growth has clearly been the other top development of 2017 – 2018. At least 20% of global upstream capital investment during this period has gone into the Permian, and the results are stunning. Over 800,000 barrels per day were added to world production during 2017 by the Permian alone – accounting for a large share of world-production growth. There is serious discussion of the Permian surpassing Ghawar Field in Saudi Arabia as the world’s largest oilfield. However, there are some dark clouds looming in form of limitations on take-away capacity. Production growth in the Permian has outstripped the ability to move that production to market through cost-efficient pipeline transportation. In addition, associated gas production is rapidly exceeding the capacity to move that gas out of the Permian. The result has been an increasing discount for Permian production relative to production with ready access to tidewater and the global market. Most analysts foresee a slowdown in the Permian’s breakneck growth until significant new takeaway capacity comes on stream later in 2019.
On the other side of the balance sheet, Iran’s incipient opening, which had attracted much interest from Europe and Asia, appears to have been slammed shut by renewed US sanctions, which may pull upwards of 500,000 barrels per day of current production, and unknown quantities of future production, off the market.
Unconventional resources and geopolitics are not the only stories, of course. Efficiency gains in offshore finding and development costs and higher realised oil prices have finally led to a resumption of new offshore development activity, in the Gulf of Mexico, Brazil, West Africa and elsewhere. Outside the US, Mexico was a focus of much attention, as the government’s successful fine-tuning of its bidding process led to several very successful offshore bid rounds, which drew interest from a wide spectrum of participants. Brazil backed away from its focus on heavy local content and Petrobras-led offshore development and as a result was able to host two very successful offshore bid rounds in 2017 and 2018. Both Mexico and Brazil now face potential changes in approach, however, as a result of new elections.
The global gas trade, while not undergoing as robust a recovery as global oil, has shown significant signs of life as well. Asian LNG growth, led by China, has been stronger than many expected, and front-end work has resumed on some proposed projects that had been on hold, or in slow mode, over the last two years. At least one final investment decision has been made on a new US Gulf Coast LNG train, and a new proposed large-scale west Africa project involving Mauritania and Senegal cross-border gas resources has been announced. Hopes of bringing significant additional LNG supplies to Europe may have been dashed, however, by the apparent success of the sponsors in launching the Nord Stream 2 gas pipeline project from Russia to Germany, which along with the TurkStream pipeline project through Turkey will significantly increase lower-cost Russian gas supplies into Europe.
A related development has been the growth of mid-size “gas to wire” projects as LNG marketers have sought to expand markets through a combination of FSRU regasification with investment in gas-fired power infrastructure. New regasification terminals tied to power generation are under construction in Pakistan, Brazil, and the Philippines, among other locations. Even small-scale projects are being examined, serving niche markets such as the Caribbean islands.
Except where it feeds liquefied natural gas projects, US gas has been on a very different path. Ever-growing associated gas supplies created by growing shale-oil production have driven long-term prices even lower, with the forward-pricing curve now down to the USD2.25 to USD3.25 range five years out. 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 at this point for the global export market.
Despite the increasing rosiness of global markets, oil and gas producers, particularly oil majors, are increasingly looking at diversification, driven by climate change concerns. They are also looking at shorter-term actions, such as reducing methane emissions. To showcase its new initiatives, Statoil even changed its name to “Equinor.” Behind these initiatives, at least in part, lies shareholder activism that is pressuring companies to analyse and disclose risks to their business that future limits on hydrocarbon use and electrification of the vehicle fleet may generate. In addition, some lenders, particularly those based in Europe, have announced limitations on their willingness to finance carbon-intensive projects and industries. If this is the beginning of a broader trend, it may over time change the nature and availability of debt finance for oil and gas projects.
Global trade wars also pose a challenge for the industry in 2018, as prices of steel are being impacted by mutual impositions of tariffs. While these have thus far not led to the announced cancellation of any major project, they may make more marginal projects uneconomic. More significantly, if trade wars lead to a global economic slowdown, that would have implications for global demand growth that could tip the world supply balance back into surplus.
The M&A market has not been as robust this year as in 2017, in part because of rising prices in the Permian, which had been the global upstream M&A engine, and perhaps in part because of the extensive deal-making that occurred in 2017. In addition, investor pressure on public companies to show more discipline in capital spending and return more revenues to shareholders has limited the participation of some strategic players in the M&A market. Nonetheless, shareholder pressure and the need to adjust portfolios strategically are driving some deals, with the major BHP Billiton disposition of its US shale holdings being a prime example. There are also no signs that the interest of private equity in the oil and gas space has abated. It would not be surprising to see a resumption of higher levels of M&A activity later in 2018.
Impact on the Legal Business
As the oil and gas recovery continues, legal work on development of new projects has begun to pick up as well. LNG work and offshore work, in particular, have shown good signs of recovery, from a fairly depressed level of a year or two ago. This work has been spread globally, with Southeast Asia, Africa, Brazil and the Gulf of Mexico being among the most active spots. Downstream infrastructure in the US, in particular, remains a hot area, with a number of construction projects planned or underway in the US Gulf Coast.
M&A work has slowed from the active pace of the last couple of years, but is still busy, with North America continuing to be the most active. As was the case last year, many deals have private equity or investment fund support on one or both sides, injecting more complexity into traditional M&A deals. Private equity sellers seek a clean break, without trailing liabilities, and those that are buying are often special-purpose vehicles with no credit or credit history, complicating dealings with counterparties such as pipelines.
Some sponsors are seeking legal support for creative ways to inject capital in the business, including special-purpose acquisition companies, or SPACs, which are “blank cheque” companies allowing investment into the sector, and mergers of private companies into existing public entities. Master limited partnerships, a US creation that cut out a layer of taxation from publicly traded companies, have proven not to be attractive to investors during hard times (and an era of rising interest rates) and as a result many are being rolled up into their parent companies or converted to traditional corporations, providing another active source of legal work, at least in the short term.
Regulatory work has strengthened even further, with cross-border trade and investment regulatory needs of clients expanding in proportion to the number of trade disputes that have arisen around the world. Energy trading and anti-bribery and corruption investigations also remain active, with companies facing increasingly co-ordinated global enforcement efforts.
Litigation work in the environmental area has been 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 will no doubt prove to be another active area in 2018-2019. In addition, cross-border commercial disputes have continued to provide a strong flow of arbitration work. The main disputes area that has been somewhat diminished has been investor-state arbitration, where fewer new disputes have arisen as many jurisdictions have sought to be more investor-friendly as part of increased global competition for still-diminished oil company investment dollars.
Overall, the outlook for legal work in this sector continues to brighten, particularly for those attorneys in the project development, private equity, regulatory and litigation ends of the business, and looks to make 2018 the best year for the legal segment of the oil and gas industry since 2014.