Energy: Oil & Gas 2020

Energy: Oil & Gas 2020 features 19 jurisdictions. The guide provides expert legal commentary on private investment in upstream, midstream and downstream petroleum operations; foreign investment; environmental, health and safety (EHS) requirements; and liquefied natural gas (LNG) projects.

Last Updated: August 10, 2020

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Sidley Austin LLP has a diverse client base that includes companies that develop, produce, transport, process and market energy. A dedicated team of 120+ energy lawyers from 15 offices in the USA and around the world assists public and private clients across the energy industry with complex, multidisciplinary legal issues, including project development, M&A, securities, financing, litigation, international arbitration, internal and government-related investigations and compliance. The team is distinguished by its deep and broad experience across oil and gas industry verticals, advising some of the largest integrated oil and gas companies, as well as smaller independents, financial investors and lenders, on achieving their business goals around the world. The noteworthy team includes former industry participants and government officials, and brings particular strength to multifaceted transactions that involve the seamless interaction of transactional and regulatory counsel.


Oil and Gas Market Developments

It is fair to say that the world has changed for the oil and gas industry since mid-2019, and not for the better.

In steady progression over the course of the year, we have seen:

  • the investment community tire of meagre (or negative) returns on capital from the industry, particularly from a number of US shale players;
  • downward pressure on oil prices due to increasing supplies from US shale, Brazil and elsewhere;
  • a collapse of global LNG prices due to another warm northern hemisphere winter and a surplus of new LNG supplies;
  • the failure of OPEC+ to agree upon an extension of output cuts, leading to a brutal price war between Saudi Arabia and Russia; and
  • the rapid spread of COVID-19 around the world, leading to unprecedented shutdowns of large segments of the global economy, destroying demand at the same time the price war was increasing supply, and crushing oil prices.

These factors and some unique circumstances in the derivatives market led to the first ever negative daily price close for prompt month (May) WTI crude oil, in April 2020. The May WTI contract ultimately closed out in positive numbers, but at levels that would have bankrupted a substantial part of the industry if they had continued for an extended period.

During April, inventories soared and storage space became the hottest commodity in the industry. Companies and traders scoured the globe, looking for unused space in sometimes very remote locations. Tankers became floating storage.

The market suffered from extreme volatility, providing profit opportunities for some trading operations but wreaking havoc on corporate hedging programmes.

In May 2020, OPEC+ managed to reach agreement on unprecedented emergency output cuts, of 9.7 million barrels per day. Combined with price-driven shut-ins of several million barrels per day in North America, this proved to be enough to move prices back into the USD30s, which was still an unsustainable level for a number of companies, particularly those that were heavily leveraged.

Even in the unattractive USD30s, the industry was relying on continued sanctions on Iran, a meltdown of the industry in Venezuela, turmoil in Libya, and some restraint by US shale producers to avoid another price collapse.

LNG continued to suffer as well, driving more LNG into the spot and short-term market and putting the brakes on some potential new project launches. Financing for new projects became increasingly challenged as lenders continued to insist on long-term baseload contracts, while many buyers remained reluctant to commit in the face of very low short-term and spot prices. Some buyers began to pressure sellers to renegotiate existing long-term contracts, at least until oil prices fell to very low levels and did that work for them.

Although new deals of the size of Occidental’s acquisition of Anadarko or Aramco’s investment in Reliance were not to be seen, the second half of 2019 still saw the announcement of a limited number of significant M&A deals, including BP’s sale of its Alaska assets, Total’s buy-in to Apache’s Suriname project, and Hess Midstream’s acquisition of Hess Infrastructure. By early 2020, price volatility and much lower commodity prices substantially impaired the M&A market, leading to a large reduction in deal count and the renegotiation of pricing of a number of deals. The action by May shifted to potential purchases of assets out of bankruptcy, and opportunistic acquisitions at low prices by private equity and other financial players who still held cash. Though the majors also still had enough cash on hand to make strategic acquisitions, there was as yet no sign of their doing so.

As noted above, the past year saw an acceleration of the US capital market’s loss of patience with poor or non-existent net cash flow to shareholders from many shale producers. Pressure by large shareholders for capital discipline and more returns to shareholders, and the substantial loss of cash flow in the face of falling prices, reduced the enthusiasm of many companies not only for new acquisitions but also for previously planned drilling programmes. From the majors down to small independents, capital budgets have been reduced, often repeatedly.

Banks also lost patience with low commodity prices, finally reducing borrowing bases for a number of independent oil and gas companies based on lower expected forward commodity prices. The repayment obligations facing some independents as a result of lower commitment levels appear to be more than they can manage. Deprived of access to equity and debt financing, many smaller and mid-size independents, particularly in the US, began moving toward anticipated bankruptcy filings.

The impact on the oilfield services industry has been predictably severe. Industry leaders significantly cut their staff and their dividends, and some reduced their North American assets to reflect expected trends in decreasing industry demand. Smaller oilfield service companies followed suit. On the brighter side, increased interest in remote operating and remote working technologies following the fallout from COVID-19 should present new opportunities to some of the larger oilfield service companies.

The news was not all doom and gloom. There were some bright spots in the exploration and production field, with new exploration and development activities proceeding in Guyana as a follow-up to ExxonMobil’s Liza discovery, and offshore activity in Brazil remaining fairly robust despite the significant impact of COVID-19 in that country. Activities in the Arabian peninsula continued, including significant upstream, midstream and downstream expansions in Qatar. In contrast, energy nationalism in Mexico, reflected in an increased focus on PEMEX production increases, import substitution goals, the dispute over operatorship of the Zama Block, and the required renegotiation of terms granted to pipeline developers, among other things, calls into question how much new investment will continue to flow into that country’s oil and gas sector.

In the trade field, China agreed to a significant increase in its purchases of US energy products, but growing tensions between the two nations and the sheer size of the promise call into question how many of these purchases will actually materialise.

Climate change continues to be a challenge to industry growth and practices. As noted last year, 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 the 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’s efforts to promote natural gas as an environmentally friendly “transition” fuel appear to be running into headwinds by growing focus in some jurisdictions on moving directly to renewables, and the increasing drop in the delivered energy price from renewable installations.

In the United States, politics also presents a significant risk to the industry, with a November 2020 Presidential election looming and Democratic candidate Joe Biden promising, among other things, to ban oil and gas permitting on federal lands, to make federal permitting for infrastructure more difficult, to increase methane emissions restrictions, to increase royalty rates, and to decrease demand through fuel efficiency standards. A number of leading Democrats have spoken in support of banning hydraulic fracturing at the federal level, though it is unclear whether that could be done. 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. Any such developments could actually help producers elsewhere, by reducing the global supplies.

Impact on the Legal Business

During 2019-2020, existing projects that were well along continued but market pressures began to impact new project work, particularly in the LNG area, as a number of projects stalled due to a lack of buyers. In general, projects financed by deep pocketed sponsors not reliant on project finance showed greater likelihood of proceeding. The same could be said for big offshore developments, particularly in places like Brazil. However, the fallout from the Saudi-Russian price war and COVID-19 put even some of these projects on hold by spring. Beyond market demand issues and cash flow constraints at even large companies, COVID-19 related supply chain issues at the big Asian yards began to interfere with project schedules. All of this had a significant depressive effect on project and project finance legal work, as least on the transactional side. Force majeure and other contractual disputes, and renegotiations, became the source of much of the new work in the oil and gas projects legal world.

M&A work also continued to slow into 2020, when the bottom largely fell out of the market. Following major price declines in March and April, existing deals were often repriced, and new deals were increasingly hard to sign up. Strategic buyers largely exited the market, as their own cash flow dried up and new acquisitions were placed far down the list of priorities. Private equity continued to look at opportunities for distressed asset acquisitions, both within and out of bankruptcy, but activity levels were low compared to a year or two earlier. M&A lawyers brushed up on their skills in acquiring companies and assets out of bankruptcy or insolvency proceedings. Once again, North America has seen the biggest collapse in activity, given the relative disadvantage shale investment faces in a low price environment. However, if past experience is any indicator, at some point the market will turn and current circumstances will likely lead to a wave of consolidation.

Capital markets remained largely closed to exploration and production companies, or at least those without sterling credit. While majors and other large companies were able to successfully place debt financing early in 2020, most others struggled, so work in this area for the upstream industry, at least, remained subdued.

Regulatory work continued its inexorable expansion, with companies adding demands for advice on all matters related to COVID-19, from government loan programmes to labour and employment issues, on top of prior demands for advice on sanctions and trade issues, securities expertise in dealing with activist shareholders and environmental advice on greenhouse gas issues. Any change in administration in Washington, DC will clearly lead to a flurry of regulatory activity.

Litigation work also began to grow, as companies sought to exit contracts or to assert defences to performance, in light of the market collapse in March and April. In the environmental area, significant litigation continued, including both challenges to infrastructure projects and climate change litigation. Trade and investment-related claims remained active, in a continuation of last year’s growth.

Except for the regulatory and litigation bars, we appear to be in a period of reduced activity, the end of which will in part depend upon how rapidly the global economy recovers. However, history shows that the economic carnage of these periods eventually leads to a burst of rebuilding activity, initially through M&A and then through new investment. May that part of history repeat itself.

Author



Sidley Austin LLP has a diverse client base that includes companies that develop, produce, transport, process and market energy. A dedicated team of 120+ energy lawyers from 15 offices in the USA and around the world assists public and private clients across the energy industry with complex, multidisciplinary legal issues, including project development, M&A, securities, financing, litigation, international arbitration, internal and government-related investigations and compliance. The team is distinguished by its deep and broad experience across oil and gas industry verticals, advising some of the largest integrated oil and gas companies, as well as smaller independents, financial investors and lenders, on achieving their business goals around the world. The noteworthy team includes former industry participants and government officials, and brings particular strength to multifaceted transactions that involve the seamless interaction of transactional and regulatory counsel.