Why Best-Laid Plans Often Go Awry – Observations of a Senior Oil and Gas Practitioner

My recollection of times past is that, however serious the public issues of the day, there was a widely shared sense that they would be resolved sooner or later – and, on the whole, they were. 

This leaves aside, of course, the reality that, during the Cold War, the rivalry between the superpowers overrode everything. It formed a background that was just accepted and, mostly, ignored unless some particular feature of it intruded into people’s field of vision – but it also may have injected an element into people’s lives that made the consequences of failure, or even mishandling serious matters, feel much more serious.

During the Cold War, of course, people were facing nuclear annihilation if things got out of control, but that prospect was sufficiently daunting to both sides to provide a high degree of assurance – at least from day to day over long time periods – that it would not happen. 

Climate change is something else. If anything, those focused on climate change do not want people to get relaxed about it – rather, the reverse is their intention. 

My own specialist area – oil and gas – is much less central to consideration nowadays and alternative energy sources are much more important.  However, petroleum has a way of creeping back into focus, however much some people might wish it would not. For those who detest fossil fuels, it must seem like the plot of Jaws recast onto the energy scene.

Oil and gas M&A deals

When I was at a magic circle firm in London, I did a lot of oil and gas M&A deals. Although some features of such deals – and the way people go about them – have changed, the fundamentals are still the same.

By way of initial instruction, I would often be summoned to the offices of my client. There I would be told emphatically that the client “really, really, really” wanted to do the deal, and the details would then be explained to me.

In simplified terms, there were always a few essential terms (say, A, B, C, D and E) to be included and a few terms that the client very much wished to avoid (say X, Y and Z). I would discuss these with the client at length and prepare accordingly. Depending on which side of the deal I was on, that required either drafting the deal documentation or reviewing the drafts prepared by the other side.

At the first meeting, it would become apparent that the lawyer on the other side had also been briefed that their client was very keen to do the deal, but that the essential terms included X, Y and Z and that a selection from A, B, C, D and E were not to be accepted.

So what did we do? Usually, because we could think of nothing better, we would do a page turn. It took time and gave us a chance to go over the details, but at the end we were usually still in the same position on key issues. 

However, by repeating the page-turn at further meetings with subsequent drafts, we would make marginal progress, although the main hurdles remained ever-present. Eventually, however, what would become apparent was that some of the issues were of materially greater importance to one party than the other, and that with give and take and careful balancing, it could be possible to reach a compromise that might – only just – be acceptable. I would try this out on my client, who would initially hesitate but would, eventually and after careful consideration, be prepared to accept it as a package if the other side would do the same without any variation. It was tricky and risky to put this to the other side, but often we got the deal done. This is unlikely to work, however, if the package is clearly weighted towards one side far more than the other and it has no real credibility.

When I started working in Russia, I found that deals did get done there, but the psychology was very different. The Russian side would often start very aggressively by presenting their position with no room for manoeuvre – to the point where there might seem to be no point in continuing discussions. However, they would inevitably soften up when they realised that the deal would not get done on the basis they were proposing.

Over time, however, the Russians became much more sophisticated and negotiating deals became much more like in London, but some aspect of the approach described in the previous paragraph always remained. One of the greatest lessons I learned in Russia was to have confidence in one’s own position (assuming it was well thought out) and, notwithstanding the pressures, to always be honest and straightforward – but firm – in presentation. Brinkmanship might be appropriate at some point, but only if the client really was prepared to walk away. 

Nonetheless, throughout my time as a transactional lawyer doing oil and gas deals, whether in the UK, Russia or elsewhere, I had a sense that the issues which concerned the legal negotiating team (including commercial and management people) were not what really made a deal happen. In the upstream oil and gas industry, it is the geology and engineering that really determine whether the deal gets done or not.

There is also another important feature. A number of business school studies on the subject indicate that, in M&A deals, buyers tend to overpay. This should not be surprising, because sellers are intimately familiar with their assets in a way that a buyer could not be. The seller will have tried to wring as much advantage as possible before offering them to someone else. 

There are often strategic reasons why a particular asset – or collection of assets – no longer fits the seller’s portfolio and might suit the buyer better.  For example, for a number of years, the UK tax regime allowed exploration costs to be set off against production income. Consequently, new arrivals who wanted to get started were prepared to pay a premium for producing assets that would enable them to get the tax leverage necessary to compete on an equal footing with established players.

What saved a lot of oil and gas deals after they were done – from a potentially remorseful buyer’s perspective – was that the reserves turned out to be greater than they thought and market prices of oil and gas went up, so that, after the deal was done, the value of the assets concerned became greater than anticipated.

People with experience of benefiting from such upsides would be much more inclined to do further deals. Most of the time, those involved in deals have had such experiences because, when economic or financial circumstances deteriorate, they exit the industry for better opportunities. If prices get too low, deal flow dries up – buyers do not want to pay too much or sellers to accept too little. 

However, another truism is that the good conditions for deals have a way of coming back – eventually.

“Nothing is agreed until everything is agreed”

One thing I found particularly annoying and which complicated negotiations unnecessarily, was that, if a particular issue was resolved early in the negotiations, it was very difficult to reopen it. I myself was relaxed about allowing the other side to reopen a point if they so wanted, as I accepted that perspectives might change in the course of a long negotiation. However, if there were consequences for other issues and it was to the other side’s advantage not to reopen the point that had already been resolved, they would insist that it could not be. This, of course, was not just a matter for me but also for my client and, if the client thought the point important enough, they would insist on reopening it if the deal was to be done.

Eventually, I adopted a practice of starting negotiations by tabling the principle that “nothing is agreed until everything is agreed”. Usually, the lawyer on the other side would react favourably to this, and it made the ensuing negotiations overall much more fluid and even (sometimes) friendlier, because we had established a level of rapport at the outset.

In Russia, especially in the early days, I found that it was not appropriate to take this approach. As indicated above, the usual Russian approach to negotiations was to start incredibly aggressively but after an equally aggressive knock-back, they would realise that they had to make compromises if they wanted to get the deal done. I felt that “nothing is agreed until everything is agreed” was not the right approach there because there was such a serious risk that nothing would be agreed. 

Much later, in the negotiations on the UK-EU Trade and Cooperation Agreement, various Tory politicos – to quell the disquiet and disparity of views in their own party – would forcefully enunciate the principle “nothing is agreed until everything is agreed”. It could not, of course, be otherwise in a negotiation of this kind because so many of the issues were intertwined, and, between sovereign governments the principle would, even if not stated, inevitably apply. But there they were using this principle, not as a negotiating tool, but to calm their own side – which probably proves that the principle simply reflects reality.

Policy, ISDS and the energy trilemma

Why are so many aspects of energy policy in such a mess nowadays?

Before the late 19th century, under leaders such as Nebuchadnezzar, Alexander the Great or Cleopatra or, closer to the present, Louis XIV, Catherine the Great or even Otto von Bismarck (who spoke of “iron and blood”, not coal and steel), there was no need for an “energy policy”. It was the development of the internal combustion engine, aviation and electric power networks throughout the 20th century and continuing into the 21st which created such energy dependency.

It would also be fair to say that there have been many energy policy successes – it is not all doom, gloom and disaster. So why does it sometimes seem like that?

If we look at it in historical perspective, we can see that the problems were much simpler in scope (although nonetheless very difficult to resolve) in the first half of the 20th century. At that time, transportation fuels consisted primarily of oil or coal. Winston Churchill played a key role in the establishment of the Anglo-Persian Oil Company in 1909 (now BP) because he foresaw the need for the British navy to have access to oil supplies from sources which were independent of the other big suppliers of the time, Standard Oil (now ExxonMobil) and Royal Dutch Shell (now Shell). 

Access to oil was highly problematic for the Axis powers during World War 2. One of the important drivers for Germany’s invasion of the Soviet Union in 1941 was the desire for access to the Baku oil fields in what is now Azerbaijan. The US stopping its oil supplies to Japan was an important part of the background to the attack on Pearl Harbor that same year which brought the US into the war. 

In the post-WW2 era, oil remained the most important source of fuel for road and air transportation and, together with coal, for power generation, rail and shipping. However, natural gas, which previously was a poor relation of oil, became an increasingly important resource as natural gas pipeline networks developed. Markets were developed, often with the aid of legislation, and in some places, pricing hubs emerged. More recently, the technology and infrastructure for LNG has opened up markets in countries for which natural gas would otherwise be inaccessible, and the availability of spot LNG cargoes has enabled markets to treat LNG much more as a fungible, tradeable commodity.

As the infrastructure and markets developed over the later parts of this period, the interaction and trade-offs between gas and electricity prices became an increasingly important feature of the energy scene. 

In the 1970s, as a result of resource nationalism (and nationalisations) in the Middle East, the rise of OPEC and the Iranian revolution (which resulted in BP’s exit from that country), secure access to supplies remained an important feature of energy policy for all advanced nations that did not have their own indigenous hydrocarbon sources. Fortunately for Western nations, the expansion of the geographical horizons of the international petroleum industry (to include offshore continental shelf resources in the UK, for example) and a succession of imaginative and ground-breaking developments in technology helped resolve these issues. Nonetheless, the tensions between the interests of producers and consumers continued both in international relations and also in the domestic politics of countries where both groups featured significantly.

However, starting in the 1980s, concerns about environment, climate change, global warming and the like introduced new dimensions to energy policy, which grew in importance over time to change the focus dramatically.  Instead of a comparatively narrow set of issues, the need to consider and develop a wide range of alternatives to hydrocarbons forced governments to focus on sources and technologies – renewables especially – with which they were unfamiliar. The saga of the solar sector in Spain is an example of how governments can make policy mistakes which are hard to shake off and can limit their scope for manoeuvre – particularly in this age of ISDS.

ISDS (investor state dispute solution) provides investors with rights under treaties that enable an investor to take a host government to international arbitration if the latter does not fulfil its obligations under the relevant treaty or associated contractual documentation. ISDS is particularly relevant to the energy sector, where host governments feature extensively and treaties such as the Energy Charter Treaty were initially intended to attract investment and development to them. 

However, governments in advanced countries seem to have been surprised that ISDS could be used against them (and cost them a lot of money) and there is now a strong movement among those governments – including in the EU especially but also in other areas like Latin America – to change the way ISDS operates.

To give another example, the German government seems to have been completely astonished that, after it decided to phase out the use of nuclear power in Germany, the Swedish investor Vattenfall used every avenue available to try to recover its losses. Germany had a history of domestic debate about nuclear – the Greens have long been a powerful, anti-nuclear lobby – but the government nonetheless went ahead with an ambitious nuclear programme. After the Fukushima disaster in Japan, however, there was a complete reversal of policy in Germany. It is evident from those documents in the dispute with Vattenfall which have become public, that the German government bitterly fought the company’s claims. However, Vattenfall persisted and eventually the government settled.

There is now a wide range of groups competing for attention and some of them – for example, Greenpeace and Just Stop Oil – can be physically aggressive in their tactics. Huge global conferences on climate change have been held with widely acclaimed declarations of common purposes and approaches.

Where this all leads, however, is not entirely clear. One the features of the scene which many find surprising is the continuity of major hydrocarbons-producing companies, such as those mentioned previously – the demise of which has long been predicted – well into the 21st century. Mark Twain’s comment that “reports of my death are greatly exaggerated” comes to mind.

There are energy needs still to be met when the wind does not blow and the sun does not shine. There are still large populations in the world (eg, in China – which for most of the period surveyed above was inconsequential but is now one of the most important political and economic powers) who would prefer cheap and reliable sources of energy, such as coal – even if dirty – and there are still issues about what happens globally to the already well-established industries producing hydrocarbons. 

There have always been uncertainties for the energy industries, particularly given the long lead times for the development of production projects and infrastructure – which entail large risks. However, the situation is now much more complicated and there is a plethora of key concepts which are meaningful to initiates but can require extensive explanation for others to understand. Examples include greenhouse gases, decarbonisation, carbon credits and trading, carbon capture and storage, net zero, renewables (solar, wind – onshore and offshore, hydro, tidal and geothermal, among others), various colours of hydrogen (green, blue and grey), biofuels, EVs, electrification of road transportation and the inevitably complex issues relating to nuclear power. 

Many people talk about the “energy transition” but exactly where the transition goes – and how – remains the subject of wide debate and discussion.

One concept which I find particularly helpful currently is the “energy trilemma”. Exponents of this point out that there is a trade-off between affordability, security and sustainability and that, inevitably, any solution which resolves one aspect of the trilemma will be problematic for one or both of the others. It reminds me of the old saying about the characteristics of service providers which many regard as a truism: “price, quality, speed – pick any two”.

Dispute resolution

I have mentioned ISDS above, which is at one end of the spectrum of dispute resolution in terms of legal specialisation and expense. ISDS involves a small range of potential parties and practitioners, but the issues are complex and interesting. This leads to a great deal of focus on the subject among major law firms and at arbitration conferences. However, in practice, most dispute resolution in the energy industries is dealt with in commercial arbitration (or the courts).

Among major concerns are the costs incurred in international arbitrations. I have heard expressions of amazement, shock and even horror from very experienced arbitrators at the amounts of money the parties involved are prepared to spend on arbitrations. Part of the problem is that once parties with ample resources become engaged in disputes, the will to win – and sometimes the egos of individuals – come into play and can lead to a “no expense spared” approach. 

There are alternatives, however, provided the parties are prepared to limit the scope and complexity of the process. Documents-only procedures, online hearings, time limits for hearings, word limits in pleadings, no or limited discovery, time limits for the issue of the award can all help. The experiences of the arbitration community during the pandemic have proved the effectiveness of many of these techniques and encouraged their use.