The Energy: Oil & Gas guide provides expert legal commentary on the key issues for businesses involved in Energy: Oil & Gas. The guide covers the important developments in the most significant jurisdictions.
Last Updated October 21, 2016
David Asmus is the leader of the Energy Transactions Practice at Morgan, Lewis & Bockius LLP and one of the world’s leading oil and gas attorneys. His practice focuses on large-scale project development, including offshore projects, LNG, petrochemicals and refining, and acquisitions and divestitures of oil and gas interests from the upstream through downstream, as well as financing of all of the above. He has served as President of the Association of International Petroleum Negotiators, Chairman of the Institute for Energy Law, and Chair of the Oil and Gas Committee of the International Bar Association.
Peter Hays is a partner in the Energy Transactions Practice at Morgan Lewis. He represents major companies, independents, start-ups and entrepreneurs in hydrocarbon transactions. His practice focuses on the acquisition and divestiture of hydrocarbon assets in US and foreign jurisdictions, upstream and midstream project development, and country-entry investments, including advising on bid rounds and government concessions. He is certified as a specialist in oil and gas law by the Texas Board of Legal Specialization.
Morgan, Lewis Bockius LLP is a global energy practice is renowned for its work on multibillion-dollar energy transactions often involving the development, financing, acquisition and divestiture of both conventional and unconventional resources. Morgan Lewis lawyers also have experience resolving the most complex energy regulatory issues and handling high-stakes commercial disputes.
Oil and Gas Market Developments
2015 and the latter part of 2014 have been a period of radical change in the oil and gas industry. Following years of elevated activity driven by sustained high oil prices, the commodities markets brought the business back down to earth with a thud, as a decision by OPEC in November 2014 not to reduce production to protect prices accelerated a price decline that had begun several months earlier, ultimately leading to an approximately 50% drop in the major crude oil price indices between the summer of 2014 and the summer of 2015.
Of course, OPEC was not the sole cause of the price drop; the OPEC decision was merely the culmination of a series of pressures that had been building in the market for some time. Two that stand out are the remarkable growth in US crude oil production from shale and the slowing of growth rates in China. As to the first, the net increase in US oil production from 2008 until 2014 amounted to nearly four million barrels per day, easily enough to tip the world supply equilibrium into surplus. As this was happening, growth in China began to cool. China was the engine that, more than any other, had driven up world demand, with its oil consumption rising from 7.7 million barrels per day to 10.7 million barrels per day during the period between 2008 and 2014. When it became clear that growth rates in China were declining, all commodities were impacted, including crude oil. The combination of slowing Chinese demand, ever increasing US production, and the very public OPEC decision to do nothing about the market imbalance led to the collapse in prices. Increasing Iraqi production, and the expected end to sanctions on Iran, added to market pressures.
It was a remarkable sign of the times that the rise of ISIS, war in Yemen and the complete collapse of Libya failed to have any measurable impact on oil markets.
The effects of the price change have been widespread. Oilfield service companies and oil companies together announced approximately 150,000 layoffs globally between the fall of 2014 and the summer of 2015. Capital budgets of major oil companies were slashed in 2015 to on average 15-20% below 2014 levels, and a number of major projects that had not reached the final investment decision stage were put on hold or cancelled. The mergers and acquisitions market in the upstream oil and gas industry collapsed, as sellers and buyers were unable to agree on a suitable basis for pricing reserves. In the first quarter of 2015, the global total for upstream oil and gas M&A amounted by some measures to only USD3.6 billion, a decrease of over 70% in total deal value from the first quarter of 2014.
Gas was also impacted severely in North America, as was the global LNG market, by a continuing glut of gas and the deceleration of economic growth in Asia. US gas production rose from 55.2 bcf per day to 70.5 bcf per day over the same period from 2008 to 2014, driving the US Henry Hub index price down from USD11.09 per MMBtu in July of 2008 to USD2.76 per MMBtu in July of 2015. For oil-linked LNG prices typically used in Asia, the drop in oil prices drove a corresponding drop in LNG prices, and this, coupled with a drop in Chinese demand, generated a significant impact in the LNG spot market. An expected wave of new LNG projects in Australia and the United States will add to LNG price strains over time. Beyond those projects now online, seven total projects have reached the final investment decision stage in Australia, one has received a conditional final investment decision in Canada, and a remarkable 47 have received at least FTA export authorisation in the United States. Though a majority of the US projects are unlikely ever to be constructed, the US, Canadian and Australian projects to be built could add well over 100 million tons per annum to the global supply by the end of the decade, suggesting a risk of significant oversupply near the end of that period.
The news for the oil and gas sector was not all bad, as refining and petrochemicals profitability rose with declining feedstock prices and increasing spreads. The “reindustrialisation of America” continued, with refinery expansions and new petrochemical plants sprouting throughout the Texas and Louisiana Gulf Coasts. Middle East players also ramped up expansions, taking advantage of the availability of inexpensive feedstock. Capital expenditure in this sector looks set to continue at a strong pace over the next year.
Impacts on the Legal Business
Unsurprisingly, the legal work surrounding the oil and gas industry has also changed significantly.
The greatest impact has been felt in the M&A market, as noted above. As prices have remained in the USD60s and below, some M&A has gradually reappeared as sellers in need of cash have finally given up waiting for a better price environment. More deal activity is likely to appear in the fall, as banks begin to cut the credit available to indebted oil and gas borrowers and hedges that have protected some from current low prices roll off. Some recent activity has consisted of something not seen much in recent years, distressed deals in oil and gas, and more seem likely to come. One of the biggest open questions in the oil and gas M&A market is how much private equity will spend to buy assets in this down market. Many billions have been raised by funds established for this purpose, but far less has actually been spent to date. Private equity makes up a much larger share of the oil and gas M&A market, particularly in North America, than it once did, so the answer to this question will have a significant impact on the market. Finally, there is a possibility of megadeals by majors who are in a more financially sound position than the large independents. To date, only the Shell-BG deal has appeared, but the possibility of others is a matter of great speculation.
Project development can be expected to continue to drop off, given the cuts to capital spending, but for large projects that constitute long term investments, the decisions will be taken more gradually and the impact on the legal market will be more incremental. The most immediate cuts have hit drilling, which tends to be less legally intensive than major facility or plant construction.
The bankruptcy and restructuring side of the energy business is booming with loan restructuring work if not bankruptcies. Readily available capital, trying to invest after the price dropped, supported some companies during the first part of the year, reducing actual bankruptcy filings below what might have been expected.
Lastly, as is often the case in similar circumstances, litigation has been on the increase. Companies have sought to cancel or renegotiate contracts for expensive rigs and to dump excess transportation capacity. Deals have been cancelled. Royalty owners in the U.S., unhappy with their reduced payments, have sued. The receding price tide has exposed many problems that would have remained hidden, had oil prices remained above USD100 per barrel.
The impact of low prices has largely overwhelmed other trends in the business, but two worth noting are the impact of efforts to reduce carbon emissions and the opening of Mexico’s oil industry to private investment.
Although Canada succeeded in parrying an attempt by some in the EU to specially disadvantage Canadian oil sands production as a consequence of an alleged higher carbon footprint, in general the news for producers has been a story of increasing regulation driven by carbon concerns. In particular, the United States is set to release in August draft regulations for reducing methane emissions in oil field operations, and carbon emission regulations for the refining industry are expected to follow. Developments in this area certainly bear watching.
Mexico has gone through several past rounds of oil and gas reforms, none of which allowed risk-based foreign investment that was attractive to international oil companies. This changed in December 2013, when amendments to the Mexican constitution were adopted which, for the first time in many decades, removed the PEMEX monopoly and allowed direct private investment into upstream oil and gas. Secondary legislation to implement the reforms was enacted in 2014, and the first bid round was held by Mexico in the summer of 2015. Although the first round was not a success, perhaps due to unattractive blocks on offer and high minimum government take, the degree of interest shown by the international oil and gas community suggests that with some adjustments Mexico may become one of the new destinations for sought-after capital investment dollars in today’s reduced budget environment.