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 March 07, 2018
Oil and Gas Market Developments
Since the oil and gas markets bottomed out in January and February of 2016, the story has been one of a gradual stabilisation of oil prices in a range from the low USD40s through the mid-USD50s. While this range still reflects a significant percentage swing, it has been narrow enough to finally allow companies to make plans, raise funding and do deals.
Analysts have battled over the general direction of prices from here. In one camp sit those who look at global decline rates, annual consumption increases and the limits on how much additional crude oil US shale can supply and predict that sometime in 2018 - 2019 prices will start an inexorable rise reflecting years of under investment outside of US shale. In the other camp sit those who feel US shale has always delivered more than expected, global demand is peaking and will soon start a slow decline, and inventories are so large it will take an extended period to work them off, all resulting in an extended decline in oil prices back into the low USD40s, or even high USD30s. One camp will be wrong, or at least materially off in its timing; which turns out to be right will have significant consequences for the entire industry.
Regardless of price level, prices have become more volatile, driven in part by the rise of speculators and other financial players as dominant players in the oil futures markets. This has led to increased volatility as technical traders sometimes win the battle against fundamentals. Even the relevance of various fundamentals is uncertain, as focus shifts from OPEC production cuts, to inventory levels, to increases in production of US shale oil. Volatility in turn has caused an increased interest in hedging by numerous industry players.
In contrast to the recent excitement in the oil markets, gas prices have largely stayed in the doldrums. A surplus of gas in the US, and a surplus of LNG globally, has kept markets soft, with the exception of certain individual jurisdictions, such as Australia. In contrast to the Australian experience, in the US perceptions of long term oversupply have kept a lid on prices, despite the promise of a number of LNG export projects coming on stream over the next couple of years. This moderate forward pricing curve (still USD3 - USD4/MMBtu five years out) has encouraged the continued pursuit of petrochemical projects in the US, with the prospect of the US becoming a petrochemicals as well as a LNG powerhouse. Internationally, some gas producers have turned to gas-to-wire projects in which they develop power plants as a means of generating demand for their gas or LNG.
Capital budgets of most larger oil companies remain constrained, though they have moved upward. Amounts the companies have been investing have often been focused on US shale, which capital investment flexibility and lowered finding and development costs have made more attractive than many competing global opportunities. Breakthroughs in well design (such as longer laterals and more frack stages) and efficiency (such as multi-well pads) have substantially lowered the breakeven price for new wells in many US shale basins.
Thanks to political change, Argentina may finally start to realise its potential as one of the other geologically attractive shale basins in the world. Several major oil companies have announced plans to ramp up investment there.
As has been the case with shale, increased efficiencies have been realised in conventional production, such as offshore development, the industry downturn has lowered service costs, and the larger companies have started to resume work on the more attractive conventional projects in their portfolios, though break even costs for many conventional projects remain too high. The recovery remains in an earlier stage outside of North American (and perhaps Argentine) shale.
M&A trends have unsurprisingly in many cases followed trends in new development, with the US being the hot spot and the Permian Basin the hot spot within the US. The Permian Basin, in particular, has even reached the point of being overpriced, leading purchasers to return to other less popular shale basins to seek better deals. Canada has gone through a significant round of consolidation in the oil sands projects, making it one of the better performing M&A markets. Non-North American markets have been slower to recover, but activity has begun to pick up, reflecting more broadly increased comfort with the range of oil prices. The role of private equity funds in the oil and gas M&A market has continued to increase, and the desire by private equity to purchase at the bottom of the cycle helped launch the M&A market recovery during the second half of 2016. Many medium and large-sized companies continue to exit non-core assets, further enhancing the M&A market. On the other hand, Chinese SOEs, a major factor globally before the downturn, have been much less active than in the past, thanks to anticorruption probes, budget restraints, newly imposed controls on capital leaving China, and some hard lessons learned regarding buying at a market peak.
Climate change and reductions in carbon emissions have remained critical issues for the oil industry, despite political change in the US that has reduced emphasis in this area. The direction and tenor of efforts differ significantly between the US, Europe and elsewhere, with some emphasszing the carbon reducing benefits of gas for coal (or oil) substitution while others emphasise diversification into renewable power. Activists have sought to challenge oil companies over climate change on a number of fronts, with challenges regarding disclosure of climate risks to investors being the latest.
Impact on the Legal Business
The top story in the oil and gas legal market is no doubt the return of M&A, particularly in North America. The deals have typically been mid-sized and smaller, without any of the megadeals that might have been expected based on previous downturns. Perhaps companies have pared budgets, cut back spending and increased efficiencies so much that there are few readily identifiable synergies to be wrung from large scale acquisitions.
Many deals today have private equity or investment fund support on one or both sides, injecting a new complexity into traditional M&A deals. Private equity portfolio companies that are selling assets 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 third parties having approval rights with respect to the transactions. Financing, and the parties providing it, play a larger role in many of today’s deals.
On the other hand, the great boom in bankruptcy and restructuring work that arrived with the downturn is tailing off. Some companies are still failing, but at a noticeably lower rate. Many smaller companies have become much more adept at using hedging and other planning techniques to avoid being caught on the wrong side of a major price shift.
Upstream development work globally has been heavily focused on North America, including successful Mexico bid rounds, but other bright spots have appeared as well, such as the significant development work being planned for discoveries offshore Senegal and Mauritania, and Mozambique, with related M&A work in both locations. Brazil, which had suffered heavily as a result of “Operation Car Wash” corruption probes, unrealistic local content requirements, and shortage of capacity at ANP and Petrobras, has begun to recover, with both M&A and development work gradually returning.
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. A smaller but appreciable burst of activity can also be seen around Mexico’s energy opening, with a number of lawyers focused on new pipeline and other infrastructure now being implemented with private investment. For much of the world outside North America, however, work on downstream development remained depressed.
Regulatory work, particularly dealing with energy trading and anti-bribery and corruption investigations, remains active, with companies facing increasingly coordinated global enforcement efforts. Sanctions related work has been one of the limited bright spots with respect to Russian oil and gas. In the US, the new administration has sought to roll back limitations on oil and gas development, but it remains to be seen how much change will be achieved in practice.
As a whole, the outlook for legal work in the oil and gas sector is brighter than it has been the last couple of years, and trending in a positive direction. With the great uncertainties in the direction of markets, however, the one thing that can be predicted is that change will continue to characterise the oil and gas legal business, much as it characterises the industry that it serves.