SHELL’S DISPOSAL TO PRIVATE EQUITY:
BRIDGING VALUATION GAPS AND OTHER BARRIERS TO M&A IN THE UK NORTH SEA
Marc Hammerson, Partner
Sam Gill, Trainee solicitor
2016 REVIEW: DEVELOPMENTS IN THE REGULATION OF THE UNITED KINGDOM CONTINENTAL SHELF
A significant development occurred in the UK’s oil & gas industry on 1 October 2016. The Oil & Gas Authority (OGA), the industry regulator, was converted from an executive agency of the government to a company with the Secretary of State for Business Energy and Industrial Strategy as its sole shareholder.
It marks the final step in the creation of an independent regulator. This change coincided with a number of OGA policy and strategy papers intended to promote efficient operating standards in the UK continental shelf (UKCS). The central theme of these papers, as well as the creation and existence of the OGA, is to keep the UKCS competitive and sustainable as a mature basin operating in a low oil price environment.
Shortly following the OGA’s incorporation, a number of additional strategy papers were published designed to encourage better behaviours among UK industry participants. This blog briefly describes the creation of the OGA and policies introduced since incorporation.
Mitigation following a breach of contract – how far does the duty extend?
The rout in commodity prices continues to impact nations and stocks across the globe. Already this year the price of oil has dipped below US$30 a barrel, with a seemingly unrelenting oversupply of crude and markets preparing for the return of Iran post-sanctions. Sadly, falling prices often result in contract re-negotiations or default, leading to claims and innocent parties with goods on their hands and a difficult search for a willing buyer prepared to pay a reasonable price.
Following a breach of contract, the innocent party has a duty to mitigate the loss it has suffered. However, failure to mitigate loss may prevent that party from recovering damages for avoidable loss. A standard defence which the defaulting party often invokes to reduce the damages payable is that the innocent party has failed to act reasonably to mitigate its loss. The burden of proving a failure to mitigate falls, however, on the defaulting party.
As one might imagine, the courts are generally sympathetic to efforts made by an innocent party seeking to deal with a breach of contract. The requirement to take 'reasonable steps' to mitigate loss is not a particularly high standard. This so-called ‘duty’ requires reasonable steps to be taken to limit the losses that are incurred (and also to avoid incurring unnecessary expenditure in seeking to remedy the breach). An innocent party need not, however, take unusual steps that would be outside the normal course of its business, or even incur undue costs. Reasonable costs of mitigation incurred by the innocent party will generally be recoverable from the defaulting party.
Ronnie King is a Partner at Ashurst LLP and consulting editor of Dispute Resolution in the Energy Sector published by Globe Law and Business.
An understanding of dispute resolution mechanisms has rarely been more important to companies in the oil and gas sector. If past experience is anything to go by, the recent significant drop in oil prices is likely to lead to a variety of disputes. This decline in oil prices has had a serious effect on oil and gas companies around the world and connected parties (eg, contractors and offtakers), all of which may now face problems arising from decline in investment, price reductions, payment delays, employee redundancies, cash flow difficulties and takeover bids. These difficulties create fertile ground for disputes. Some of the potential areas are outlined below.
Oil exploration and drilling contracts on hold
As oil prices fall, oil exploration and drilling contracts are likely to be put on hold or cancelled altogether. The number of oil and gas rigs in operation is already beginning to drop, indicating that exploration companies are starting to reduce their investments; this will also have an effect on the companies supplying the rigs.
Joseph Dutton is an energy policy researcher at the University of Exeter and contributor to Globe Law and Business title, Shale Gas: A Practitioner's Guide to Shale Gas and Other Unconventional Resources.
The UK shale industry has endured a tough time in recent years, even though there is not yet an industry to speak of. A seemingly endless stream of negative press spiked with mass coverage in 2011 following induced seismicity during fracking operations at Cuadrilla Resources’ Preese Hall well in Lancashire, and again in 2013 following the summer holiday-swelled protests at Cuadrilla’s Balcombe drilling site in Sussex. Even though the Balcombe exploration well targeted conventional oil – having originally been drilled in 1986 by Conoco – and there was no fracking in the licence application, the reaction it stirred is a measure of the controversy and misinformation that surround fracking and shale gas.
Things briefly looked more positive in 2014 following an announcement in March that shale resources in Northwest England were 50% larger than previously thought, while in November chemical firm INEOS said that it would invest around £700 million in its shale licences in Scotland to establish supply of gas for its Grangemouth petrochemical plant.
But as the corner was turned into 2015, the negative press returned. Lancashire County Council planning officers recommended that an application from Cuadrilla to drill four wells at its Preston New Road site be rejected, even though the Environment Agency had granted Cuadrilla a permit on January 13 to drill at the site. Following a six-month assessment, the agency permit set out conditions regarding ground and surface water, air quality and waste water disposal, and the organisation was confident that the right controls were in place to manage waste disposal, the safe flaring of gas and the protection of local water resources. However, the local authority decided that not enough had been done to tackle noise pollution and disturbance to local residents. An application to drill four wells at Cuadrilla’s Roseacre site was also rejected due to noise and traffic concerns.
Nicholas Antonas and Hannah Marshall are both lawyers at the London office of Akin Gump Strauss Fauer & Feld.
The recent sharp fall in oil prices, which has seen Brent crude oil and US crude oil both fall below $50 a barrel, has shocked the oil industry. Growing US shale production and high Organisation of the Petroleum Exporting Countries (OPEC) output, combined with weak demand in Europe and Asia, have contributed to a price drop of more than 45% from recent highs. While the full ramifications of the new market conditions are yet to be seen, certain winners, losers and opportunities are beginning to emerge. In addition, lessons can be learnt from the last time the market was at this low level.
Winners and losers?
OPEC has so far refused to cut its supply of oil in response to the falling prices. This has been viewed as an attempt by Saudi Arabia, using its influence over OPEC, to protect its market share. The drop in prices puts considerable pressure on competitors that use higher cost production methods, such as US shale production and deep water production. Saudi Arabia’s oil minister has stated that it does not intend to reduce its production even if the oil price falls significantly further.
OPEC’s lack of response to falling prices does not advantage all OPEC members though. This is the case for those countries (eg, Nigeria and Venezuela) which are heavily dependent on oil revenue and do not have the large foreign currency reserves of Saudi Arabia and the United Arab Emirates. Nigeria has already taken the step of reducing its 2015 budget by $3 billion in response to falling market conditions.
Huw Thomas is a partner at Ashurst LLP and consulting editor of a forthcoming title on energy finance for Globe Law and Business.
Exploration and production (E&P) companies have benefited from the hunger for yield in the Norwegian bond market over the last couple of years. Norwegian bonds have been issued by a number of E&P companies which own assets ranging from the North Sea (Norwegian and UK) to onshore UK, Kurdistan and Southeast Asia. Issuers have included Sterling Resources, IGas Energy, Det norske, Kris Energy, Iona Energy, Salamander Energy, Gulf Keystone and Xcite Energy.
If you have not been involved in a Norwegian bond issue, you may be curious as to what is involved and how difficult the process may be. The answer is: not very. In fact, for borrowers that tick the right boxes, the process can be surprisingly fast and painless. I will break it down into its simple component parts so that you can judge for yourself.
Africa is one of the most underexplored regions of the world (specially East Africa). However, significant interest is developing in new hydrocarbon provinces in East Africa. For example, the US Geological Survey has estimated that 253 trillion cubic feet may lie off the coasts of Kenya, Tanzania and Mozambique. Recent discoveries in the region have attracted a great amount of international attention (especially in the liquefied natural gas markets).
Given the existence of proven hydrocarbon reserves and the large areas to be explored, the appetite of investors in East Africa is likely to increase. However, the question that any host government should be asking is who is interested in their countries. While the qualification process in a bid round or direct negotiation might be fairly simple and straightforward under most hydrocarbons codes (in comparison with the fiscal regime and contractual framework), it is not well observed in quite a few Eastern African countries.
Some countries might have the luxury of implementing a lengthy, slow and complex qualification process; but not all countries can afford this type of process, as investments are required to explore their hydrocarbon potential. The urgency of raising investments might encourage some countries and governmental officials to speed up the process and award a contract to the first investor that knocks on their doors.
The main risk that a host government faces is the possibility that the investor is a broker rather than a serious investor. A broker will lack the technical and/or financial capability to develop the assets itself, but is rather seeking to acquire the asset from the host government and immediately flip them to a third party by acting as an intermediary.
Why does the oil & gas industry use joint operating agreements?
In any oil and gas exploration activity, there will be a vertical relationship between the resource holder (usually the government of the host country) and the company (usually an international oil company) that wishes to explore for oil and gas. This relationship is governed by a concession agreement. Where multiple companies wish to work together to explore for and exploit hydrocarbons through a joint venture (JV), a joint operating agreement (JOA) is used as the contractual structure governing the horizontal relationship between the co-venturers to ensure the proper performance of the terms of the concession.
Given the large-scale, capital intensive and inherently risky nature of upstream oil and gas exploration activities, companies partaking in such oil and gas projects will often choose to do so through a JV. This allows two or more companies to share the burden of the expenses and commercial risks of the project between them. The JOA’s key function is to define each party’s percentage interest share in the project, as between the co-venturers. This in turn informs profit and cost-sharing considerations under the JOA, as well as the allocation of the collective liability of the co-venturers to the resource holder.
What makes a JOA different from other incorporated JV companies used by other industries?