Research Trends and Conclusions: Oil & Gas 2010
Richard Noakes
No other area of commercial law can match the geopolitical importance of the oil and gas sector. Recent examples include Russia’s decision to reduce the gas supply to Belarus, which caused ripples of concern across Europe, but there is also a softer side.
One leading practitioner noted that “unlike other practice areas, oil and gas has a thrilling romance to the business. Clients take a big gamble on their projects and I have seen many fortunes made by people certain that there is oil down there, and on their very last dime.”
The oil and gas industry is undergoing profound changes that will reverberate through the sector for years to come. The BP oil spill, unconventional oil and gas resources and climate change all exert a force that will change the practice of lawyers involved in the industry.
Gulf of Mexico Oil Spill
Regulatory and litigation experts in the oil sector will be affected by the biggest oil-related environmental disaster in US history, the Macondo spill in the Gulf of Mexico. The Obama administration has attempted to put a six-month ban on issuing drilling permits to allow for a full review of safety processes and requirements. The new regulations that will be put in place are set to increase the demand for lawyers’ compliance advice. Doug Glass at Akin Gump Strauss Hauer & Feld LLP in London says, “No doubt regulatory lawyers, especially environmental lawyers, will see an increase in work on advising clients how to comply with the expected new regulation. In addition, lawyers who negotiate and draft service contracts for offshore work may find that new regulations require a reassessment of risk allocation from the norms that have held previously.” Lawyers expect the conception of risk to be revised and governments elsewhere are taking stock of what has happened. The UK Department of Energy and Climate Change announced that, in light of the oil spill in the Gulf, it will increase its inspection of North Sea drilling rigs. Afren, an African independent oil and gas company, announced that it had already experienced a 7-8 per cent increase in costs from an offshore project in Ghana following the safety response of the Ghanaian authorities.
What does this mean for the future of upstream deepwater oil exploration? Eugene Elrod at Sidley Austin LLP is optimistic: “There’s no doubt that federal regulation and oversight of deepwater exploration and production will increase. But companies that engage in these activities are accustomed to dealing with tough challenges. Given the deepwater’s importance as a source of new production, I’m confident they will meet the challenges.”
More than 70 lawsuits were filed in the two weeks following the start of the spill. A judicial panel is due to decide on whether to combine more than 130 federal cases into a multidistrict proceeding. A number of law firms have therefore been focusing their resources on securing cases surrounding the crisis. Given that the clean-up operation is expected to cost up to $30 billion, the oil spill is set to soak up lawyers’ resources for years to come. This environmental catastrophe is directly prompting work throughout the oil sector and is likely to create a legal industry of its own.
Diversifying Legal Practice
Recent developments in the marketplace have made it more important for lawyers to have a broader skill base. Interviewees noted an increasing number of joint ventures and alliances initiated by clients and a larger volume of deals where private equity groups have been involved. One source insists that “lawyers now need to provide a more rounded offering to clients as a knowledge of finance and joint venture deals is required.” Alexander Msimang, managing partner of Vinson & Elkins’ London office, reinforces the importance of this approach, stating that “versatility and flexibility is a strength during economic uncertainty as lawyers can adjust and refocus their practices; more importantly, it also happens to be what energy-sector clients expect from their legal advisers.” Lawyers have noted that there has been a slowdown in investment into the industry because of such economic uncertainty, and as a result joint ventures and alliances are more attractive to clients looking to reduce risk to their investments and potentially benefit from a partner’s local technological resources. In May 2010 alone there were two significant joint ventures. TNK-BP Holding and Iraq Oil Company for Oil Investments agreed to enter into a joint venture to identify potential projects to acquire and develop in Iraq, while BG group entered into a joint venture with its US shale partner EXCO Resources.
A number of individuals throughout the research have noted an increasing demand in the industry for law firms’ project finance departments. Companies are going back to equity markets to raise money and there are an increasing number of smaller players that need to fund their operations. As Alexander Msimang notes, “The increasing demand for firms’ energy finance capabilities is a reflection of the activity of smaller companies in the industry and of the recovery of the credit markets.” Hugh Tucker at Baker Botts LLP states that “clients are adapting as more private equity groups are investing in or with energy companies; there are no longer just two traditional energy companies involved.” The increasing activity of financial entities and joint ventures in the oil and gas industry means that those firms with a strong project finance and capital markets pedigree are aptly positioned to provide clients with a well-rounded service.
Unconventional oil and gas resources have also been an increasing source of work. An important topic of discussion during the research has been the importance of findings of shale gas in the United States and Canada that will transform both countries’ gas exports. This has had a negative impact on the activity of liquefied natural gas (LNG) projects worldwide, marking a significant change in the market from previous editions where the growing importance and magnitude of LNG projects had been repeatedly cited to researchers. In particular, excitement over the profitability that these projects offered has somewhat subsided as gas prices have come down. Companies are halting LNG projects that are now viewed as unprofitable in the current economic environment. NorthernStar Natural Gas suspended its six-year effort to build an import terminal in the state of Oregon that has so far cost the company $100 million. One interviewee noted, “There is certainly a trend away from LNG towards shale gas due to developments in technology and the fact that shale is easier and cheaper to extract.” However, Steven Miles from Baker Botts LLP argues that although “shale gas is a threat in the short term in relation to the development of new receiving terminals, in the long term shale gas makes the US a place to move excess cargoes and so will create more work.” While LNG projects will continue in the long term, shale gas has been the focus of the major oil companies. In December 2009 Exxon Mobil Corporation carried out an all-stock transaction of XTO Energy valued at $41 billion that will significantly enhance its position in the development of unconventional oil and gas resources.
Similarly, Canada has seen an increase in oil sands projects. According to Glenn Cameron at Stikeman Elliott LLP, “the recovery in oil prices combined with lower costs of construction has allowed oil sands projects to be restarted.” There has been significant investment from Asian companies into the country. In December 2009 PetroChina acquired a 60 per cent interest in Athabasca Oil Sands Corporation for C$1.9 billion. In April 2010 Sinopec Group acquired a 9.03 per cent stake in a joint venture oil sands project from ConocoPhillips worth C$4.675 billion. The drop in LNG projects and rise of unconventional oil and gas resources demonstrates the benefits to lawyers of a diversified legal practice that encompasses experience in both areas and the ability to adjust to mirror demand. Additionally, those law firms based within proximity of unconventional projects are well placed to develop their experience and build market leading practices in an area that will be an increasing source of work for the future.
These changing dynamics have also had a positive knock on affect for litigators and arbitration specialists. Ronnie King at Ashurst says, “Clients are analysing contracts for ways to challenge prices and minimum purchase obligations. There is evidence of increased tension between oil companies and governments in the developing world over tax relief and costs recovery. The number of disputes and contract renegotiations is on the rise. Companies are also looking for new ways to secure foreign investments against government interference.” Particularly as gas prices have remained low, projects have become unprofitable and companies are trying to get out of their contracts. The growing number of joint ventures that increasingly may lead to conflicts of interest, as well as smaller entities that are more inclined to see disputes through to the end, are two additional factors that are contributing to an increase in disputes proceedings in the industry.
Shale gas is also keeping the sector’s regulatory experts busy as there are concerns over the hydraulic fracturing process and the contamination of nearby drinking water. Lawyers in the US have expressed concern that infrastructure capacity is strained in the areas of new shale gas exploration and that there are problems with the ability to link the supply of shale gas to the current infrastructure in place. As government agencies seek to keep up with this developing industry, up-to-date and practical counsel will become ever more valuable for clients.
Looking Forward
Continued pressure on governments over climate change and the need to reduce dependency on oil reserves, coupled with an increasing focus on energy efficiency and renewable energy, are gradually changing the oil and gas landscape. Our researchers received reports of this shift in emphasis from sources around the world. David Asmus at Morgan Lewis & Bockius in Houston says: “In the short term, the relatively higher price of oil is driving producers to focus on liquids production. However, over the longer term relatively cleaner and less expensive natural gas will continue to gain market share at the expense of oil. We already see renewed interest in new gas-fired power generation, in addition to nuclear and renewables, in the developed markets.” James Dallas from Denton Wilde Sapte & Co in Dubai reports that “there is a push for power other than from hydrocarbons and more solar projects are coming forward than in the past”. Rino Caiazzo from Dewey & LeBoeuf in Rome makes the point that “there are more and more projects in renewables, particularly in wind and solar parks, which means some energy lawyers are diversifying away from fossil fuels.” The environmental damage from the oil spill in the Gulf of Mexico, combined with growing concern that demand for oil will soon outstrip supply and the obvious geopolitical benefit for governments not having to rely on unstable regions of the world, will put more pressure on policymakers to diversify their sources of energy. It is clear that already the industry is seeing increasing activity in renewable energy and a shift away from oil. We can now expect to see a similar shift by the sector’s leading firms.
In the decades to come the oil and gas sector will inevitably undergo significant change. Unconventional oil and gas extraction and resources will ultimately become conventional, and alternative sources of energy – particularly renewable energy – will make up a more significant portion of the world’s energy resources. Lawyers who are able to demonstrate their expert understanding of the industry by staying one step ahead of a changing environment, and who can provide flexibility in their expertise, will be highly valued by clients.