May 5, 2015

The low oil price – Share or shelve the longer term oil & gas prospects?

We can all empathize with the nervousness in energy companies today. Who will be the next target and where will the jobs fall? How quickly will the Iranian agreement release an extra half a million extra barrels a day and will this push the oil price down further?  Fields are being closed down and licences relinquished, yet there are huge exploration successes from Sussex to the Southern Ocean. The E&P companies who have already invested time and money in these projects want to find a way of keeping hold of them. They are negotiating changes to the licence agreements or work programmes and while this is generally permissible by law, it is also a political process which brings the risk of additional unwelcome changes. An in-depth knowledge of the local subsoil, constitutional and civil law are essential because it may be that a novel solution is required. The investor will also need to consider the geo-political reality and the host government’s energy strategy for the next 10 to 20 years.The type of original licence award (competitive public tender, acquisition or direct negotiation) will frame the negotiation.  Investors at the very start of negotiations for a new block may be asking for exclusivity and an option that will last a few years. During the E&P phase, reducing the work programme and increasing terms would be helpful as would bringing in a new partner to share the risk.

At any stage, the investor may relinquish a licence, ‘buying out’ the remaining well and seismic obligations. In the current circumstances, this will come with a high price and no right to enter back in if there is a later discovery on the same acreage, even by a former partner. Not many governments are receptive to an investor buying out of the licence or production sharing obligation, while also retaining an area of mutual agreement (‘AMI’) arrangement. Looking at the options for each stage and the pros and cons of each:

Options during early negotiations:

  • The investor may want to summarise the current negotiations into a legally binding Memorandum of Understanding (‘MOU’) with exclusivity, an option for 2 years at least, confidentiality and even a minimal international arbitration agreement.

Business advantages: This exclusivity will hopefully last until the oil price rises and there is more funding or appetite for exploration.

Legal caution: It is likely the host government will want the MOU to be governed by local law. This need not be a deterrent as good local lawyers can advise on the enforceability of the agreement and ‘value’ of both the option and exclusivity clauses. In times such as these, investors may find that there are parallel MOUs being signed up for identical or overlapping blocks and this is just a fact of the business environment to be investigated. There is an advantage in keeping the MOU fairly short, as anything too detailed can resemble an ‘agreement to agree’ allowing local courts in some countries to fill in the blanks without negotiation with the investor. This is particularly the case in civil law countries, including the former Soviet states.

  • Reduce focus from those regions and sectors that are less welcoming of the extractive industry, where the local population is creating legal roadblocks and the company’s legal and public affairs departments are shouldering an increasingly heavy burden with a reduced workforce. Such hostility may be directed towards new extraction methods with less well documented environmental impact such as shale gas in both mainland Europe and the UK, or national opposition to foreign investment, such as in Eastern Europe and the Middle East.

Business advantage: The investor can save money and limit reputational damage in the increasingly impossible media battleground.

Legal caution: The investor may prefer to keep the licences in place. Force majeure may be available to the investor where regulatory permits are delayed for political reasons. During this period, it is important that engagement continues between national or supra-national regulators with  experienced investors to help develop a workable regulatory framework.

Options during the minimum work programme stage:

  • Renegotiate the licence to provide for extensions, less wells or more time to establish a gas market or transportation.

Business advantages: From the investor’s perspective, longer-term opportunities provide future reserves so it is important they are kept in the portfolio. The host government would also prefer to agree changes to the work programme than see investors walk away.

Legal caution: Support will be required from all relevant government departments to achieve a licence amendment, so a powerful NOC or ministerial supporter is necessary. The first concern is always for stability of the hard-negotiated, long-term agreements. Any ‘re-opening’ of the deal might allow unwelcome changes and it might be less possible to obtain stabilization in the current political framework. Obviously companies will only risk this if the project budget has gone. Each jurisdiction will treat stabilization differently. In some, a presidential edict or decree can apply to an agreement even if amended. In others, the whole character of an approving parliament may have changed and a harsher investment regime might be in place.

  • Bring partners in to share costs and risks. This can be at any stage in the life of project.

Business advantages: The licence can be kept and there is a chance to offload operatorship if this is an added resource burden.

Legal caution:  Government or NOC approval is likely to be necessary unless the new partner takes a beneficial interest only and can sit behind the project partner. The assignment and change of control provisions in the project agreements and applicable local law will need to be reviewed to confirm what consents, pre-emptions and processes are required.

Options during the development and production stage:

  • Besides bringing in partners as proposed above, infrastructure sharing could be winning solution. There are projects which justify new pipelines, ports or other facilities to be constructed and some governments request them for reasons of independence or security. It is normally the case though that investors are encouraged to share existing infrastructure with neighbouring projects. Some investors refuse because they cannot maintain control (be it  financial, reputational, technical or legal / compliance) but in any low oil price environment, infrastructure sharing is worth considering.

Business advantages: The host government will generally be supportive because recoverable costs will be lower.

Legal caution: There may be legal restrictions on partnering with a neighbouring field or operator and if this is cross-border, a treaty or at least intergovernmental agreement will be required. These latter instruments are useful for the extra stabilization they may provide to the project. Sanctions may apply to either the location or a partner with whom the investor would now be ‘sharing’ so would be a temporary hurdle. The legal documentation required will address:

  • the financing of expanded capacity, assuming the infrastructure is not underutilized;
  • ownership issues, will the new participants take title or just contract as a shipper or third party user; and
  • maintenance and upgrade.

Whichever decision is made: to buy out remaining well obligations, to relinquish or to amend, extend or share, broad policy and legal support is required. The impact of a decision to exit an E&P agreement is profound for both the investor and the host country.