Uwe M Erling of Noerr, Douglas Glass of Akin Gump Strauss Hauer & Feld, Angus Jones of Allen & Overy, Mathew Kidwell of Morgan Lewis & Bockius, Paul Murphy of Milbank Tweed Hadley & McCloy and Craig Spurn of McCarthy Tetrault discuss the volume of transactional work, regulatory developments, the impact of major energy disasters and changes to the legal market in their jurisdictions.
Uwe M Erling
Who’s Who Legal: We have had mixed reports regarding the volume of transactional work in the energy sector from lawyers in different jurisdictions. Has it been active in jurisdiction? What type of transactions have you been seeing?
Angus Jones: Globally, M&A activity in the oil and gas sector remained very strong in 2012, accounting for 15 per cent of all global M&A activity, despite difficult global economic conditions. However, continuing political and economic challenges have resulted in a demonstrable slowdown of energy M&A in the first quarter of 2013 and deal flow has dipped in terms of both value and volume.
Much of the M&A activity in the energy sector has been driven by the continued prominence of US shale gas exploration and development. It has attracted considerable international investment and also encouraged many of the US players to refocus their efforts on North America. In some cases, this has buoyed M&A in other regions as international assets are divested to fund North American reinvestment.
Shale gas will continue to be a key driver in M&A activity in the remainder of 2013 and beyond. In Australia, we expect majors to maintain interest in shale opportunities (such as Chevron’s recent farm-in to Beach’s Cooper Basin shale interests). Continuing funding constraints on small/mid-cap explorers will also create significant opportunities for potential buyers with strong balance sheets.
In the Australian LNG sector, there is potential for ongoing divestments (or even further asset swaps) as participants realign their portfolios and priorities, for example forming a view on floating liquefaction plants over traditional onshore facilities. Long-awaited consolidation among the Queensland coal seam gas to LNG projects may also arise during the remainder of 2013 and 2014, at least in relation to pipelines or other non-core infrastructure as proponents seek to deal with ongoing cost pressures. Buy-side interest in the LNG sector, particularly from China and Japan, remains high.
The global disparity between low gas prices in the US and much higher prices from international LNG projects is also yet to play out. We also expect to see the NOCs – and not just those from Asia – continue to expand internationally, driving up competition for attractive assets in all jurisdictions. New hotspots such as Kurdistan, Israel, East Africa and the Arctic are also emerging and we anticipate further investment and M&A activity in these regions.
Paul Murphy: I specialise in nuclear power, and – with the exception of the reactors under construction at Watts Bar, Vogtle and Summer – all the new-build activity is occurring outside the United States. There is a trend towards government-to-government transactions, with financing being one of the key determining factors in whether or not projects move forward. After Fukushima (in March 2011), there was a pause in new build, as well as in programmatic planning; however, as we have gone beyond the second anniversary of that event, there is heightened activity in the sector, with China, India and the Middle East being areas of particular activity, and the UK being another potential area for significant new-build opportunities (assuming that the UK government and EDF can reach agreement on the “contract for difference” pricing mechanism).
Douglas Glass: While some regions have experienced something of a slowdown in M&A activity, we have seen considerable activity in emerging markets. Some companies have decided to exit areas that have experienced political turmoil, such as Egypt and Libya. And at the same time, buyers have seen opportunities in areas where the political and attendant economic risk may be challenging, but where the rewards are large – for example, in new frontier areas of offshore East and West Africa, and in places like Vietnam. Buyers and sellers have also been active in Brazil and Kurdistan. Somewhat surprisingly, some of the medium-sized independents such as Apache, Hess and Chesapeake are trying to slim down and improve their focus and their balance sheets, which has led to sales inventories industry-wide picking up. As mentioned by Angus Jones, shale oil and gas continues to attract buyers who are finding people who want to cash in on their good fortune. There have also been a few large deals, such as the BP–TNK transaction; and we have also seen activity in the MLP space, such as the recent Crestwood Midstream Partners–Inergy deal. Our firm worked on both of these.
Uwe M Erling: Transactional work in the energy sector has been particularly strong in Germany in the previous years. This trend is driven mainly by the fact that we see numerous foreign investors trying to enter the German renewable energy market (which is still considered one of the most advanced of such markets). In addition, given the highly competitive renewable energy market, we have seen a strong trend for consolidation and a need for recapitalisation, especially in the area of solar power companies. A number of domestic solar companies were forced to sell or had to look for new capital and investors. This trend has generated additional legal work in the area of finance and corporate restructuring.
Craig Spurn: We’ve seen some slowdown in transactional work in the energy sector in Canada over the last four or five quarters, up to the second quarter of 2013. In particular, public M&A in the oil and gas sector has tailed off dramatically. At the moment, there appears to be a significant inventory of assets on the market but a lack of serious bidders. While there has been more private equity interest in the oil and gas sector in 2013 than in 2012 this has not made up for international companies slowing down their pace of acquisitions in Canada this year. However, we are seeing more pre-bid activity right now than we did at this time last year and, accordingly, in the medium term we see transaction activity picking up significantly, as players in the sector gain greater confidence and certainty with respect to the establishment of LNG export capability in Canada and increased pipeline and other crude oil export capabilities.
Mathew Kidwell: Over the last 12 months, transactional volumes in the oil and gas E&P sector have been buoyed by a number of factors and trends. In particular, there has been a growing trend among publicly traded IOCs (including majors) to rationalise, consolidate and focus their asset portfolios, so stimulating increased A&D activity. The driving force for this has been an increasing investor perception of widening divergences in the environment for oil and gas developments across various provinces and countries – whether in gas price variations, political and regulatory risk, market conditions, access to capital and competition from a wider variety of industry players with differing strategic priorities. Against this background, the overseas investment arms of Asian national oil companies have been developing an increasingly diverse appetite for strategic energy investments and taking advantage of the new investment opportunities generated by IOC asset rationalisation. At the same time, new development opportunities have been opening in the frontier provinces in Africa, as well as through various licensing rounds in Brazil, South East Asia, the Eastern Mediterranean and elsewhere.
Who’s Who Legal: Have there been any significant regulatory developments in relation to the energy industry in your jurisdiction or are you expecting any in the near future? What impact are they having or will they have on the sector and the legal market?
Angus Jones: Companies in Australia are still working out the effect that the Clean Energy Act (carbon price) will have on the energy industry as a whole. Larger companies are rolling out compliance programmes, but with the Federal Opposition committed to unwinding this scheme if elected at the general election due in September 2013, there remains considerable uncertainty.
The new rules for coal seam gas development, particularly in New South Wales, has led to some projects there being put on hold. The development of these projects, and the competing interests of landholders, is expected to lead to increased tension/competition between export and domestic demand.
Federal environmental approval (the last required approval to go to production) has recently been given to Toro Energy’s Wiluna Uranium Project. This marks the practical end of a long period of no uranium production in Western Australia (the official ban was lifted in 2008), a region that has high prospective areas for uranium and several proposed projects, so uranium could become a large new export industry for the state. Australia is estimated to have a third of the world’s uranium, so new approvals are promising for the sector nationally.
Paul Murphy: Specifically with regard to the nuclear sector, some countries decided to exit nuclear power (eg, Germany), whereas many other countries have continued to pursue nuclear power as a viable form of clean, baseload generation. Nevertheless, heightened safety standards, coming out of the “lessons learned” from Fukushima, will have an effect on new plant design and build requirements, as well as imposing upgrades on the existing fleet, with associated costs being rather significant. Utilities in Germany and Japan have particularly suffered from the lost revenue from power generation, due to fleet-wide shutdowns imposed by their governments, as well as the impending and accelerated decommissioning costs for those units that will not resume operations.
An area to watch is the renewable subsidy arena, as subsidies are coming under pressure from two angles: first, with governments under increasing fiscal pressures, subsidies are being carved back; second, subsidies to renewables have had market-distorting effects on the power sector, as baseload generation, especially in Europe, is under intense market pressures, with gas plants shutting down and power producers also turning to cheap coal, which puts further pressure on carbon-reduction goals.
Another development is the third revision to the Equator Principles, launched on 4 June 2013 and which will affect applicable transactions entered into on or after 1 January 2014. The expansion of the Equator Principles reveals yet another data point in the continued and growing trend of reputational risk considerations – in this case, environmental and social considerations – in modern lending practices.
Douglas Glass: On the regulatory side, one cannot escape the various country and US state-specific attempts at regulating hydraulic fracturing. Some efforts have been abandoned, whilst others (France) are in place, seemingly for the medium or longer term. The focus is not only on the alleged effects of injected chemicals, but also on the prolific use of water and the effect of the withdrawal of groundwater that would otherwise be potentially available for agriculture and domestic purposes. How all of these efforts will play out will affect the ability of the industry to continue the “shale revolution”. Aside from this, there is the United States Dodd-Frank rule on the disclosure by US reporting companies of payments of all kinds made to foreign governments. Industry continues to push back on the implementing regulations on the basis that to make such disclosures in the detail required will force disclosure of competitive information that the companies would otherwise not wish to share with their competitors. And industry has pointed out that the effort is a misplaced desire to ferret out corruption, when in fact virtually all payments made under foreign concessions, licences and production-sharing contracts are not subject to the various anti-bribery and anti-corruption legislation.
Uwe M Erling: There is strong competition between renewable energy installations and conventional power stations in the German energy market. However, with regard to the legally protected priority right of renewable energy installations to feed into the grid, fossil fuel-based power plants increasingly face a situation where the operation of the plant is not viable anymore. The same applies also to hydro pump storage facilities. A number of utilities have therefore put their plans to build such facilities on hold. This is particularly of concern as power generated from renewable energy installations is highly volatile. The operations of fossil fuel power stations and hydro pump storage facilities are required to stabilise the grid. In particular, when there is a high demand for power (as is the case in winter) and the sun does not shine, the volatility in the grid causes severe problems. This situation is even more troublesome with sufficient transmission lines between the north and south of Germany still missing; and the building of those lines is expected to take some time. In order to stabilise the grid, last winter the German Federal Network Agency ordered a number of fossil fuel-based power stations in the south of Germany to stay in operation as a so-called cold reserve in order to balance a high intake of wind power generated in wind farms in the north of Germany. Clearly this kind of emergency action hardly qualifies as a permanent solution. The regulatory framework for renewable and fossil fuel power plants needs to be adjusted quickly to break up this imbalance.
Craig Spurn: The most significant recent legal developments in the Canadian energy sector have been announcements by the government of Canada in respect of revised guidelines under and proposed amendments to the Investment Canada Act. In December 2012 the Canadian government announced it had approved the $15.1 billion proposed acquisition of Nexen Inc by Chinese state-owned CNOOC Ltd, and concurrently announced the approval of Malaysia’s PETRONAS Carigali Canada Ltd’s proposed $6 billion acquisition of Progress Energy Resources Corp, having determined that under the Investment Canada Act each transaction will likely be of net benefit to Canada. With this announcement, the government of Canada introduced new guidelines for the review of investments in Canada by state-owned enterprises (SOEs), including that acquisitions of control by SOEs of a Canadian oil sands business will, going forward, be found to be of net benefit on an exceptional basis only and that SOE transactions will be closely monitored, particularly in respect of the degree/influence an SOE would likely exert on the Canadian business being acquired and the extent to which a foreign state is likely to exercise control or influence of the SOE. The Canadian government has subsequently introduced proposed amendments to the Investment Canada Act to, among other things, clarify its definition of “state-owned enterprise” to include agencies, entities and individuals acting under the influence, directly or indirectly, of a government or government agency and to apply a lower review threshold for investments by SOEs compared to non-SOE foreign investments.
Prior to this clarification, there was some uncertainty as to the Canadian government’s position with respect to foreign control transactions and as a result we saw more greenfield investments, syndicated investments and joint venture transactions in the place of control transactions. These developments are, overall, positive and confirm that foreign investment is welcome in Canada. The investment rules are now clarified such that SOEs and non-SOEs should have a high degree of confidence that investments into Canada’s energy sector will be permitted, with only the strong caveat in respect of SOE control transactions in the oil sands.
Mathew Kidwell: The growing perception of potential of European shale gas plays has regrettably not been matched by resolute action by governments to kick-start this industry. In the UK, for example, the Bowland shale in Lancashire is a mile thick and yet, in the face of vigorous Gaslands environmental lobbying, the Department of Energy and Climate Change has been faltering in its development of a regulatory framework to facilitate fracking operations. At the end of last year, the UK government did, however, lift its temporary ban on shale gas exploration, with the result that renewed fracking campaigns can start to generate a more accurate picture of how much of the resources are technically and commercially viable. Elsewhere, a complete moratorium remains in France on hydraulic fracturing, despite France being considered as one of the most promising countries in Europe for shale gas. Separately, as other panellists have emphasised, oil companies operating internationally continue to devote extensive resources to developing compliance systems for the Dodd-Frank rule on government disclosures, as well as for international anti-bribery regulation (recently augmented by the UK Bribery Act), particularly as it impacts on supply chains and subcontractors.
Who’s Who Legal: What are the main energy products imported and exported in your jurisdiction? Are there any issues around these imports and/or exports?
Angus Jones: Coal, natural gas, uranium, crude oil and LPG are the main exports. However, Australia is a net importer of crude oil and LPG. No uranium is consumed in the Australian domestic market, and there has been resistance to uranium mining in many Australian states until recently. Growing commercialisation of coal seam gas reserves in Australia (for both export and domestic use) remains contentious. Issues for coal seam gas include resistance from local communities/landholders and environmental groups, particularly in relation to the impact on water resources.
With as many as nine offshore projects currently looking at the possibility of using floating LNG technology, this development will significantly alter the Australian petroleum industry. The decision to proceed with an offshore floating liquefaction plant means companies can avoid issues associated with onshore processing facilities (including development restrictions, native title and environmental requirements/opposition and also domestic gas reservation policies of state government) and governments of all levels need to consider the balance between projects proceeding and maximising local content/employment opportunities.
Paul Murphy: Shale gas, through the use of fracking, has dramatically changed the energy landscape in the United States. While the regulatory and environmental stories are still being written with regard to that sector, it has changed the way that utilities view energy markets and new project development in the United States. Cheniere’s Sabine Pass project is a clear example of the impact of fracking, turning an LNG import terminal into an export facility. Moreover, there is now a bit of a debate as to the level of products that should be exported from the United States, as foreign markets (eg, India, Korea, Japan) look at US natural gas prices and see the benefit of US-exported gas to such countries. Enhanced oil recovery techniques are also changing the energy position of the United States, and it will be interesting to watch how OPEC responds to new (and significant) oil production coming from the United States.
Douglas Glass: The major development that continues apace is the effort to export LNG from, rather than import LNG into the United States, something that a few years ago was not only unthinkable, but practically impossible. The extent to which these initiatives will be implemented will depend in part upon policymakers, as there are politicians who are opposed to the idea. An additional factor is the requirement to obtain approval of such exports, even when the ability to export is demonstrated, to non-Free Trade Agreement countries. The other continuing saga over global exports of petroleum products involves the contest between Russia and various other exporting and importing countries over natural gas. Russia’s historical dominance over central and eastern Europe as an energy supplier continues to be tested by parties who produce natural gas, parties who hope to produce more natural gas and parties who want to build new pipelines to provide an alternative market to Russian gas. This continuation of the Great Game in Central Asia is being closely watched by market and political observers.
Uwe M Erling: Clearly, oil and natural gas remain the primary energy products to be imported in Germany. The liberalisation of the energy market, and the growing importance of natural gas for the energy supply, have paved the way for new players to enter the market. However, as the spot prices for natural gas over the last year very often fell significantly below the prices that parties agreed in their contracts, such parties increasingly try to renegotiate or exit such contracts. We have seen an increase in litigation and arbitration in this area. As for energy exports, it is highly interesting to see that Germany – although it has shut down eight nuclear power stations after the Fukushima accident – still remains a net exporter of power. To the surprise of many, Germany in 2012 has exported a total of 66.6 terawatt hours (TWh) and imported 43.8 TWh. Moreover, the net amount of exported power has quadrupled from six TWh in 2011 to 22.8 TWh in 2012.
Craig Spurn: Canada exports significant amounts of coal, crude oil and natural gas – the latter two effectively limited to exports to the United States. The dramatic turnaround, in recent years, in the United States’ domestic production of crude oil and natural gas has highlighted the critical need for the Canadian energy sector to develop export capabilities to other markets and particularly to Asia. There are several proposed LNG export terminal projects and linked pipeline projects to allow the export of LNG. Similarly, there are several new pipeline proposals to unlock the vast production potential of Canada’s oil sands. These projects face critical financial, environmental, regulatory and public opinion challenges that will have to be overcome before Canada has meaningful export capabilities to destinations other than the United States.
Mathew Kidwell: With its own gas production in long-term decline, the UK has become increasingly dependent on LNG imports, such that it became the largest market in Europe for LNG in 2011. The UK’s demand for natural gas is such that some industry analysts are predicting a substantial capacity crunch for natural gas around the corner. In due course, US shale gas supplies will start to impact on Western European gas markets, with ExxonMobil and Qatar Petroleum having recently agreed to make capacity available at their South Hook receiving terminal for gas exports from the Golden Pass export terminal project in Texas. Similar deals have been signed by BG and Centrica for US LNG exports. Those exports are, however, unlikely to commence for at least five years while US permits for the various export terminal projects remain pending.
Who’s Who Legal: What has been the impact of the major energy disasters of the past few years, such as the 2011 Fukushima nuclear disaster, the 2010 Deepwater Horizon (BP) oil spill and the 2009 Sayano–Shushenskaya hydroelectric power plant blast, on the energy market?
Angus Jones: The 2011 Fukushima incident had numerous consequences, including a spike in LNG demand as power generation switched to gas – but interestingly, not a corresponding (supply/demand) spike in spot prices. Sellers did not take advantage; this is reflective of the value of long-term relationships with Japanese buyers. It also spurred the development of alternate energy (eg, methane hydrate) solutions for Japan (reliance on expensive “foreign” gas is a hot political issue (and featured heavily in recent elections) and influenced M&A activity and Japanese trading houses/utilities active in global markets (Australia, Canada, Middle East) as they seek to ensure security of supply.
The 2010 Deepwater disaster, plus the 2011 Montara incident off the Australian coast, have been central in the move to establish national (not state) based safety and integrity authorities. In Australia, the increasing safety oversight of the oil and gas industry (particularly in offshore territories) is increasing the reporting and compliance burden on companies. This has been reflected in recent negotiations of joint operating agreements (JOAs) that we have been involved in, with increased indemnities of operators and more stringent security requirements imposed on all joint ventures to ensure they can “pay their share” in the event of an incident. We have also seen increased focus on the insurance provisions in JOAs.
Paul Murphy: Any time that there is a large-scale industrial accident, there is a renewed focus on safety. Safety should always be a top priority, but such disasters provide opportunities to see facilities in a different way and draw new “lessons learned” from such events, which can then be applied to future projects, as well as facilities in operation. These industries are never static environments, but there are certainly “watershed” events that, after the passage of time, demonstrate that industry has fundamentally changed the way that it has done business. For the nuclear industry, Three Mile Island was that first watershed event, and the industry has emerged stronger from it, taking lessons and applying them internationally through the use of industry groups that have promoted the open exchange of information. Similar progress will come from Fukushima, but we must continue to challenge ourselves to find better, safer, more efficient ways to develop and operate these projects. At the same time, there is a tendency to overreact to these events, especially in the heat of the moment. As a result, it is critical that rational decisions are made, based on a prudent assessment of the facts and the ability to distinguish between a “fixable” flaw and a “fatal” flaw. It is quite telling that, after the passage of time, the new Japanese government has already reassessed its view towards nuclear power, recognising the necessity that nuclear power generation has for the country.
In parallel, it will be interesting to monitor the decisions of plant operators, who are faced with significant costs to match the post-Fukushima safety standards and corresponding upgrades. For smaller and older plants, such upgrades might not be considered economical, given current market conditions and the remaining useful life of the assets in question, resulting in permanent plant shutdowns.
Douglas Glass: Anyone who has negotiated offshore drilling contracts and service contracts since the Gulf of Mexico Macondo blowout knows all too well the impact of the Deepwater Horizon accident on indemnity provisions, insurance requirements and other safety-related issues. This is true whether the project is in the Gulf of Mexico or other deepwater projects. While such focus puts a premium on what contracting draftsmen do, it also results in increased costs for the industry as a whole. But the industry has responded appropriately, and companies are designing new and enhanced features to deal with deepwater drilling and to protect environments in frontier offshore areas such as the Arctic, Africa and South America. An as-yet-unknown by-product of the Fukushima disaster is the effect on the development of any future nuclear energy development. At present, the glut of natural gas in the US, and the related global LNG development is a natural buffer against any such plans. Whether other governments will turn to nuclear energy anytime soon remains to be seen, but the memory of the Fukushima event presents a significant challenge for any policymaker.
Uwe M Erling: Energy production in Germany will be under major reconstruction for the next decade, or perhaps longer. Massive investments are due since the German government adopted an energy transition after the nuclear catastrophe of Fukushima. The planned shutdown of 17 nuclear power stations by 2022 (instead of 2036 as originally planned) is forcing Germany to rapidly find new sources of energy for a quarter of its electricity supply. This conversion is particularly expected to push the development of renewable energy projects even further. The share of renewable energy is meant to increase from the current share of 23 per cent to 35 per cent by 2020. Given this fundamental change in energy policy (and expected investments) there is an increased demand for project advice. There has never been a better time to be an energy lawyer in Germany.
Craig Spurn: We’ve seen similar developments in our practice and experience in Canada, and the repercussions have been felt in a number of ways. In particular we’ve noted the emphasis that many major economies are now placing on natural gas because of its relative safety and because its environmental impact compares favourably to other fossil fuels and sources of energy. This has clearly led to a greater interest in investing in natural gas production and LNG exportation around the world, including Canada. We’ve also seen a greater emphasis on effective and enforced environmental regulations and a great deal of public activism in this area, which has greatly hampered efforts to develop crude oil export pipelines, such as the Gateway Pipeline and Keystone.
Mathew Kidwell: The Deepwater Horizon spill has of course had a major impact on the risk profile and economics of deepwater operations. Both the increased perception of risk and associated demand for insurance and the prospect of increases in actual liabilities (such as government moves towards raising or removing the cap on pollution liabilities) has been driving up the cost of insurance. For deepwater operations, insurance costs have risen by around 50 per cent since Deepwater Horizon. The heightened perception of risk, particularly in technically challenging offshore operations, has led operators, non-operators, service companies and equipment providers to adopt a more precise and forensic approach to risk management through revised and updated policy working and careful engineering of contractual indemnities. Similarly, the ongoing rounds of litigation resulting from the accident continue to test and reveal a variety of routes for parties to reallocate or lay off risks and liabilities that are not always intended (such as through “additional insured” provisions).
Who’s Who Legal: We heard reports from around the world of firms growing their energy practices and lawyers keeping very busy. Is this the case for your firm? What impact has the growth in energy practices had on the legal market? Are you seeing firms looking to enter the market, either through lateral hires or mergers?
Angus Jones: This was the case for the last year or two but, consistent with our comments above in relation to the level of M&A activity, growth seems to have slowed in the last six months. In terms of other firms, we do see some “rebranding” by lawyers, but generally the sophisticated clients want genuine oil and gas/energy lawyers on their significant transactions, so we most often see the firms that are traditionally strong in this sector rather than new names.
Paul Murphy: Milbank has historically been known for its power and energy, and infrastructure practices. Energy and development go hand in hand; consequently