Looking at legal issues borne out of the oil price

Certainly the region itself comprises of countries at completely different stages of development of their upstream sector, production profiles and ability to manage a low oil price environment. However, aspects of what we summarise below will be relevant in whatever oil province one is considering.

With every decline, comes opportunity. Upstream companies with strong balance sheets and operating in low cost basins will be well positioned to weather this dip in the oil price.

As well as a selection of the oil majors and international oil companies, this environment represents a good opportunity for oil hungry nations through their national oil companies and investment funds to acquire assets at all stages of the project cycle.

Risk appetite and investment horizons amongst these players differs – some are comfortable with non-operator minority equity positions. In any case, many are currently finalising their overseas investment strategy which, as well as hydrocarbon related issues, is being defined by appetite for above surface risk in host countries – political, security, regulatory and legal.

Currently we are advising various clients on these issues from a legal or regulatory perspective including how these risks may be best mitigated as part of our clients’ evaluation of possible investment opportunities.

Based on the work coming across our desks, we agree that there will no doubt be an increase in M&A activity. The first assets coming to market may principally be those owned by companies in a degree of financial distress.

However, as companies complete their portfolio reviews, oil price hedging arrangements expire, reserves based lending redeterminations are completed and buyer and seller price expectations start to align, we expect to see increased activity going into mid and late summer.

This is clearly less so in jurisdictions which are dominated by strong national oil companies and majors (for example Abu Dhabi, Saudi Arabia, Federal Iraq) but more likely in many parts of East and West Africa and Kurdistan-Iraq for example.

Structurally we may see an increase in hostile bids, traditionally not prevalent in upstream. The current financial climate may impose a sense of urgency and makes it very difficult to establish a common basis for valuation of potential targets.

Defensive mergers with shared exchanges may also increase in popularity, particularly amongst those companies which have suffered significant falls in their market capitalisation, to reduce the chances of these companies becoming prey.

Legal due diligence exercises in preparation for sale or buy processes are reflecting current issues of particular potential concern in the current environment.

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Particular attention must be given to pre-emption provisions and how they operate in the scenario of foreclosure by a distressed party’s lenders, existing security and indemnity arrangements which require to be released – and any relinquishment rights of host government in the case of seller’s in financial difficulty.

In addition, governments in the region are increasingly looking at appropriate allocation of liability in the instance of environmental catastrophe and eventual decommissioning. Increasingly this now requires an agreement between the seller and buyer, as to who picks up the cost in these instances.

It is imperative that material adverse change clauses are tightly drafted. It is just as important to state what is not a material adverse change, as well as what is. The interests of parties to a Joint Operating Agreement (JOA) are at risk of becoming increasingly misaligned as their financial positions and ability to absorb a low oil price vary.

Sole risk provisions take on increasing relevance in the current climate. There must be sufficient ability in the JOA for financially secure companies to break away from their less stable counterparts to progress with sole risk projects.

We are also seeing increasing scrutiny of the role of operator, and the requirement for greater oversight on how they discharge their functions from other co-venturers – restrictions on the co-mingling of funds and a more prescriptive Authorisation for Expenditure processes set out in the JOA.

This is in stark contrast to the position taken in the high oil price climate, where the contractual procedure would often be overridden by the custom and practice favoured by the parties.

In short, we are seeing greater flexibility to negotiate what were previously considered to be relatively boilerplate provisions of JOAs.

The declining oil price is having clear implications on the supply chain. This is the case throughout the region. Clients are driving a programme of cost reduction and project rescheduling, which is having consequences throughout the supply chain.

This is resulting in the renegotiation of contracts and sub-contracts and a deluge of contractual variation claims based on time delay.

Clients throughout the supply chain are currently preparing themselves for these discussions, including auditing of contractual performance to-date and, at host government level.

Reviewing the cost recoverability of expenses discharged in the development of projects. For lawyers, the low oil price environment has brought significant change in the types of work we are carrying out for our clients.

There will be winners and losers in the industry. For lawyers, our work continues to focus on the most effective ways to help our clients to measure and mitigate above-surface risk and position them in the best place to survive and prosper.