November 29, 2012 5:02 am
Entries for the energy section of this year’s US Innovative Lawyers ranking speak volumes about the way the industry is changing.
The countries involved in the deals entered include Brazil, China, India and Venezuela – rising or potential powers in global energy.
Deals in the US reflect the way the shale revolution is transforming oil and gas production, leaving other emerging energy technologies fighting for space. The landscape of 20 years ago has been transformed. Mature oilfields in places such as Alaska and the North Sea are in decline, and the large western groups that traditionally dominated those areas are struggling to find growth.
Now, these groups are looking to new frontiers in Africa, Latin America and Asia, and investing in “unconventional” resources not previously accessible on commercially attractive terms, which have been opened up by improvements in production techniques.
They face challenges from rising companies in the emerging economies. Such companies are appearing as significant forces in world markets, often helped by cheap capital or large domestic resource bases, or both.
At the same time, governments in most developed countries, as well as in some emerging economies, are backing investment in renewable energy sources, such as solar and wind power, in a bid to strengthen energy security and cut pollution, including greenhouse gas emissions that contribute to climate change.
As markets and technologies evolve, legal and financing structures are moving with them. New participants and new types of business are creating new challenges.
One striking example among this year’s entries is a “south-south” deal between PDVSA, the Venezuelan state oil company, and Industrial and Commercial Bank of China. PDVSA, advised by Hogan Lovells lawyers from its Beijing, Caracas, Washington, London and Amsterdam offices, wanted to borrow against future revenues. ICBC was willing to lend but there was little precedent for the transaction: a Chinese bank had completed an oil pre-payment financing only once before, and never in Latin America.
The solution involved setting up a special purpose company in the Netherlands, owned by an orphan trust, as the route for the oil sales, giving ICBC the security it required. Meeting the particular requirements of the Venezuelan and Chinese parties required what the firm describes as a “complex three-tiered structure”.
In another transaction involving two companies from emerging economies, Michael Bolton of DLA Piper led a team working for TNK-BP, the Russian joint venture 50-per-cent-owned at the time by BP of the UK. The $1bn deal with HRT Oil and Gas, a Brazilian independent company, gave TNK-BP a 45 per cent interest in 21 oil and gas exploration blocks covering 48,500 square kilometres in Amazon’s Solimões Basin in northern Brazil.
As with the PDVSA/ICBC financing, the alignment of two companies from very different cultures and systems was the greatest challenge. TNK-BP has in the past concentrated almost exclusively on its Russian home territory and is having to build its understanding of international dealmaking.
Inside the US, the issues are different. One key factor in many deals is the existence of the master limited partnership (MLP): a tax-privileged structure, protected under 1987 legislation that allows its use for companies in a handful of industries, including natural resources.
The MLP has been a favoured model in the “midstream” pipeline business, where relatively stable revenues allow for high rates of dividend distribution, but it is also increasingly used for oil and gas production. The restrictions attached to these structures mean that deals are often more complex than transactions involving registered corporations. For example, in the $2.9bn sale of the propane operations of Energy Transfer Partners (ETP) to AmeriGas Partners, two MLPs, the two parties wanted a deal structure that would deliver ETP a significant amount of cash upfront but also allow it to defer the tax.
Shearman & Sterling, working for AmeriGas, helped to come up with a rarely used structure, in which ETP provided a contingent residual guarantee for the $1.5bn cash component of the deal paid by AmeriGas, enabling it to defer the capital gains tax liability from the sale.
Vinson & Elkins, ETP’s legal adviser on that deal, also worked on the creation of a new variety of MLP – one with a stated intention of paying variable dividends over time, depending on its performance. (The standard MLP aims to have steadily rising distributions, if all goes well.)
The importance of the innovation is that it allows companies in cyclical industries to benefit from the tax advantages of the MLP structure. It was used for a company that focuses mainly on making fertiliser, which had an initial public offering in April 2011.
As the US frets about the approach of the fiscal cliff, there has been speculation that MLPs’ tax-favoured status could be under threat. Changes in tax and regulation are an ever-present hazard in the energy business, as are upheavals in technology and markets. Right now, the industry is evolving particularly rapidly.
Lawyers will need to continue to innovate in order to keep up.
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