Taken in isolation – and at £35bn, one of the largest oil and gas deals on record stands pretty well on its own – the acquisition of BG Group by Shell could be seen as a bellwether for a confident oil and gas market. But headline deals aside, the freefall in oil prices has had a lasting negative effect on the sector. And while the price of crude passed the psychologically important level of $50 per barrel recently, the attritional effect of the last 18 months is there to see.
When the BG/Shell tie-up was announced in 2015, chief executive Ben van Beurden said the addition of BG’s natural gas business made strategic sense, ahead of the long-term growth in demand Shell predicts for this cleaner-burning fuel.
While, the backdrop of falling oil prices – which worsened by the time the deal completed in February – led critics to suggest Shell paid too much for its new asset. Legal director Donny Ching argues the business case was clear.
‘There was a lot of debate about whether this was the right thing to do for Shell but at the end of the day 86% of shareholders or so backed us. They saw the strategic fit and it all boiled down to that. Adding BG’s strengths in upstream deepwater and in liquefied natural gas helped advance our strategy by about ten years, it was just so compelling.
‘The precipitous drop in the oil price created a lot of negativity in the market around the deal but when you sit down, particularly with institutional investors, you look at a strategy and you look at the complementary fit of their business with ours and you take a
The buyer universe is very different now. Sovereign wealth funds, private equity and individuals set up funds to invest in oil and gas.
Donny Ching – Shell
Ching’s point about market gloom is understandable: the market has been awash with failed mergers, joint ventures and projects. 18 months ago all the international oil majors – BP, Total, Chevron, ExxonMobil and Shell – had their credit ratings downgraded. Senior legal counsel find themselves in the eye of the storm. Aborted bids and ultimately fruitless due diligence exercises have taken their toll on in-house teams.
‘The BG/Shell merger was announced when there was still turbulence and it took the market by surprise – it was definitely a strategic play by Shell to move into BG,’ says Anna Howell, co-head of the global energy group at Herbert Smith Freehills. ‘That deal has inflated figures for last year as, if you look at the number of deals rather than the value of the deals, they are very low. There is a sharp drop compared to other years.’
Howell is not alone in her analysis – private practice partners at leading international firms as well as senior energy in-house counsel have noted a marked decrease in M&A activity in the last six to eight months. There are a lot of assets for sale but very few concluded deals. A reason for this is the falling price environment making it very difficult for buyers and sellers to have price convergence. The only deals being done are either strategic, such as Shell/BG, or distressed.
‘There is a bit of activity at the top-end of the market but there hasn’t been the amount that people expected,’ says Anthony Patten, project development and finance partner at Shearman & Sterling, who was once in-house counsel at Shell. ‘That has been because of uncertainty over where the oil prices might end up. And it has also got to do with the fact that some of the companies people expected to be distressed haven’t fallen into difficulties as quickly as people thought.’
Even those companies with cash and resources to make acquisitions in distressed markets are holding back because, as Milbank Tweed Hadley & McCloy partner Matthew Hagopian points out: ‘Buyers don’t feel confident with the pricing curve. They don’t have confidence in their valuations or that an acquisition will give them a good position within a defined time period.’
The result, according to Hagopian’s colleague Manzer Ijaz, is exploration activity grinding to a halt. ‘There are big players out there who are sitting on a lot of cash and looking for opportunities in exploration – not to develop but to buy when it’s cheap.’
There is some movement – mostly divestments. Ching says that Shell has committed to making over $30bn worth of divestments, mostly as a result of the acquisition of BG, while Jorge Perez-Vera, senior legal counsel at Total Marketing & Services, says: ‘Divestments have been a long-term trend over the last ten years, many oil companies have divested in downstream for instance.’
Another route for companies looking to improve their positions is to explore interim phases before full consolidation, increasing their capital through asset sales or strategic corporate deals, such as joint ventures.
‘In the past you used joint ventures only in cases where you didn’t have any option,’ says Perez-Vera. ‘Now it is becoming part of the strategy to share the risk with other people. In some countries you need a local partner, because local partners have assets, knowhow, money, skilled people – doing business together makes sense in this case. It is definitively a new trend.’
Certainly in the context of depressed oil prices, there is more collaboration. Oil companies are tendering together, there is more rig-sharing, more joint ventures. Companies are coming together to try and optimise different parts of their businesses.
Barbarians at the well
A consequence of an energy sector in flux has been an increased interest coming in from alternative investors. New players coming in include private equity and hedge fund clients – who are looking at distressed opportunities.
Significant names in private equity focused on the energy sector include The Carlyle Group and Blackstone. Houses like Warburg Pincus and Riverstone have been around for a while and their focus seems to be more moving into things like renewables rather than oil and gas (for more on renewables, see boxout).
‘In the future I see private equity doing more deals – in the midstream they have been successfully closing deals, but in the upstream it’s been slower, so I think there will be more private equity coming in but not until there is better price convergence,’ Howell says.
Cleaning up: challenges for the renewables sector
‘You can reasonably say the shift towards renewable energy has been going on for ten years, certainly the last six or seven years has seen an increased acceleration,’ so says Tom Cowling, general counsel of green energy supplier Ecotricity. With momentum firmly behind finding cleaner fuel alternatives and with oil prices frozen, one might expect renewables companies to be thriving. However, there are inevitable bumps in the road in one of the most highly politicised and highly regulated sectors in the UK.
‘Renewables are referenced against even the price of oil, because if the price of energy is cheaper overall, renewables looks less clever in that context,’ says Richard Goodfellow, head of energy at Addleshaw Goddard.
‘The drop in oil prices has not been beneficial for renewable energy at all. Renewable energy is a substitute competitor to oil and oil-powered gas stations are now cheaper to run than they were three years ago,’ adds Cowling.
In addition, the renewables sector has hit what Cowling describes as ‘a significant roadblock’ following the general election in the UK last year – subsidies were cut for future projects, including projects that were already under development. As such, consolidation is likely to follow in a difficult and challenging environment.
‘Management is going to need to be agile; management is going to need to have the ability to diversify and think on its feet. If you are just in the business of turning fields into solar parks or fields into windfarms, then you might be struggling,’ comments Cowling.
‘The buyer universe is very different now,’ says Ching. ‘We are looking at sovereign wealth funds, private equity and individuals who set up particular funds to invest in oil and gas. It is less traditional oil and gas players. And that requires us to learn about how they look at things, and how they value certain businesses and certain efforts and all these things – it is a continuous learning process.’
However, Patten warns against overhyping the role played by private equity investors and says while many companies have been trying to sell assets there have been few buyers.
However, he adds: ‘We are seeing private equity firms interested in energy assets, particularly energy infrastructure, which suits their investment model.’
Drain on resources
But sluggish M&A activity in the sector does not equate to quiet periods for legal teams at major energy companies. In-house lawyers remain busy – operating in one of the most complex and heavily regulated global industries.
‘Now that we have done the BG transactions, we’ve got a commitment out there that we will be doing $30bn of divestments so we have moved lawyers back into M&A again,’ says Ching. ‘Having a very large and deep pool of lawyers allows us to be flexible in terms of how we deploy our people.’
‘The fall in oil prices has created a new environment – that is for sure,’ says Perez-Vera. ‘Many big projects in the upstream area that were progressing have been stopped or reorganised. The oil companies are becoming more selective in their investments and there are lots of internal reorganisations in progress. You cannot spend money as you did in the past – so you are cutting costs, reorganising the teams.’
The fall in oil prices is forcing boards to look at how they resource their businesses generally and that extends to functions like legal. It will be interesting to see how this plays out, because it impacts both on the ability to outsource work but also the actual cost of the in-house department and staff numbers.
Private practice lawyers and general counsel report a significant movement towards bringing more work in-house. However, they themselves might have hiring freezes so not only can they not add to their team – they have more work than they had before.
Externally, there is much more competitive tendering for work, because every oil company is on a cost-cutting drive and needs to justify why it is appropriate to hire a particular law firm. Although expertise is of paramount importance, they also need to justify their rates.
A recent example of this is BP, whose current panel members were told in May that they will now be required to pitch against each other for instructions worth over $1m in legal fees, in a bid to curb costs. The move comes after BP increased scrutiny of its cost base when profits dropped 51% in 2015 to $5.9bn following the slide in oil prices. And as BP’s most recent quarterly results show, it took a $917m charge for the 2010 Gulf of Mexico oil spill, taking the total fines to $56.4bn.
‘Where we used to ask for external services in the past, today the first reaction is to try and do that job internally,’ says Perez-Vera. ‘As much as we can, we try to do the job internally. We try to do more with the same number of people.’
Internal resourcing is a particular issue, with the pressure to drive down costs juxtaposed with the need to have bodies in order to handle more matters internally. Shell, for example, has restructured its legal team post-merger with BG and has recently announced plans to open its own offshore legal centre to service the oil giant’s global operations. A projects team, reporting to Ching, is currently scouting possible locations and considering headcount numbers for the centre, with a brief to come back by autumn.
Oil companies are becoming more selective in investments. You cannot spend money as you did in the past – you are cutting costs, reorganising the teams.
Jorge Perez-Vera – Total
‘For us it is more about saying – how do we become not just more efficient but also more productive?’ he says. ‘We are looking at various things – are there things we don’t need to do? Are there things we can teach the business to do? Are there things that we can move offshore? Initiatives we are looking at have enabled us to be more efficient and productive and therefore allowed us to reduce some numbers.’
In May, Shell announced that it was closing three UK offices, including BG’s headquarters in Reading, with the 800 staff there being offered the chance to move to Shell’s London base. A voluntary redundancy plan is ongoing to cut a total of 10,300 jobs across the merged group, with 7,500 from the original Shell business and another 2,800 following the takeover of BG. Ching says: ‘In truth we are not reducing that many numbers.
We are reducing some numbers purely in response to the drop-off in business demand – we are not doing as many projects now because of affordability issues and because of a result of that it allows us to reduce the number of project lawyers.’
And, according to Addleshaw Goddard’s head of energy Richard Goodfellow, talent development is a key issue for in-house teams in the sector.
‘They are under pressure for budgets for their own team. Energy will always be a hot topic for private practice law firms, so their really good people are always getting poached and they are really hungry for ways to help bolster, keep and develop their team. If they are under cost pressures one of the main things they can do is internalise the work but if their team is unable to handle that work then they are unable to do that.’
Despite the pressures GCs in the energy sector face, the key challenge in the current environment is to make sure they have an in-house team that is flexible and adaptable – not just for the present but for foreseeable needs they may have further down the road.
‘My view right now is that more corporate and commercial experience is required in-house because it is likely that acquisitions and disposals will increase,’ says Tom Cowling, general counsel of green energy supplier Ecotricity. ‘You may find that actually what GCs need is more advice and support on what assets their companies have got, what assets they want to buy.’
‘What I’ve always admired about my legal team is that when things get tough they just get going,’ adds Ching. ‘We all know that in good times and bad times there is always going to be legal work. To a large extent the nature of the work changes, so it was just a question of redeploying people to do different things. As M&A dried up a little bit – apart from BG – we moved our people to contract renegotiations and we recently renegotiated over 2,000 contracts with some of our key suppliers.’
If the turbulent times demand versatility, thankfully the energy sector has long attracted some of the most talented and technically polished lawyers working in industry. The next few years looks certain to give such counsel plenty of opportunities to demonstrate their value.