Welcome to the 2018 edition of Getting the Deal Through – Energy Disputes. We write this edition at a pivotal time for global politics and, consequently, for the global energy industry. While earnings have dwindled for some companies, others have begun to see brighter prospects ahead. Oil from countries such as Saudi Arabia, Nigeria and Algeria continues to move away from the United States and towards heightened competition in markets in Asia and elsewhere. Future energy demand is increasingly difficult to predict as technologies, policies and investor risks continue to change and evolve.
OPEC continues to stabilise potentially oversupplied markets. At the time of writing, OPEC has indicated that it will likely extend supply cuts implemented last year that helped remove nearly 180 million barrels from storage during that time. The success of this deal will depend on OPEC members’ continued adherence to their promises, plus the participation of non-member countries and the ability of US shale drillers to quickly increase production as prices rise. Additionally, political turmoil and debt crises in member countries such as Venezuela could have adverse consequences on the effectiveness of OPEC stabilisation efforts. Driven by increasing LNG export capacity, the US remains forecast to become a net exporter of natural gas in the coming years, the first time since 1955 that the US will export more natural gas than it imports. Continued efficiency gains will also make natural gas cheaper going forward.
Although prices of OPEC’s benchmark crude have fallen in recent years, markets and prices appear to be on the rise. Experts are optimistic about the growth of demand and near two-year highs for oil prices, as hedge-fund investment in oil futures approaches record highs. Despite recent gains, the global drop in the price of oil has resulted in decreased drilling worldwide and substantial job losses in the industry. At the time of writing, in North America alone, at least 134 exploration and production companies, 21 midstream companies and 155 oilfield services companies have filed for bankruptcy since 2015, with experts predicting that the current bankruptcy cycle is far from complete. However, the rate of bankruptcy filings has decreased this year, with only twenty exploration and production companies filing compared to sixty this time last year. Additionally, as of the time of writing, no new midstream company bankruptcies have been filed since April 2017. Still, as reorganised and insolvent companies are no longer able to honour contracts, disputes related to those contracts will necessarily follow. An increase in disputes related to royalty payments or other rights of leaseholders and host governments may also result. Major economic impacts on joint operating agreement (JOA) participants with cash flow crunches will lead to JOA defaults, with a possible impact on work programme obligations owed to host governments and their national oil companies, and growing concerns for unanticipated decommissioning costs not fulfilled by defaulting parties. That said, lower oil prices have encouraged producers to innovate ways to cut production costs to remain profitable, and investors have shifted focus to shorter-cycle projects which increases opportunities for narrower, specialist explorers and producers rather than large, generalist companies. If production costs are kept low as prices continue to rise, many countries could see increased gains in the energy sector.
Nearly a year into the Trump presidency, the President’s commitment to deregulate the energy industry and achieve energy independence has manifested in a variety of ways and will continue affecting the energy sector in the coming years. The Trump administration, through the EPA, continues to dismantle Obama-era energy regulations that require states to develop clean energy plans, and has already fast-tracked massive pipeline projects such as Dakota Access and Keystone XL. Further, the President’s protectionist trade policies have resulted in greater uncertainty regarding the US’s role in the global energy industry. Increased emphasis on domestic coal production could hinder development of renewable energy sources, and the President’s potential renegotiation of NAFTA could introduce new tariffs on US energy exports to Mexico. President Trump’s recent commitment to ‘decertify’ the international nuclear agreement that lifted sanctions against Iran could slow the pace of investment in Iran’s oil sector, and heightened geopolitical tensions in the region could threaten transit lines or otherwise destabilise the global oil market. In all, the President’s domestic and foreign policy decisions have already begun to affect the global energy industry and the country’s role as both an energy producer and consumer.
The new administration, however, is finding that deregulating is not so simple. As the EPA pushes deregulatory efforts, challenges to agency actions will likely result in new disputes that could affect the entire regulatory landscape. Environmental groups are already challenging EPA regulatory rollbacks, and the DC Circuit Court already upheld one such challenge to the EPA’s suspension of the Climate Action Plan, an Obama-era policy encouraging clean energy production and reducing emissions. Vacancies in key administrative positions also limit the government’s ability to deregulate. As the EPA attempts further deregulation, 2018 will likely see increased efforts to prevent the elimination of long-standing energy and environmental regulations in the US.
There is some uncertainty over how the Brexit vote will affect UK energy policy. Withdrawal negotiations began in June of 2017, and the UK is currently scheduled to leave the EU on 29 March 2019. Although the Supreme Court has held that the UK government cannot give formal notice to exit the EU without first obtaining the approval of parliament, parliament approved the exit in March of this year. Until the UK exits the EU, the existing legal and regulatory regime is likely to remain in place in materially the same form. If the government follows Prime Minister Theresa May’s proposal to introduce a Great Repeal Bill, converting existing EU law into domestic law, then this will provide further certainty that any changes are likely to be introduced gradually and following parliamentary debate. The government has always retained control over its energy policy, including key matters such as licensing and taxation of oil and gas exploration, appraisal, development and production activities. Consequently, it is generally expected that there are unlikely to be dramatic changes to the UK oil and gas industry. However, the Brexit vote has already affected the organisational structure governing the UK energy industry, particularly with the merger of the Department for Energy and Climate Change with the Department for Business, Innovation and Skills to create a new Department of Business, Energy and Industrial Strategy. This may indicate more active involvement by the government in the future with an energy strategy focused increasingly towards economic stimulation and business growth.
Recent months have also seen a proliferation of decommissioning litigation following the US Bureau of Ocean Energy Management’s (BOEM) issuance of significant new supplemental financial assurance requirements. These requirements fundamentally change the way that BOEM calculates the financial strength and reliability of OCS operators and lessees and will require greater allocation of capital than previously required to cover future potential decommissioning obligations. BOEM, under the direction of the Trump administration, subsequently delayed the implementation of these new requirements to receive additional input from interested parties such as industry leaders and leaseholders. The regulations may create serious barriers to entry for small and independent operators, and may drive larger companies to invest in frontier areas such as the Arctic and ultra-deepwater. In the mature UK North Sea basin, the UK Oil and Gas Authority called for the industry to reduce its decommissioning costs by at least 35 per cent, an estimated value of around US$80 billion. According to the Financial Times, between now and the 2050s, around 270 platforms, 5,000 wells, 10,000km of pipelines and 40,000 concrete blocks will have to be removed from the North Sea, a result of oil companies operating in a low oil price world and facing diminishing production from a basin where commercial production began over 50 years ago. Delays and costs overruns will likely be a feature of this latest phase in the history of the North Sea as the market gets up to speed with the challenges of decommissioning in this environment. This will no doubt lead to disputes between oil and gas companies and the oilfield services contractors and suppliers carrying out decommissioning. Experience shows that the costs of decommissioning can quickly escalate and industry players will be nervously watching the financial health of their joint venture partners to ensure they can meet the costs of decommissioning, especially for assets that do not have adequate decommissioning security arrangements in place. The role the new Oil and Gas Authority will play in decommissioning is also an area to watch.
Emerging cybersecurity concerns threaten virtually all major industry sectors, and the energy industry is not immune. Critical energy infrastructure installations, such as pipelines and electric grid facilities are particularly vulnerable, especially as energy grids invest in new smart digital technologies. While evolving smart grid technologies can bring massive benefits, they also present new and complex cybersecurity risks. Cyberattacks can manifest in the form of data breaches, operational systems shutdowns, and even potentially total grid blackouts, all necessitating increased cooperation between industry and government to combat these new threats. The US Department of Energy and associated agencies promulgate the Critical Infrastructure Protection Guidelines, which detail cybersecurity requirements for certain energy facilities. However, compliance with these guidelines is often costly and only applies to the most critical energy infrastructure assets. Other countries continue to work with the energy industry to develop cybersecurity guidelines, best practices, and threat assessment tools. Therefore, cybersecurity compliance in the energy industry is ripe for dispute as new threats emerge and new regulations are put into place to combat them.
This year, the US announced its intention to withdraw from the Paris Climate Agreement. The agreement generally requires signatory parties to submit and update reports on the country’s greenhouse gas emissions, and parties then pledge nonbinding plans to reduce emissions. When the US announced its withdrawal, 147 countries had ratified the agreement. While the US’s withdrawal threatens to weaken the force of the agreement, many other nations, including Canada, France, Germany, Japan and the UK have all reaffirmed their commitment to the Agreement. Additionally, the US’s withdrawal does not take effect until 2020, and does not preclude states from implementing climate action plans and adhering to the guidelines and framework of the Paris Agreement. In fact, several states, such as California, New York and Washington have announced continued commitment to advancing climate policy. Thus, withdrawing from the Agreement is unlikely to stop the transition to renewable energy, especially as wind, solar and other alternatives become more competitive in the marketplace. The 23rd annual UN climate conference (COP23) in Bonn, Germany, gave the remaining parties to the Paris Agreement an opportunity to further develop the rules of the Agreement and discuss concerns about the US’s withdrawal. The conference also saw the launch of the Powering Past Coal Alliance, led by the UK and Canada, seeking to phase-out traditional coal power by 2030 to meet the goals of the Paris Agreement. The next COP in Poland will likely see a finished draft of the Paris Agreement’s ‘rulebook’, where parties to the Agreement plan to finalise these rules.
Energy disputes may arise in the near future as a result of the privatisation of certain oil and gas sectors in countries such as Mexico. Foreign (ie, non-Mexican) energy companies may benefit from such denationalisation, both economically and politically. However, it remains uncertain whether foreign companies will have sufficient incentives to partner with Petróleos Mexicanos (Pemex) on energy development, particularly deepwater transboundary development, as Mexico lacks significant deepwater experience to date, and foregoing complicated agreements in lieu of the rule of capture is a much simpler alternative. As with the contractual frameworks now permitted by the Mexican Constitutional amendments, it also remains to be seen how the 2012 US–Mexico Transboundary Hydrocarbons Agreement will be implemented in areas in which the ban on exploration and development of hydrocarbon reservoirs had been in place. That said, if the legislating bodies in Mexico continue to keep in mind the guiding principle of maximising revenues, in order to achieve the greatest benefit for long-term development, the Mexican energy reforms may achieve far-reaching impact on economic growth in Mexico, beginning with an infusion of private investment that it is hoped will boost oil and gas production, lower the cost of energy and create new jobs in Mexico. Saudi Arabia also announced a decision to publicly offer for purchase a portion of its state-owned oil company Aramco in an effort to diversify the Saudi economy. Saudi Arabia is one of the largest oil producers in the world, and Aramco’s 5 per cent IPO could make massive waves in the energy industry. This move will likely lead to increased transparency of the world’s largest oil company, and Aramaco’s structure will probably reorganise to align the country’s financial interests with private shareholders.
There is clear evidence of an uptick in domestic and cross-border litigation and international arbitration (including investor–state disputes). In addition, the number of regulatory investigations continues, many of which lead to related civil litigation cases. Like the Petrobras scandal that triggered investigations and civil litigation outside Brazil (most of which remain pending), 2018 will likely yield continued investigations and litigation related to alleged payments by mining company Rio Tinto to a consultant who helped acquire rights to mine the Simandou iron-ore deposit in West Africa, and bribery allegations against Unaoil for its activities in Iraq.
There is set to be a year of continued reinvention of revenue and cost models for participants in the industry during 2018. Energy litigation and arbitration seems a sure bet for increasing activity, resulting from a sustained lower-commodity price environment, increased appetite for strategic and opportunistic M&A activity, changing political landscapes on a global scale, and opportunistic shifts from higher-priced purchase, sale and exchange contracts to more market-sensitive arrangements.