Navigating through upstream oil and gas acquisitions

Upstream oil and gas acquisition activities in Nigeria are on the increase. About 300,000 barrels of oil per day-worth of equity in onshore and shallow-water producing asset has been sold and transaction activity is expected to remain strong for the rest of 2014. The cumulative deal value by the end of 2014 will hit about US$11.5 billion with about 22 oil blocks scheduled to have been divested by end of the year. The highlight of these acquisitions is the significant expansion of indigenous footprint in the sector.

In a recent oil and gas seminar with the theme ’’Pitfalls and protections in upstream oil and gas acquisitions‘’ organised by Olaniwun Ajayi’s Oil and Gas Practice in Lagos, the key drivers identified for the growing upstream oil and gas acquisitions include; declining production in onshore and shallow water assets, high cost of operations, oil theft, growing insecurity for personnel, installations and facilities, unresolved host communities problems leading to the disruption of production for protracted periods, rebalancing of portfolio towards offshore assets, global capital reallocation, increasing upstream competition from other African countries; commercial and operational challenges of complying with recent Nigerian laws, policies and regulations; Uncertainty surrounding the timing and impact of the Petroleum Industry Bill (PIB).

Experiences thus far in the oil and gas asset acquisitions show that there has been delayed and protracted closure, difficulties in raising funding and operatorship not moving with assets sold. The key issue has been the “Ministerial consent” especially knowing when to apply it, what is to be considered and which transactions require the consent.   

Louis Skyner, head of oil and gas, Clifford Chance Russia at the Olaniwun Ajayi’s oil and gas seminar pointed out the diversities in the objectives of the investor and that of the government in upstream oil and gas acquisitions. According to Skyner, the objectives of an investor are typically: to develop reserves, add to the inventory, and maximise equity returns; to diversify an asset base across countries by way of forming consortia; to minimise capital and operating costs (and maximise operational freedom); and to obtain contract stability, and a reasonable limitation of liability proportionate to the risk / reward ratio. While for host government, their objectives include; gaining access to its petroleum resources and its petroleum wealth; generating revenue especially foreign currency; obtaining know how, technology transfer, and training for local personnel in petroleum technology; creating employment by insisting on the use of local goods and services and protecting the environment. Often times, there is also a political agenda on the part of government which will aim to stimulate competition in the sector, and encourage its national oil company (NOC) to reform, liberalise sector prices, access sources of capital and technical assistance.

How a balance is maintained between investor and government objectives very much depends on the type of host government contract (the Contract), and the contractual and / or corporate structuring a particular national legislation permits. Petroleum law creates a framework for the balancing of those interests. However, the areas the petroleum law should focus should include; identifying a single government agency (Competent Authority) with an exclusive mandate to implement petroleum sector policy / represent State; empowering the Competent Authority to make all necessary regulations; establishing fiscal terms that give a clear picture of the applicable tax regime; providing fiscal stability that mitigates the effects of new laws which might increase the economic burden on licensees; setting out principal duties of a licensee like reporting discoveries, presenting a development plan, using best international practice; imposing on licensee an obligation to take all necessary measures to avoid pollution / maintain safety; provide a state guarantee for the convertability and overseas remittance of funds for IOCs; enumerate the licensee’s guaranteed rights e.g. security of tenure, right to proceed from exploration to production without government discretion; clarifying the investor’s right to export hydrocarbons and allowing for international arbitration.

The basic thing about petroleum law and the legal framework is the stability it brings to the sector and deals transacted in course of divestments and acquisitions. The issues that need to be considered in engendering stability include giving an investor assurances that the terms and conditions on which it has agreed to invest will remain stable. Where such terms are changed, the investor will want to ensure that there is suitable compensation or an adjustment of contract terms. Stability provisions must be in accordance with legislation. The existence of a stability guarantee does not prohibit unilateral change by a host government, i.e. an increase in the applicable tax rate or tax base, the imposition of new taxes etc. The participation of an NOC in transactions may assist an investor in finding an enforceable stability provision because the NOC, as a commercial enterprise, can give a stability guarantee that can be triggered by government action but these may be limited to the extent of the NOC’s share or profit oil.

In Nigeria, the PIB when passed is the overall institutional and regulatory reform framework for regulatory agencies, petroleum licenses, creation of a commercially viable NOC, enforcing restrictions on transfer of interest (prior consent from the Ministry of Petroleum required for both sale of interest and change of control in parent company). Other aspects of the PIB include the duration of prospecting and mining licenses may be reduced if commercial production is not initiated within a prescribed period (blocks may be forfeited) and domestic gas supply obligations imposed: non–compliance leading to revocation of export license (risk offset by requirement that the domestic price meet the pricing principles).

Steve Fox, partner at Clifford Chance identified potential steps to mitigate any land mines both on the buyer’s and seller’s side. Key among them is due diligence. On the buyer’s side, there should be consideration of transaction structure (asset/share/joint venture) at an early stage as this will impact significantly on approach to due diligence. The buyer should avoid transactions that can lead to unmanageable liability risk, or consider carveouts of problematic business units and should plan ahead on what policies, practices and procedures will be needed to be implemented post-completion?

On the seller’s side, his consideration of transaction structure at an early stage should focus on pre-sale restructuring, approach to partners especially partners who have pre-emption rights. The seller also needs to consider if the sale of a package of upstream interests makes a difference. The seller should also find out if confidentiality restrictions in agreements mean that there is need third party consent to disclose key information relating to the target assets to prospective purchasers. 

However, the watchword is vigilance. The seller should consider the following; who are the bidders? What are the pressure points around a particular bidder? How much time are you spending with each bidder? What approach should you adopt in discussions with a particular bidder? What approach should you adopt in negotiating mark-ups of documents? When should the bidders be provided with access to management? Are there any particular themes emerging with respect to a particular buyer? Are there any strengths/weaknesses of a particular buyer?

Lessons have been learnt in recent acquisitions in Nigeria and such lessons have improved successive deals. 

Frank Uzuegbunam