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INVESTI NGPARTNER B U I L D I NGPARTNER PLANNI NGPARTNER A DV I S I NGPARTNER FINANCI NGPARTNER
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From the best map data to software that maximizes the value of your spend and keeps you in compliance, P2 Energy Solutions has the right package to fit your company, large or small.
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March 2011
®
Will Michael Bromwich
reopen the GOM to deepwater drilling?
INSIDE • • • •
Contents
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Assessing CapEx risks Shale gas: a global game changer Commercializing new technology Insurance lessons from deepwater
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___________________________________________
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CONTENTS V8/#3
FEATURES
✱
ON THE COVER: Michael Bromwich, director of the Bureau of Ocean Energy Management, Regulation and Enforcement. ©2011 Michael Stravato. Provided courtesy of the James A. Baker III Institute for Public Policy, Rice University.
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COVER STORY: Gulf of Mexico While the debate continues over safety and risk mitigation issues in the Gulf of Mexico, some participants have grown weary of the uncertainty and are preparing to exit the Gulf for friendlier waters in other parts of the globe. OGFJ editor Don Stowers gathers details and insight from various industry participants, including BOEMRE director Michael Bromwich.
20 Shale impact Shale gas use has grown from near zero to roughly 20% of the US gas stream. Many changes are likely to result from its development. Mayer Brown’s Dallas Parker outlines changes that reflect the economic impact of shale gas on global politics and energy policies.
24 Insurance lessons The Deepwater Horizon incident
and the drilling moratorium put the spotlight on many things, including insurance as a critical resource. Insurance issues should be considered early and often, as policyholders have arguments to overcome popular insurer efforts to avoid coverage. Linda Kornfeld and Selena Linde of Dickstein Shapiro say to consider the damage at issue,
and review policy terms to determine which coverage issues may arise and which arguments will be the most effective.
that considers both CapEx and Operations Risks and their impact on NPV.
can’t afford to relearn the same lessons.
28 Assessing risk
32 Avoid losing $ on ETRM An ETRM implementation is an expensive deployment of missioncritical software with countless challenges. Sapient’s Larry Hickey discusses some key lessons learned from implementations. In this environment, you
The sun provides more energy to the earth’s surface in one hour than mankind uses in a year. But much work remains to be done to turn solar power into liquid transportation fuels. Joseph Gallehugh talks to Dr. Jim Trainham of the Research Triangle Solar
Energy sector opportunities abound, but many are capital intensive and carry significant CapEx risks. Richard Westney of Westney Consulting Group discusses ways to assess NPV
36 Solar fuel’s impact
Fuels Institute for an idea of how this new energy direction could impact the oil and gas industry.
39 Utica Shale Lying below the Marcellus Shale in some areas, the lesser-known Utica Shale may contain more than 20 tcf of natural gas. The mineralogy differs from the Marcellus, but with challenges come opportunities.
Oil & Gas Financial Journal® (ISSN: 1555-4082) is published 12 times a year, monthly, by PennWell, 1421 S. Sheridan Rd., Tulsa, OK 74112. Periodicals Postage Paid at Tulsa, OK, and additional mailing offices. POSTMASTER: Send address changes to Oil & Gas Financial Journal, 1421 S. Sheridan Rd., Tulsa, OK 74112. Change of address notices should be sent promptly with old as well as new address and with ZIP or postal code. Allow 30 days for change of address. Copyright 2011 by PennWell. (Registered in US Patent & Trademark Office.) All rights reserved. Permission, however, is granted for libraries and others registered with the Copyright Clearance Center Inc. (CCC), 222 Rosewood Drive, Danvers, MA 01923, Phone (508) 750-8400, Fax (508) 750-4744, to photocopy articles for a base fee of $1 per copy of the article, plus 35 cents per page. Payment should be sent directly to the CCC. Federal copyright law prohibits unauthorized reproduction by any means and imposes fines up to $25,000 for violations. Requests for bulk orders should be sent directly to the Editor. Back issues are available upon request.
March 2011 Oil & Gas Financial Journal • www.ogfj.com
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DEPARTMENTS [Editor’s Comment]
5 Middle East unrest Conflicts in the Middle East are a contributing factor in the run-up in crude oil prices. Libya alone may not cause much instability, but if protests continue to spread, prices could spike. Prodemocracy movements in some countries may inadvertently cause people to suffer in others. OGFJ editor Don Stowers runs down the list of some of the players and countries who could be caught in the middle. [Capital Perspectives]
6 Commercializing energy tech Technology will play an ever increasing role in meeting technical challenges and complex economic conditions in the oil industry. Jessica Rouse of OTM
Consulting details the participation of Oiltech at the Energy Technology Capital Conf. and its thoughts on how to commercialize new technology. [Upstream News]
10 Enlarging Ensco Two of the industry’s most well-known offshore drilling companies, Ensco plc and Pride Int’l, have agreed to merge. The combined company holds an estimated enterprise value of $16B and a revenue backlog near $10B.
47 Co./Ad Index
40 Deal Monitor
[Beyond the Well]
48 Teach For America
42 Industry Briefs 44 Energy Players
ExxonMobil has donated $500,000 to Teach For America programs to help recruit, train, and support science and math educators.
OGFJ.com▶ ___________________________________
FACILITIES AND INFRASTRUCTURE MAPS In collaboration with PennWell’s MAPSeach and OGJ, OGFJ is working to bring you new maps detailing facilities and infrastructure in various oil and gas plays. Visit the Unconventional Resource Center page on OGFJ.com for more information.
LEGALLY SPEAKING Energy attorney Aaron Ball continues as a guest blogger for OGFJ.com. Read recent posts on the risky and profitable business of investing in spin-off companies, the likelihood of tax hikes on the industry, as well as details about Iraqi oil production shortfalls as land mines and other issues hinder development. Join the discussion and post your comments today!
FEATURED STORIES Updated daily, OGFJ.com brings you the latest information from the industry. Get details on the recent addition of Marcellus Shale acreage by the Gastar Exploration/Antrim joint venture, the recent study showing $3B in revenue generation by the Eagle Ford Shale in 2010, and the $2.85B merger transaction between Holly and Frontier creating one of the largest US refiners. Find information on recent executive moves at Apache, Babst Calland, Northern Offshore, and more. 2
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ENERGY PHOTO OF THE WEEK ▶ Send us your photos, along with a short description, and your photo could appear online as our Energy Photo of the Week.
www.ogfj.com • Oil & Gas Financial Journal March 2011
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When it comes to treasury management, our expertise runs deep.
With all of the elements involved in the oil and gas industry, it’s important to have an experienced financial partner that knows the terrain. For over twenty years, Union Bank® has put its vast reserves of lending and banking expertise to work for some of the major players in the energy industry. By tapping into our award-winning treasury management services, we can help you streamline reporting for accurate response times. And our electronic settlement service lets you process payments and invoices remotely, helping you meet your monthly settlement deadlines. That’s one powerful combination working on your behalf.
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Energy Capital Services: Andrew Koch Vice President 214-922-4233
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©2011 Union Bank, N.A. Union Bank is a proud member of the Mitsubishi UFJ Financial Group (MUFG), one of the world’s largest financial organizations. Financing subject to credit and collateral approval. Other restrictions may apply. Terms and conditions subject to change. ________ unionbank.com
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Visit our Unconventional Resources Center on OGFJ.com
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orth American shale plays such as the Eagle Ford, Barnett, Haynesville, Marcellus, Bakken, and Woodford are all noteworthy formations, but unconventional resources include more than shale. They also include tight gas, coalbed methane, oil sands, and heavy oil. Get up-to-date information on the most talked about formations in the unconventional resources space –– all in one place.
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Reports from Don Warlick of Warlick International provide insight into the top 5 US shale plays and the 7 factors driving the shale business.
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E&P companies are shifting budgets to high-BTU, liquid-rich plays. Bentek’s Rusty Braziel provides expert analysis.
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Editor’s Comment
Middle East unrest causing instability in world oil markets Don Stowers Editor-OGFJ
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s we watch crude oil prices climb past the $100 mark and prices at the pump creep well past $3.00 a gallon, some of us are wondering what effect this will have on the economic recovery in the US and elsewhere and what it portends for the oil and gas industry as well. The consensus among those who earn a living making economic forecasts is that sustained high oil prices will have a negative impact on economic growth, and slow growth would not be good for the energy industry either. Of course higher prices generally mean bigger profits for oil companies, but continual high prices for months and months means that on the retail level consumers will start to adjust their habits, drive less, car-pool with neighbors, and think twice about that cross-country road trip. If the economy slows down again, demand will decline and oil prices will have to adjust to this new paradigm. In a nutshell, it means that, ideally, prices should be high enough for industry participants to make a nice profit, but should not be too high for too long. Excessively high prices are counterproductive. What is driving the current run-up in crude oil prices? The uncertainty caused by the conflicts in the Middle East is a significant factor. Prices seemed to rise almost overnight when Libya, the fourth-largest oil exporting nation in Africa, was forced to cut off an estimated 75% of its 1.7 million barrels per
day of production, 1.5 million barrels of which are exported, mostly to Europe. Think what might happen to oil prices if this were Saudi Arabia, the world’s largest oil exporter. The protests against the governments in Tunisia, Egypt, Bahrain, Jordan, Oman, Iran, and Libya and the ensuing violence in many of those countries not only has Middle East leaders worried, it has European and other countries concerned as well. The Europeans, Chinese, Japanese, and others who rely on oil imports from Middle Eastern countries are worried that oil supplies will be dramatically reduced or cut off entirely from countries that may be embroiled in a civil war. Quite a few international petroleum companies could be affected by the strife in Libya and potentially in other countries as well. There are currently 35 foreign oil and gas companies active in Libya, including leading NOCs and IOCs from every continent except Antarctica, according to UK-based Evaluate Energy, an energy research firm. Some of the most important foreign producers in Libya are ENI, OMV, RepsolYPF, ConocoPhillips, Hess, Marathon, Occidental, and Suncor. In addition, there is a second tier of companies that are producing, but on a smaller scale. These include Statoil, GDF Suez, Total, Wintershall, and Gazprom. Shell, RWE-DEA, and Australia’s Woodside Petroleum also have a presence. “Although there may be short-term mayhem, Libyan oil and gas prospects may improve in the medium term as a result of structural changes that take place now,” said Evaluate Energy’s Dan Krijgsman. He added, “Libya may not be as strategically important to its trading partners as many other Arab oil and gas producers, but it is definitely now well connected to many countries and
companies worldwide, which makes the current disruptions a truly international, not local, issue.” Saudi Arabia seems to be immune from the unrest at the moment, but no one knows if that situation will change. On Feb. 23, the Saudi monarch promised $37 billion in benefits to low- and middle-income citizens, including funds to alleviate the country’s chronic housing shortage. He obviously hopes that taking this step will head off unrest and insulate the country from the current wave of uprisings. To address the decline in oil exports from Libya and elsewhere in the region, Saudi Arabia says it will increase its own production accordingly, although some industry observers doubt whether Riyadh has the excess capacity needed to ramp up production to this level. If the Saudis are unsuccessful in alleviating the oil export shortage, expect prices to continue to climb. Libya alone probably won’t cause too much instability in oil markets. However, if the protests continue to spread, possibly even outside the region, industry analysts are concerned that prices could spike to $125, $150, even $200 a barrel, depending on which countries may be affected by the strife. In Europe and the US, sustained high oil prices are likely to slow the pace of growth, and the already-high unemployment rates in some countries will rise. In emerging nations in Africa and Asia, including China and India, the impact of higher prices will be worse because it means food prices may climb beyond affordable levels. In short, the pro-democracy movements in some countries may inadvertently cause people to suffer in others. OGFJ Have an opinion about this? Visit www.ogfj.com to comment.
March 2011 Oil & Gas Financial Journal • www.ogfj.com
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Capital Perspectives
How to commercialize new technology Jessica Rouse, OTM Consulting, London
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f you’ve ever had an idea for a great new invention for the oil industry but wondered how to get the financial backing you need to produce and market it, you should have been in Houston on Feb. 9. If you had attended the Energy Technology Capital Conference (ETCC), you might have gotten answers to some of your questions about commercializing new energy technology. One group of influential investors representing the Oiltech Investment Network (Oiltech) participated in a panel discussion in which they presented the results of a technology commercialization study conducted among operators, oilfield service companies, investors, and innovators. Oiltech is a consortium of 10 global investors in upstream oil and gas technologies who joined together in 2010 to form the network. The key objective of Oiltech is to encourage entrepreneurship and maximize the quality of technology investment opportunities within the oil and gas sector. Members of Oiltech collectively have invested over $950 million in more than 70 oil and gas technology companies over the last five years. Oiltech members include Altira Group, Chevron Technology Ventures, Energy Capital Management, Energy Ventures, Epi-V, Investinor, Lime Rock Partners, SEP, Shoaibi Group, and Viking Venture. They are based in North America, Europe, and the Middle East. The network collaborated with the Houston Technology Center (HTC) to launch the first of many Oiltech events planned in the US. The ETCC was organized by HTC 6
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and attracted more than 250 delegates this year, including entrepreneurs seeking investment funding for more than 40 emerging technologies. Oiltech facilitated one-onone meetings between its investor members and companies seeking funding, providing an opportunity for companies to showcase their technologies and business plans, discuss their investment needs, and explore potential routes to market. One of the objectives of the network is to drive innovation by providing a platform to connect operator oil companies to innovative technology providers, and entrepreneurs to energy-focused investors. The network also ran an entrepreneurs’ advisory workshop in Aberdeen [Scotland] in October 2010 that connected 29 upstream oil and gas technology companies to Oiltech members. The event pro-
vided a platform for entrepreneurial companies to meet with investors to discuss their technology offering in the hope of securing funding. The network hoped to replicate the opportunity by collaborating with HTC at the Energy Technology Capital Conference in the US. OTM Consulting, an independent technology management consultancy in the upstream oil and gas sector, manages the Oiltech Investment Network. OTM recently completed the aforementioned technology commercialization study. The study analyzed case histories for more than 40 technologies, and participants were asked to assess key success factors that result in effective uptake of new technologies. The commercialization study findings were a springboard for discussions at the ETCC Oiltech lunchtime panel, which included
Oiltech Investment Network members at Energy Technology Capital Conference in Houston on Feb. 9. (L to R) Chris Dudgeon, Trevor Burgess, Leif Andre Skare, Dirk McDermott, David Malone, and John Hanten. Photo courtesy of Oiltech.
www.ogfj.com • Oil & Gas Financial Journal March 2011
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New Worlds. Source market intelligence and insight through the PLS M&A Database.*
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Aggressive buyers & sellers need information to guide their business decisions.
PLS’ M&A Database is cross-linked with various PLS reports and other data sets. The database includes not only corporate and asset deals, but also joint ventures, VPPs and acreage acquisitions.
At PLS, our firm offers a number of products and tools—including a comprehensive Mergers & Acquisitions Database to help clients steer a straight course.
The U.S. and Canada Database allows searching by conventional and unconventional transactions, while the Global Database has a unique calendar presentation. All three databases include a one button click-through to a relational database of “Deals in Play”— a unique extension of the PLS multiple listing service. This allows clients to gain a good sense of the current inventory of assets for sale.
The M&A Database provides buyers and sellers current market values and price comparables on oil and gas transactions on a reserve or production basis. PLS’ M&A Database offers a number of unique features including: source documents for every deal (press releases, investor presentations, PLS research and SEC filings), various quick looks, analyst comments, oil/gas equivalent ratio toggling ([6-1] up to [15-1]) and two-click downloads to Excel.
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Capital Perspectives five Oiltech members. The five ‘top scoring’ commercialization success factors identified in the study, were discussed by panel members. These success factors are: 1. Business need 2. Value articulation 3. Developer skills 4. Operator engagement – the developer of the technology engages with and understands the real needs of end-users 5. Operator involvement – the end-users of the technology are involved throughout the development and testing of the technology, and understand from an early stage the features and benefits of the new technology Chris Dudgeon, managing director of OTM Consulting, served as panel moderator. He commented, “The study was a great opportunity to understand the key drivers in the uptake of technology within the sector. Technology products associated with oil and gas often take a long time to be implemented, and we wanted to identify why this was and how we could accelerate this process.” The study indicated that new technologies should be seen as a solution to a clearly defined business need. Leif Andre Skare, partner at Energy Ventures in Houston, added, “We closely track customers to ensure we understand their drivers and needs. We also look closely at timing – to confirm that a product can realistically be launched by the time a customer needs it.” The value of the product to the end-user must be clearly articulated and measured, said Trevor Burgess of Lime Rock Partners. He explained, “No one will buy your product if you can’t explain the value it will bring. A major success factor for companies is to show how the product will save endusers money, increase production rates or reduce operational risks. 8
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Technology developers need to be specific – how does their product do this? They should define the market areas where their technology adds value, and quantify that value. They should also explain the potential risks, and how these can be mitigated.” Another key success factor is the need for sufficient skills to be available to develop the product or technology within the developer’s organization. “You can’t push a technology onto an organization; it needs to be pulled from within. The functionality of the product needs to justify the cost of introducing or replacing the existing technology,” said John Hanten, venture executive for Chevron Technology Ventures. A common pitfall for technology developers is misunderstanding the real needs of the end-user. Developers need to work closely with operators to offer solutions that really provide an answer to a problem that cannot be solved in any other way. David Malone, chief technology officer for Shoaibi Group commented, “A key factor to success is to develop a sponsor within an enduser who believes in your idea. This will help you to develop your technology so that it becomes a valued product. You can’t sell a technology, but you can sell a product.” The final point raised during the discussion was that end-users of the technology need to be involved throughout the development and testing stages. Operators (E&P companies) need to understand from the outset the features and benefits that the new technology will offer. Dirk McDermott, founder and managing partner of Altira Group, highlighted the importance of domain expertise and knowledge transfer between technology developers and investors.
“Over the past 12 years I have learned the value of expert people within a portfolio company. They can make or break an organization. We invest in people who are experienced in their profession, and this has added value over and over again. Private equity funding can bring many benefits – money, experience, access to advisors, and additional investors. However, it is important to ask the question, ‘Who do I want to partner with over the next 5 to 10 years?’ Great business plans don’t always proceed in the way we would hope, and so it is important to have the right investor partner engaged to guide you through the tough times and also celebrate your successes.” Technology will play an ever more significant role in meeting increasingly demanding technical challenges and complex economic conditions. Entrepreneurs and innovators are the key to these developments, and the growing levels of investment and commercialization expertise provided by members of the Oiltech Investment Network will be a key factor in realizing the potential of new technologies. Entrepreneurs wanting to connect with energy-focused investors, and end-users searching for innovative technology solutions should visit www.oiltechinvest.com to learn more. OGFJ About the author Jessica Rouse works for OTM Consulting and is manager of the Oiltech Investment Network. She has done extensive market analysis on emerging technologies for unconventional gas applications. She holds a bachelor’s degree in chemistry from Cardiff University and a PhD in materials science from the University of Southampton.
www.ogfj.com • Oil & Gas Financial Journal March 2011
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Upstream News BP looks to grow production offshore India with Reliance agreement
Chevron builds on drilling successes offshore Western Australia with new gas hit
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ith its Orthrus-2 well, Chevron Corp. has hit gas in the Carnarvon Basin offshore Western Australia. The Orthrus-2 well is located in the WA-24-R permit area approximately 60 miles northwest of Barrow Island. The well was drilled to a total depth of 14,098 feet. Combining both appraisal and exploration objectives, the well encountered 243 feet of net gas pay, of which 102 feet of net gas pay was encountered in a deeper, previously unexplored target interval in the Orthrus field. George Kirkland, vice chairman, Chevron, said, “The find at Orthrus-2 represents our tenth offshore discovery in Australia within the past 18 months.” Chevron’s Australian subsidiary is the operator of WA-24-R and holds a 50% interest, while Mobil Australia Resources Co. Pty Ltd. holds 25%. Shell Development (Australia) Pty Ltd. and BP Exploration Alpha Ltd. each hold a 12.5% interest.
n its second major deal since the Gulf of Mexico oil spill, BP has agreed to acquire upstream assets offshore India from privately-held Reliance Industries Ltd. for US$7.2 billion. Completion of the transaction, subject to Indian regulatory approvals and other conditions, would result in BP taking a 30% stake in 23 oil and gas production sharing contracts covering 270,000 square kilometers that Reliance operates in India, including the producing KG D6 block. This block contains the D-1 and D-3 gas fields, which contain over 13tcf of proved and probable reserves. According to a Feb. 21 report by Jefferies & Co. Inc., these particular fields have been producing at a combined rate of 1.8 bcf/d in recent months, although production rates have fallen as reservoir complexity has restricted well deliverability. The fields were originally planned to peak at 2.8 bcf/d, and Jefferies speculates that restoring field output may be one reason Reliance agreed to partner with BP. A 50/50 joint venture would also be created to source and market gas in India as well as to accelerate the creation of infrastructure to handle the gas. BP will pay Reliance an aggregate consideration of US$7.2 billion, and completion adjustments, for the interests in the production sharing contracts. Jefferies & Co. translates the unit price for the proved and probable reserves near US$9.3/boe. The company is expected to pay the US$7.2 billion sequentially over 2011 out of cash reserves. Payments of up to US$1.8 billion could be shelled out by BP depending on further exploration success. Reliance will continue to serve as operator of the 23 oil and gas blocks that currently produce nearly 1.8 bcf of gas per day, over 30% of India’s total consumption, and over 40% of India’s total production. “India is one of the fastest growing economies in the world. By allying ourselves with Reliance, we will access the most prolific gas basin in India and secure a place in the fast growing Indian gas markets, creating a genuinely distinctive BP position,” said Robert Dudley, BP Group chief executive. In an effort to rebuild after the Deepwater Horizon disaster last year, the company is looking to markets where it can grow. Last month the company was involved in an $8 billion share swap deal with Russia’s Rosneft to explore the Russian Arctic region. – Mikaila Adams
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Ensco, Pride merger to create second largest offshore driller
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wo of the industry’s most well-known offshore drilling companies, Ensco plc and Pride International Inc., have agreed to merge into a combined company with an estimated enterprise value of $16 billion and a revenue backlog estimated to be near $10 billion. Ensco will combine with Pride in a cash and stock transaction valued at $41.60 per share based on Ensco’s closing share price on Feb. 4. The implied offer price represents a premium of 21% to Pride’s closing share price as of the same date and a premium of 25% to the one month volume weighted average closing price of Pride. “Although Ensco is paying a healthy premium, we believe the transaction makes great strategic sense,” noted Jefferies & Co. Inc. in a Feb. 7 report. “Ensco is paying a 21% premium, which we estimate is 8.4x our 2012 TEV/ EBITDA, 153% of NAV and 114% of replacement value. In comparison, we estimate the deal is a 20-30% premium to the other diversified offshore drillers trading at 7.0x our 2012 TEV/EBITDA and 120% of NAV.” Under the terms of the merger agreement, Pride stockholders will receive 0.4778 newly-issued shares of Ensco plus $15.60 in cash for each share of Pride common stock. Upon closing, Pride stockholders collectively will own approximately 38% of Ensco’s outstanding shares. Total cash paid to Pride shareholders will be approximately $2.8 billion. Ensco has received commitments from Deutsche Bank Securities Inc. and Citibank NA to finance the incremental debt required for the transaction.
www.ogfj.com • Oil & Gas Financial Journal March 2011
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Upstream News Ensco expects the combined company to realize annual pre-tax expense synergies of at least $50 million for full year 2012 and beyond. Jefferies & Co. Inc. believes the number could be “significantly higher” as Pride’s cost infrastructure was geared towards building a larger company. A Feb. 10 report by Jefferies puts the cost saving in the $150 million to $200 million range. Ensco plc’s chairman, president, and CEO, Dan Rabun, stated, “Pride has gained valuable expertise building and operating ultra-deepwater semisubmersibles and drillships and has strong relationships with leading customers in Brazil and West Africa, two of the fastestgrowing deepwater markets in the world. Ensco is a leading provider of premium jackups and ultra-deepwater semisubmersible rigs with a major presence in the North Sea, Southeast Asia, North America and the Middle East. Together, we will form an even stronger company that is ideally positioned to capitalize on growth opportunities within our industry.” Pride International’s president and CEO Louis Raspino added, “I have always been an advocate of scale, believing that a company with critical mass is afforded numerous benefits, including operational efficiencies, marketing advantages and the ability to attract and retain talented individuals that will help to secure a strong future for our company.”
ment will be named at a later date. Ensco’s eight board members will continue to serve as directors and two Pride directors will be appointed to an expanded board effective at closing. Ensco’s lead financial advisor and strategic advisor for the transaction is Deutsche Bank AG Cayman Islands Branch and Citi also served as financial advisor, and its legal advisor is Baker & McKenzie LLP. The financial advisor for Pride is Goldman, Sachs & Co. and its legal advisors are Baker Botts LLP and Wachtell, Lipton, Rosen & Katz. The companies anticipate that the transaction could close as soon as 2Q11. – Mikaila Adams
Statoil finds gas near Gullfaks in North Sea
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tatoil has found gas and condensate around two kilometers west of the Gullfaks South field in the middle sector of the North Sea. The size of the discovery is estimated at between 19 and 75 million barrels of recoverable oil equivalent. Plans call for tie-back of the discovery to existing infrastructure in the Gullfaks South area. “The discovery by Gullfaks confirms once again that infrastructure-led exploration is important and leads to finds with high profitability that can quickly come on Combined company stream,” said Gro Gunleiksrud Haatvedt, senior vice The transaction will create the second largest offshore president for exploration on the Norwegian continental driller with operations and drilling contracts in more than shelf (NCS). 25 countries on six continents in both deep and shallow The discovery was made in the Rimfaks valley where water basins utilizing 74 rigs including 21 ultra-deepwater drilling of well 34/10-53 S confirmed a column of around 300 meters in good-quality reservoir rocks. Gas and deepwater rigs. was found in the Brent group while no hydrocarbons Within the fleet of 27 floating rigs (semisubmersibles were discovered in the Statfjord group. and drillships) are 21 deepwater drilling rigs, including The well was drilled to a vertical depth of 3,847 meters seven rigs delivered since 2008 and another five ultra below sea level, and was concluded in the Lower Jurassic deepwater rigs expected to be delivered between now and 2013. Thirteen of the rigs are rated for operations in rocks of the Statfjord group. Water depth in the area is 136 meters. water depths of 7,500 feet and greater. “Even if the volumes are modest compared to the large The combined company’s jackup rig fleet, composed discoveries previously made on the NCS, discoveries of of 47 rigs, all with independent leg design, includes 27 this type are important in order to maximize the potential units with water depth ratings of 300 feet and greater, on the NCS,” said Haatvedt. with nine units delivered since 2000. Mid-water rigs will While not formation tested, further data acquisition represent 8% of the combined fleet. Noting the combined company’s “premium fleet,” Jeffer- and sampling are being made to determine the hydrocarbon system and estimate contacts. ies says the company is “poised to generate significant EPS The well was drilled by the Deepsea Atlantic drilling growth” and estimates 75% of the combined company’s rig. After completion, the rig is to drill a sidetrack well to EBITDA will be derived from premium assets by 2013. Opal, which is a prospect in the Middle Jurassic reservoir The combined company, to retain the name Ensco rocks (Brent group) located west of the Rimfaks valley in plc, will remain domiciled in the UK, as will most of production license 050B. the senior executives. Dan Rabun will remain chairman, The licensees of PL050 and PL050B are Statoil (operapresident, and CEO and James W. Swent will continue as tor, 70%) and Petoro (30%). OGFJ senior vice president and CFO. The remaining manageMarch 2011 Oil & Gas Financial Journal • www.ogfj.com
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Twilight or dawn in the Gulf of Mexico? While the debate continues over safety and risk mitigation issues in the Gulf of Mexico, some participants have grown weary of the uncertainty and are preparing to exit the Gulf for friendlier waters in other parts of the globe. Don Stowers, Editor – OGFJ
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www.ogfj.com • Oil & Gas Financial Journal March 2011
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The Chevron-operated Hercules 173 in Gulf of Mexico shallow waters. Photo courtesy of Hercules Offshore
I am very confident we are getting close to the point where we can issue deepwater permits. – BOEMRE’s Michael Bromwich, Feb. 25
y the time this issue of Oil & Gas Financial Journal goes to press, the US Department of the Interior will probably have issued the first new deepwater drilling permits in the Gulf of Mexico since the Deepwater Horizon well blowout last April 20. However, the offshore industry needs to know: Is this a token action or will the number of permits issued return to previous levels? Oil and gas companies have sharply criticized the Obama administration for creating a de facto drilling ban in the Gulf long after the official drilling moratorium put into effect after the BP oil spill was lifted. Offshore operators with excellent safety records believe they are all being punished unjustly for an accident that happened to one operator, BP. March 2011 Oil & Gas Financial Journal • www.ogfj.com
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“The perception was that we were a permitting mill…It would be irresponsible to approve new drilling before we have answered the simple, yet compelling question, ‘How do you deal with it.’” – Michael Bromwich, BOEMRE
©2011 Michael Stravato. Provided courtesy of the James A. Baker III Institute for Public Policy, Rice University
As of late February, not a single new deepwater permit had been granted except for two water injection wells. Only 31 drilling permits for the shelf were issued during this period. This compares with an average of about 20 shallowwater permits per month prior to April 20, creating a deficit of about 130 wells that weren’t drilled on the shelf during the past 10 months. On Feb. 11, the Baker Institute for Public Policy at Rice University in Houston held a conference aimed at examining the policy implications of the deadly explosion in the Gulf and the subsequent oil spill as well as the economic and political impact of the shutdown in new drilling activity. Addressing conference attendees, Michael Bromwich, director of the Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE), said the domestic offshore industry should not expect his agency to begin issuing new permits until fundamental questions concerning disaster prevention and spill containment plans have been answered. “It would be irresponsible to approve new drilling before we have answered the simple, yet compelling question, ‘How do you deal with it,’” said Bromwich. BOEMRE, a division of the Interior Department, regulates offshore exploration and production and was formed after the previous regulator, the Minerals Management Service (MMS), was dissolved after facing criticism it was a “rubber stamp” for the petroleum industry. 14
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Speaking before a gathering of about 200 or so energy executives, academics, and reporters, Bromwich emphasized his agency’s commitment to aggressive regulation and enforcement, adding that it isn’t likely permitting will ever return to the levels prior to the Deepwater Horizon disaster. “The perception was that we were a permitting mill,” he said, adding that the drilling permit process will now take longer due to tougher safety and environmental standards put in place following the incident. Although Bromwich said he didn’t anticipate any further rulemaking, the offshore industry is concerned about delays caused by extensive reports, analyses, meetings, and what one policy wonk called “bureaucratic foot-dragging.” BOEMRE plans to prepare an Environmental Impact Statement (EIS) for proposed oil and gas lease sales in the Western and Central Planning Areas of the Gulf of Mexico, off the coasts of Texas, Louisiana, Mississippi, and Alabama, for the five-year oil and gas leasing program from 2012 to 2017. “This important step in the offshore resource evaluation and development process will help ensure that all interests and concerns regarding oil and gas leasing, exploration, development, and production from proposed sales are appropriately considered,” said Bromwich. “Every comment will be analyzed and considered as we continue to prepare for the next five-year program.” Noble Corp. is among the drillers that have grown tired www.ogfj.com • Oil & Gas Financial Journal March 2011
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Previous Page Contents Zoom In Zoom Out Front Cover Search Issue Next Page Interior Secretary Ken Salazar and Marine Well Containment Company CEO Marty Massey view the company’s interim system capping stack with industry and government officials. Photo courtesy of Business Wire
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of waiting for Washington to act. The company recently said it will move its Clyde Boudreaux rig to Brazil because the current leaseholder in the Gulf of Mexico declined to extend its contract with Noble due the lack of permits being issued by BOEMRE. Roger Hunt, Noble’s senior vice president for marketing and new contracts, told analysts in a recent conference call that the company has endured the moratorium but finally has decided it cannot wait any longer. The company said there was too much uncertainty, and this situation had contributed to a serious decline in fourth-quarter profits. Another speaker at the Baker Institute forum expressed concern about the “new regulatory environment” in Washington. Karen Harbert, president and CEO of the Institute for 21st Century Energy for the US Chamber of Commerce, said she is afraid this will “put the government in the boardroom.” She added, “We don’t need more regulation – we need better regulation. The government has an obligation not to change the rules of the game every two years.” Harbert added, “You may not realize this, but there is more opportunity than there is capital,” adding that Gulf of Mexico operators could move their rigs elsewhere if regulations and the cost of drilling in the Gulf become too onerous. J. Robinson West, chairman and CEO of PFC Energy, an energy advisory firm, concurred, “The industry is going to invest in the deepwater. The money will be spent, but it will go elsewhere if drilling doesn’t resume soon.” He added, “Whatever oil isn’t produced in the Gulf will have to be imported.” According to a July 2010 report by IHS Global Insight, the Gulf of Mexico oil and gas industry generated almost $70 billion of economic value and 400,000 jobs in 2009. The Greater Houston Partnership noted, “A restriction on offshore drilling results in significant job losses, lose government revenues, and decreased national security.”
www.ogfj.com • Oil & Gas Financial Journal March 2011
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However, Shirley Neff, a senior analyst with the National Commission on the BP Deepwater Horizon Oil Spill and Offshore Drilling, said their research shows that stricter regulation is needed. “We have a higher fatality rate in the Gulf of Mexico than elsewhere [in the world],” said Neff. She pointed to Norway, Canada, Australia, Brazil, and the United Kingdom as examples of countries with better safety records than the US. She also pointed out that the US government currently regulates operators, but not other companies operating in the deepwater arena, and this is an area that needs to be addressed. The drilling moratorium that went into effect after the deadly April 20 blowout just 40 miles off the Louisiana coast was lifted in October by Interior Secretary Ken Salazar. Although, to date, it has not led to the issuance of any new deepwater drilling permits, there are signs that is about to change. Salazar, in lifting the moratorium, said that information gathered in recent months shows “significant progress in reforms to “What happened in the Gulf of Mexico, obviously, was tragic. It never should have happened. But I continue to believe it’s an anomaly. I simply do not accept the notion that there is a systemic issue with safety and operating capability across the industry. That defies logic.” – John Hofmeister, former president of Shell Oil Co.
drilling and workplace safety regulations and standards, and increased availability of oil spill response resources since the Macondo well was contained on July 15 and killed on September 19, and improved blowout containment capabilities.” He added, “The oil and gas industry will be operating under tighter rules, stronger oversight, and in a regulatory environment that will remain dynamic as we continue to build on the reforms we have already implemented.” Salazar has acknowledged that the new, more stringent rules would add to the cost of deepwater projects, but he said he didn’t know to what extent. Two projects have helped a great deal in moving forward the drilling permit process: 1. The creation of new oil spill response task forces by NOIA, IPAA, and API to respond to oil spills in the Gulf of Mexico, and 2. a new interim containment system launched by Marine Well Containment Company, a not-for-profit, independent organization formed by several oil majors and open to all oil and gas operators in the US Gulf of Mexico. 18
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The task forces will review spill response actions that occurred in the Macondo well spill and make recommendations as to how to improve future response and containment efforts. “A recurring theme…is that the technology exists to drill successfully in deeper and deeper water, but the technology to respond to release of oil in these environments appears not to have kept pace,” said NOIA president Randall Luthi. On Feb. 25, Salazar and Bromwich visited Houston to view a new capping stack built by Marine Well Containment Company (MWCC). The system will provide rapid containment response capabilities in the event of a potential future underwater well control incident in the deepwater Gulf. “The interim well containment system is complete and available for use,” said Marty Massey, MWCC’s CEO. “Over the past six months, we have worked closely with BOEMRE, the Coast Guard, and other authorities to help ensure that the design meets the regulatory requirements. BOEMRE has reviewed the functional specifications of the interim response system and its input has been included in the final specification.” He added, “Our objective is to ensure that the well containment response system is in a state of continuous operational readiness to facilitate rapid deployment and response in the event that it is required.” The capability of the interim containment system will continue to build as components of the expanded system are completed and delivered to MWCC. Massey says the expanded system is on track to be completed in 2012. A second well containment system being developed by Helix Corporation is expected to be ready by the end of March. John Hofmeister, former president of Houston-based Shell Oil Co. who now heads Citizens for Affordable Energy, a public policy organization aimed at educating the public about energy, recently told the Houston Business Journal, “What happened in the Gulf of Mexico, obviously, was tragic. It never should have happened. But I continue to believe it’s an anomaly. I simply do not accept the notion that there is a systemic issue with safety and operating capability across the industry. That defies logic.” OGFJ
www.ogfj.com • Oil & Gas Financial Journal March 2011
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Shale gas: a global game changer Dallas Parker, Mayer Brown , Houston
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en years ago, few crystal balls foresaw the lightning impact and development of shale gas on the world’s energy scene. In the last 10 years – during which shale gas became commercial in the US – its use has grown from near zero to about 20% of the already enormous US gas stream. Booked shale gas reserves, at present rates of production, may still be onstream 100 years into the future, a figure that will increase if gas begins to approach oil on a price parity basis. Many likely changes will result from shale gas development. But the most important ones reflect the economic impact of shale gas on global politics and today’s energy producers.
Economic model implications Let’s start with one of the more subtle changes: that of the economic models used around the world. Although shale deposits are distributed globally and have been so 20
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for millions of years, it was US research and development with its entrepreneurial risk-takers that put recoverable shale gas on the mineral inventories of many nations. Hopefully, spreading of the entrepreneurial model will be one of the more lasting effects of the shale gas story. Traditionally, US capital and know-how migrated in search of raw materials. In the case of shale gas, other countries are inverting that approach and bringing capital here, investing billions in the expertise and reserves of US shale gas companies: Norway’s Statoil, CNOOC of China, Mitsui of Japan, Reliance of India, and France’s Total, to name a few. It’s hard to imagine they will value the technology that enables the production of this tight gas – yet ignore the competitive economic system that produced the technology. Interestingly, we are even seeing some of this result already in China, where the major state-owned energy companies find themselves in tough competition with each other for limited global resources.
www.ogfj.com • Oil & Gas Financial Journal March 2011
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A farm and a Marcellus shale well coexist. Photo courtesy of Range Resources
The shale gas impact won’t stop in abstract economics. Developing reserves will help stop the wealth drain and spread prosperity. For example, in the US, as we drill wells and hook up gathering systems, we’ll see investment in exploration, pipelines, storage facilities, conversions of electricity generation to gas, cheaper and cleaner electricity, more competitive US manufacturing, good jobs, royalties to property owners, and a better US balance of payments. These activities will generate concrete real economic growth in the US – and can produce similar results worldwide.
environmental issues. They have no tradition of American-style entrepreneurship. What they do have is reliance on Russia’s Gazprom in a power-constrained economy. They want to accelerate the development of their shale gas reserves. This story is repeated many places.
Cartel pricing versus market pricing
Politics aside, shale gas pricing could thwart the once likely coalescing of a Russian-Persian Gulf gas cartel. Gas prices will likely reflect real costs rather than cartel-engineered prices that spike with every political flare-up. With competitive, market-priced shale gas onstream, Worldwide political impact of shale gas the massive international wealth transfers of the last 40 The distribution of shale gas is so widespread that locally years could retrench. But other developments will affect produced shale gas may become the standard fuel in many gas exporters’ global strategy. For example, five years ago places. Traditional gas imports (by pipeline or as LNG) the US was building LNG import facilities and signing may become incremental sources. up long-term cartel suppliers. Today, we are seeing a very The potential of shale gas implies a loss of political leverage for some sellers. For example, Russia has used threats of interruptions – and actual interruptions – like “Politics aside, shale gas pricing could thwart old-time gunboats, notably with Ukraine, but with other the once likely coalescing of a Russian-PersianEuropean countries, too. Gulf gas cartel. Gas prices will likely reflect real I recently attended a conference on shale gas in Poland costs rather than cartel-engineered prices that on behalf of Mayer Brown. The Poles share with other spike with every political flare-up.” Europeans concerns about fracking, water recycling, and March 2011 Oil & Gas Financial Journal • www.ogfj.com
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likely prospect of US gas exports. This unexpected development hits global LNG prices three ways: One, US demand no longer supports extreme gas prices. Two, we may compete for LNG customers – or help other nations establish their own production. Three, the economics of gas-to-liquid projects have seemingly been immutably changed. Gas exporting countries will still be suppliers but likely not as they anticipated.
ments to wind and solar capability. In any case, subsidized, vested interests will no doubt fight to hold their favored positions – even at the risk of losing a job-producing, indigenous energy supply and a more prosperous national economy. But we can also focus on a more positive future, one in which shale gas accomplishes two things: A) it removes a huge area of international economic uncertainty, one in which – for decades – a supply conDevelopment of renewables centration in volatile regions of the globe held many of and nuclear power the cards in basic energy; and Because shale gas can be distributed through existing B) because low-emission gas power plants are cheaper gas facilities, it can decrease the to build and operate than coal urgency with which some counplants, shale gas may permit tries pursue solar and wind projgreater progress in reducing ects. But these renewables have greenhouse gases. been supported by global warmIn such a world, the results ing concerns and benefited from would be nations economically deliberately high subsidies. So grounded on safe, reliable, and a commitment to renewables is often domestically produced likely to remain even if gas availenergy supplies, the fostering ability is explored and ultimately of new jobs and opportunities, adopted. growing freedom from monopoBut don’t count the market listic energy pricing, and a cleaner out: Many countries will have environment. shale gas potential but no counI think the trend is in favor of try will soon have a functional, the more positive world marunsubsidized renewables indusket economy. But even if the try. In today’s global economy, more positive view of the future competitively priced gas can make starts off slowly, few consuming its own case. countries will want to extend the Where nuclear power is used, it forty-year economic drain many has already passed three big tests: have experienced, the depenA) reduced emissions, B) competdence on long sea-lanes, and itive economics, and C) exaggerpowerlessness in the face of high ated fears of catastrophic results. prices and pressure politics. Where it isn’t being used, the There are no guarantees, but A Barnett Shale well near Decatur, TX. value of those tests has been disin a world with widely distributed Photo courtesy of Devon Energy counted. I don’t see big changes shale gas reserves, this potential in today’s nuclear position. future is much closer than it was 10 years ago. OGFJ
Two potential futures
Looking at a present day oil and gas importing area like Europe, we could focus on a potentially negative outcome: a world divided into many smaller, densely populated countries with state ownership of minerals and no deep-seated entrepreneurial tradition. Such countries may resist the disruptions associated with exploration, production, hydrofracking, building an industrial infra-structure, and so on – just as US coastal state residents often resist offshore oil production – and offshore windmills, for that matter. Citizens in countries with green politics and economics are already accustomed to choosing favorites and then subsidizing them significantly. Shale gas may open economic options yet still be rejected in favor of commit22
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About the author Dallas Parker is a partner in Mayer Brown’s Houston office. He represents clients in corporate and securities law matters, with extensive experience in the areas of mergers, acquisitions, takeovers, proxy contests, public and private offerings of equity and debt securities, corporate governance, independent committees, and related matters. Parker represents US-based clients wishing to do business around the globe, as well as international clients wishing to conduct business in the US. He earned his JD, cum laude, from the University of Texas School of Law and his bachelor’s degree from Vanderbilt University. www.ogfj.com • Oil & Gas Financial Journal March 2011
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ENERGY ALLIANCE © 2011 NuTech Energy Alliance Ltd. Houston, Texas
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Response crews battle the blazing remnants of the Deepwater Horizon April 21, 2010. Photo courtesy of the US Coast Guard.
Insurance lessons from the deepwater Linda Kornfeld, Dickstein Shapiro LLP, Los Angeles Selena Linde, Dickstein Shapiro LLP, Washington, DC
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he unprecedented gush of oil into the Gulf of Mexico waters after the Deepwater Horizon explosion in April 2010 caused worldwide businesses to contemplate the implications of the likely and massive litigation and potential serious economic losses that they might suffer because of the spill. Fortunately, for many businesses, the anticipated losses did not occur. However, the event led to concern about future events and their potential impact. Part of the dialogue last year in considering how businesses may address financial hardship because of the Gulf oil spill centered on the availability of insurance. In fact, policyholders and insurers alike expected massive coverage litigation and in doing so considered the relevant coverage issues that would be addressed and resolved in that litigation. Should the oil and gas industry suffer another event similar in manner or degree, insurance will be a critical resource. Insurance issues should be considered early and often whether as a result of a significant environmental
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event that causes businesses to become defendants in litigation due to an environmental event or as a result of economic losses incurred during a government-imposed drilling moratorium (as happened after the Deepwater Horizon explosion) or due to other events that interfere with normal business operations. Commercial general liability (CGL) and business interruption insurance may offer a critical first line of assistance in responding to litigation or other business losses. In the context of similar types of large-scale losses, insurers have often responded with a host of arguments to avoid paying policyholders’ claims. Whether policyholders can defeat these arguments will depend on the particular facts involved and the applicable policy language. Regardless, policyholders never should accept an insurer’s denial of coverage as having merit, but instead should always consult with outside coverage counsel to determine independently the merits of the claim. Here we focus on certain notable insurer arguments.
www.ogfj.com • Oil & Gas Financial Journal March 2011
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Economic losses
Pollution exclusion
Plaintiffs in a number of lawsuits filed in connection with the Gulf oil spill alleged that the spill resulted in “catastrophic environmental destruction,” which has caused the plaintiffs to suffer “economic loss.” Policyholders can expect some insurers to argue against coverage for such allegations by claiming that economic losses do not constitute direct “bodily injuries” or “property damage” under CGL policies. Policyholders should reject this argument. CGL policies typically cover “those sums that the insured becomes legally obligated to pay as damages because of ‘bodily injury’ or ‘property damage’ to which this insurance applies . . .” and generally do not expressly exclude “economic losses.” Courts addressing the economic loss question have focused on the “because of” policy language and found coverage when the damages sought are “because of” bodily injury or property damage. According to those courts, as long as the claimed economic losses naturally flow from property damage or bodily injury, coverage should apply. In the context of litigation similar to that filed in response to the Deepwater Horizon disaster, coverage should not be impacted simply because some plaintiffs do not claim damage to their own property, but, instead, claim economic loss resulting from damage to other property, such as wetlands. A causal connection between damaged property and lost profits may overcome insurer economic loss defenses.
Many insurers may cite pollution exclusions in both CGL and first-party policies to defend against coverage for oil spill losses and litigation or similar catastrophic environmental events. “Policyholders can expect some insurers to [claim that] economic losses do not constitute direct ‘bodily injuries’ or ‘property damage’ under CGL policies. Policyholders should reject this argument.”
However, these exclusions do not bar coverage for all pollution-related claims. For example, although pollution exclusions often include broad definitions of “pollutant,” many courts have narrowed the applicability of the exclusion to “traditional” environmental contaminants. Thus, in connection with the Gulf oil spill, policyholders could have sought to avoid application of pollution exclusions by arguing that it does not apply to losses resulting from for example the release of “unrefined” oil or the use of chemical dispersants in the clean-up effort. The exclusion also often does not apply to product liability claims. Some Gulf oil spill plaintiffs have alleged injury
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because of the use of chemical dispersants. Companies that manufactured or sold these dispersants could argue in favor of coverage by alleging that the claims against them are for product liability claims that fall outside the pollution exclusion. The “cause” of the catastrophic event also may provide an avenue to avoid this exclusion. For example, with respect to the Gulf oil spill, the cause of the loss at issue may not have been the release of a pollutant, but rather the fire and explosion at the Deepwater Horizon. Fire and explosion are covered causes of loss under many CGL and first-party policies. Thus, policyholders could argue that the loss resulted from a covered cause of loss as opposed to one that is excluded. The success of this argument will depend on the state causation law that ultimately may apply and the specific wording of the insurance policy provisions.
Many of the suits that arose from the Deepwater Horizon oil spill included “nuisance” claims. There are two types of nuisance claims, private and public, both of which were employed in the Gulf oil spill litigation. The typical remedy sought for a nuisance claim is not compensatory damages, but the “abatement” of the nuisance. In the past, some insurers have argued that suits seeking abatement are not covered by their policies. These insurers rely on CGL policy language requiring the insurers to pay “those sums that the insured becomes legally obligated to pay as damages . . .” According to the insurers, the term “damages” is limited to “legal” monetary damages, and because abatement is an equitable remedy, the nuisance claims are not covered. In the context of oil spill-related suits insurers may raise a similar argument. However, in the environmental context courts generally have rejected attempts by insurers to draw a distinction between legal and equitable relief. These courts recognize that regardless whether the relief is styled as damages, abatement, or other injunctive relief, it still requires the policyholder to pay money because of harm caused to third-parties. 26
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Moratoriums on drilling
“Many business interruption policies pay for lost profits when a business cannot perform its normal business activities because of an order of ‘civil authority.’ Drilling ‘moratoriums’ generally should fall within this ‘civil authority’ coverage.”
Nuisance claims
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After the Deepwater Horizon explosion, President Obama issued a temporary moratorium on drilling in the Gulf waters. Any event that interferes with the ability of a business to conduct its normal business activities can result in substantial lost profits. Many companies in the oil and gas industry contain some form of “business interruption” insurance in their insurance portfolio. The policy language in these policies can vary, sometimes widely, with respect to the type of event that is necessary to trigger coverage to pay for lost profits. Frequently these policies require actual damage to the policyholder’s property that results in an “interruption” of business. However, most companies that suffered loss because of the drilling moratorium did not themselves suffer any actual damage to their property because of the Deepwater Horizon explosion. Given the language in many policy forms that fact should not matter. Indeed, many business interruption policies pay for lost profits when a business cannot perform its normal business activities because of an order of “civil authority.” Drilling “moratoriums” generally should fall within this “civil authority” coverage. Thus, policyholders should review their policies to determine the extent to particular policy language will provide adequate protection. In sum, policyholders have arguments to overcome popular insurer efforts to avoid coverage. It is important to consider the particular damage at issue, and to review the specific terms of the individual policy to determine which coverage issues may arise and which arguments will be the most effective. OGFJ About the authors Linda Kornfeld is the managing partner of Dickstein Shapiro LLP’s Los Angeles office and a partner in the insurance coverage practice. She represents corporate policyholders in complex litigation matters and provides insurance risk management advice with respect to policy procurement and renewals. Selena Linde is deputy practice leader of Dickstein Shapiro’s insurance coverage practice and is based in Washington, DC. She specializes in policyholder insurance coverage and complex civil litigation.
www.ogfj.com • Oil & Gas Financial Journal March 2011
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CONFERENCE & EXHIBITION
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Assessing the risk in capital-intensive opportunities Energy sector opportunities abound, but many are capital intensive and carry significant CapEx Risks. These risks are often underestimated, with cost overruns and schedule delays common. Richard Westney, Westney Consulting Group, Houston
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he increasing number and complexity of energy sector opportunities has made it more important than ever that investment decisions reflect a complete understanding of all the risks to economic value. Energy is a capital-intensive business, and the success of many opportunities is tied to the owner/operator’s ability to create a new capital asset. For example, the opportunity may be to participate in a newly-formed project company which intends to define, engineer, and construct a pro-
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duction facility and depends on project finance and other investors to fund the project. Or, it may be to invest in an established company with a portfolio of opportunities that require the development of capital assets. Evaluating the attractiveness of these capital-intensive opportunities requires careful answers to questions such as: • How much is the production facility likely to cost? • What is the maximum cash impairment we are likely to experience before positive cash-flow?
www.ogfj.com • Oil & Gas Financial Journal March 2011
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Operations Risks Some form of risk analysis is usually applied to develop answers to these and similar questions. In many cases, the focus is on Operations Risks. These risks create uncertainties around the base case assumptions as to the revenues and costs of the operating facility (see Fig. 1). The risk analysis will typically address potential variations from the base case assumptions for such variables as product price, production capacity, and utilities cost, in order to determine the level of risk to the Net Present Value (NPV) or similar metrics of economic value.
CapEx Risks
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Fig. 1: Cash flow during operations Revenue - based on: Production capacity Utilization rate Product price
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Cash flow
• What is the likely time required to complete construction, commissioning and startup? • How long is it likely to take to achieve full production? • What is the likelihood we will have sufficient operating margin to service the project’s debt obligations? And above all: • How likely are we to achieve our required return?
Time
Operations costs, e.g: Utilities Raw materials
– Fig. 2: Combining CapEx and operations cash flows Revenue - based on: Production capacity Utilization rate Product price
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Timing Time to financial close
Cash flow
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Capital-intensive opportunities also have significant CapEx Risks. These are the risks associated with the developer/operator’s ability to define the project, achieve financial close, complete the engineering and construction within budget and on schedule, and start-up the facility. These CapEx risks are important. Large engineering and construction projects have had a long history of cost overruns and schedule delays, often resulting in major impacts on economic value as well as investor confidence. The base case for a project is typically developed by internal and/or external engineering teams who define the scope, schedule, execution plan, and cost estimate. There is considerable experience to suggest the base case often grossly understates the cost and time required and reflects an overconfident assessment of risks. Risks to the project’s cost, time, and performance
Time to full Production Production profile
CapEx costs Engineering Procurement Construction Startup
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Operations costs, e.g: Utilities Raw materials
objectives are apt to be significant, and it can be difficult to fully transfer all these risks to contractors and suppliers. The evaluation of capital-intensive investment opportunities therefore requires the ability to assess the full range of CapEx risks and to integrate them with operations risks in order to have a complete understanding of the total economic risk exposure. Figure 2 illustrates the combined CapEx and Operations cash-flows that drive economic value. Most of the variables associated with cost and revenue have a range of uncertainty as a result of CapEx
March 2011 Oil & Gas Financial Journal • www.ogfj.com
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and Operations Risks. Since the timing of costs and revenues is also uncertain, it is usually not selfevident how these uncertainties combine into the overall level of risk. The only place where the uncertainties in all the project variables come together is in profitability, which, for this purpose, is most easily measured by NPV. The solution, then, for a capital-intensive opportunity, is to develop a probabilistic assessment of NPV which considers the combined impact of all risks. The decision-maker can use the results, together with consideration of risk appetite and other investment criteria, to evaluate the overall attractiveness of the opportunity. A probabilistic assessment of NPV is a four-step process illustrated by Fig. 3.
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which they are uncertain, and how they vary with time must be understood. A choice must be made for each variable: whether to treat it as certain or uncertain. For example, if a firm fixed-price agreement is in place for the first five years of power supply, the model would treat the cost of power as fixed. If the product is a fungible commodity to be sold on the open market, it is likely that the model would be constructed to treat product price as uncertain. In most cases timing is treated as uncertain. Although this adds complexity to the model, it is an important part in ensuring the analysis yields meaningful results.
Step 2: Assess the risks and uncertainties
For those variables that are uncertain, the risks that drive uncertainty must be identified in order to determine that variable’s range of uncertainty. For Of course, every opportunity is different. The example: specific variables that are important, the extent to • Risks to Revenue may include lower-than expected product price, reduced production capacity, or increased downtime. Fig. 3: Steps in developing a probabilistic • Risks to CapEx Costs may assessment of NPV include cost overruns from scope changes, lower-than-expected conStep 2: Step 1: Step 3: Step 4: tractor or supplier performance, or Assess the Identify the Construct the Apply the unexpected logistical difficulties. risks & variables that probabilistic analysis results • Risks to OpEx Costs may uncertainties are uncertain NPV model to decisionmaking include production inefficiencies, higher cost of feedstock, and increases in utilities costs. • Risks to Timing may include Fig. 4: Probabilistic view of NPV considering all various causes of delays to the CapEx and operations risks engineering, procurement, construction and startup of the proj100% ect. For each variable, the model will require a range of possible values, 20% of the time the NPV will be