LOOKING TO 2012: What are the major challenges are occupying the minds of senior executives at energy companies in today’s market?

A number of challenges, such as changing geopolitical relationships, the emergence of new competitors, changes in supply and demand dynamics, social and environmental pressures, and demographic shifts, are transforming and reshaping the oil and gas industry.

But there is one indisputable fact that affects not only our industry but the world as a whole: Global demand for energy will continue to increase dramatically, driven in large part by population growth and the strong desire of developing countries to achieve economic prosperity. Experts may disagree about the rate of growth, but there is no dispute that growth in the demand for energy is inevitable.

For non-NOC executives we have spoken to over the past year, the major challenges are, and will remain:

(1) Access to resources (reserve replacement),

The organic reserve replacement leader is Shell (164%), followed by BP (115%), and Hess (113%). Shell’s performance has been led by strong results in Southeast Asia/Australia where reserve bookings largely came from Australian natural gas and specifically from major LNG projects. BP benefited from strong performance in Africa, predominantly in Angola and Algeria, which will contribute 0.6 BBOE to proven reserves. Hess benefitted from positive revisions to existing reserves due to rising prices for crude oil and Hess’ disproportionately high leverage versus its peers. Organic results were weakest at Chevron (66%), Marathon (68%), and ConocoPhillips (85%). [ISI 2011]

(2) Cost (finding and development costs per barrel) and availability of services,

BP ($12/BOE), Shell ($14/BOE) and ExxonMobil ($14/BOE) hold the lowest future development costs per unit of undeveloped reserves. Marathon ($36/BOE), ConocoPhillips ($25/BOE), and Hess ($20/BOE) hold the highest future development costs. [ISI 2011]

Industry organic finding and development costs were $17/BOE during 2008-2010 which compares to $17/BOE during the previous 5-year period. The result falls to $14/BOE when including reserve additions from oil sands, which were considered mining activities before 2009. Total replacement costs, which include reserve additions from oil sands and acquisitions, were $15/BOE for integrated oils during the period. Organic finding and development costs which exclude the impact of acquisitions and oil sands bookings were best at BP ($9), Shell ($11/BOE), and ExxonMobil ($13/BOE). The highest or worst organic replacement cost performance emanated from Marathon ($29/BOE), Chevron ($25/BOE), and Hess ($21/BOE). [ISI 2011]

The discounted value of future development costs minus current capitalized expenses on current production are highest at Marathon, ConocoPhillips and Total. The companies with the best positioning in this area are Hess, Shell, and BP.

(3) Availability of skilled personnel.

Global geopolitical forces are creating a highly volatile, rapidly fluctuating crude oil and gas market. Global competition for depleting resources continues to drive the need to lower operating costs and increase finding and recovery rates. The number of skilled resources continues to decline. Shareholders are pressuring companies for a return on their investments that is commensurate with other long-term investment strategies.

Integrated Oil Performs Well, but what's next?

While there is definitely a range on performance, profits remain near record levels for "Big Oil" and the larger independents are growing larger. In E&P, both cash on cash returns and production income are up. Current integrated oil financial expectations and valuations are higher than they have been in a decade. Integrated oil companies in particular have outperformed S&P Energy and matched the S&P 500. For example, BP, COP, CVX, and OXY continue to hold strong investment potential.

ConocoPhillips (COP) is a good example of the current strength of integrated oil companies. COP equity leads its peers over the past few years, and the company appears poised to perform at even higher levels through 2012. COP’s major businesses are both high quality performers and well positioned from a competitive standpoint in their respective markets. COP's balance sheet appears strong with pro-forma dividend yields at 5% and 3% for E&P and R&M.

Investors will, however, want to avoid/sell under-funded gas focused companies (i.e., those with a poor gas/oil/NGL mix) due to what I consider to be the almost certainty of pain from a future "Marcellus fallout." Under-funded companies with greater gas exposure will find the markets less hospitable for obvious reasons.

So, in general, things look good for integrated companies and larger independents.

But what's next?

Virtually all current global oil demand growth emanates from non-OECD countries, led by Latin America, the Middle-East and Asia in 2011-2012. However, in the short term, even non-OECD demand projections fell in the past few months due to higher fuel prices, and slower economic growth. Chinese oil demand picked up by six percent in August, but was offset by weaker overall global demand. Slow economic growth, lower coal prices, heavy rains (which means lower agricultural demand and increased supply of hydroelectric power) and the release of stored inventory through "destocking" have all contributed to recent demand growth projections. Global oil demand growth is projected to slow to 0.9 and 1.3 MMBPD in 2011-2012. Non-OECD demand growth remains positive but, of course price increases will certainly impact demand in Asia, Latin America, FSU countries and Africa. These non-OECD areas represent approximately 80% of projected global demand growth in 2011-2012. Lower consumption in these countries would be negative for crude oil prices.

What strategies are best for dealing with these variables? How do companies weather the new challenges that arise every day?

I would like to hear from you, the reader, with your opinions on prospects for companies considering the current market.

What are your predictions for 2012?

A Foreigner's Perspective on Labor in the Brazilian Oil & Gas Industry

Due to the breakneck speed at which the pre-salt discoveries have fueled growth in Brazil, most companies, Brazilian and foreign alike, know it is difficult to procure all of the skilled labor required for operations.

The lack of qualified employees owes in part to the historically deficient Brazilian public education system. This system produces few candidates qualified to become petroleum engineers, geologists, geophysics, technicians, etc. As a result, many companies are obliged to create their own training centers to educate employees. Petrobras, for example, established an eleven-month-long training program for newly hired engineers to strengthen their knowledge before releasing them into the field.

Another solution is outsourcing through the importation of foreign employees. According to the Brazilian Labor Ministry, the number of authorized foreign workers rose 30% in 2010 alone. This number, however, does not mean the skilled labor shortage will be solved anytime soon since demand far exceeds even this dramatic growth. The reason for this is that Brazilian work visas can be a challenge to obtain and procuring permanent visas requires even more lengthy and expensive immigration procedures.

The burden for an "importer" of foreign labor does not end with the visa process. Foreign workers need to pass through an acculturation program and require relocation support which is extremely burdensome to the hiring company. This, together with the higher salaries paid to skilled oil and gas workers, substantially increases payroll and general operating costs.

The fun does not stop there.

Many foreign companies who have experienced light labor regulation in other Latin American countries are often surprised by the relatively onerous and inflexible Brazilian labor laws and the influence of powerful labor unions. The current, protectionist labor laws are derived from the "corporatist" labor code of the fascist government of Benito Mussolini. In fact, the Brazilian labor code is so pro-employee that a collective bargaining agreement may prevail over both the Labor Code and the Constitution if it is more beneficial to the employee. It should be no surprise then, that employee termination is also extremely difficult, with expensive severance provisions common.

To say Brazilian unions are powerful is a gross understatement. In Brazil, workers automatically "join" a union, defined by the region the worker works in, and his field of work. A worker, by law, must pay dues to that union (one day’s salary per year). In Brazil there are around 18,000 labor unions, all deeply rooted in their respective sectors, with guaranteed dues to fund their operations and enormous political influence.

This clash of labor culture may make life difficult for foreign companies doing business in Brazil. Those who fail to put this critical element into the mix when developing a plan to enter the Brazilian market, place the success of their entire venture at risk.

Patent Reform Legislation Brings Host of Changes to US Patent Law

The Leahy-Smith America Invents Act, signed by President Obama into law on September 16, 2011, is the culmination of patent reform efforts taking years. Making several significant and long-awaited changes to US patent law and a myriad of potentially less significant changes, the Act as a whole likely represents the most substantial change to US patent law since 1952. This blog entry summarizes the Act’s most important changes.

Adoption of a "First to File" Patent System

Harmonizing American patent practice with the rest of the world’s most advanced economies – and representing its single biggest change – the Act converts the US patent system from "first to invent" to "first to file." In other words, priority will be established on the basis of when a patent application is filed, and not on the basis of which inventor first conceived and reduced the invention to practice. Limited exceptions to the "first to file" regime are available for an inventor who files an application within one year of his or her first disclosure (for example, at a conference).

Some critics charge that this change will create a "race to the PTO" that unfairly burdens individuals and small entities that may not have the resources to file applications as promptly as large companies. Advocates contend that the change will reduce the expense of the patent process and of patent infringement litigation, enabling innovators to put the money saved to research, development and the creation of new industries and jobs. Time will tell who is right.

The Act will eventually eliminate patent interference practice because the earliest filing date of competing applications will establish priority. Consequently, to address claims that a patentee copied his or her claimed invention from an earlier inventor, the Act creates a new category of "derivation" petitions. Derivation petitions allow an alleged first inventor to file a petition with the PTO – or a civil action in US District Court – within one year of a patent’s issue date or one year of a patent application's publication date, seeking to have the patent or patent publication deemed derivative.

Post-Grant Proceedings

The second significant change comes in the form of two new post-grant opposition proceedings. The first – "inter partes review" – will replace the inter partes reexamination process. It allows any person (except the patent owner) to challenge an issued patent within the first nine months following its issuance on grounds of anticipation or obviousness. The PTO standard for allowing the review to proceed is "that there is a reasonable likelihood that the requester would prevail with respect to at least one of the claims challenged in the request." Discovery is available. Although the existing ex parte reexamination process is left intact, a patent owner dissatisfied with the result of an ex parte reexamination may appeal only to the Federal Circuit; it no longer may do so in district court.

"Post-grant review," the second new mechanism, allows a party to oppose a patent within the first nine months following issuance on any invalidity ground (including any requirement under Section 112 of the Patent Act other than best mode).

Prior Commercial Use

Section 273 of the Patent Act has provided alleged infringers of business method patents with a "prior commercial use" defense. The Act’s third significant change is its expansion of this defense to infringement claims involving any type of patent. Doing so will protect innovators who have chosen to maintain inventions or processes as trade secrets against infringement claims brought by later claimed inventors.

False Marking

The rash of recent false marking cases that have flooded district courts over the past two years will soon be gone. The Act eliminates the private enforcement of false marking claims except as to those who can show a competitive injury. Because the Act expressly covers all cases pending on the Act’s effective date, we expect all but a very few cases around the country will be dismissed.

The Good and Bad News Regarding PTO Fees

After siphoning off the funds collected by the PTO over the years, Congress heeded the PTO’s call to cease doing so. The Act thus allows the PTO to keep essentially all of the fees that it collects, which presumably will be used to hire more personnel and reduce the ever-increasing backlog of pending applications, reexaminations and PTO appeals. That’s the good news.

The bad news is that on September 26 (10 days after the Act’s effective date), all patent fees – including filing fees, national fees, examination fees, issue fees, disclaimer fees, appeal fees, maintenance fees, patent search fees and continued examination fees – rise by 15 percent. The Act also introduces a "prioritized examination" mechanism that, for an additional fee of US$4,800, will accelerate examination of an application deemed "important to the national economy or national competitiveness."

Nuisance Claims Are Out: Supreme Court Removes Weapon From Activist Arsenal

On June 20, 2011 the US Supreme Court issued its long-awaited decision in American Electric Power Co., Inc. v. Connecticut, holding that the Clean Air Act’s scheme for US EPA regulation of carbon dioxide and other greenhouse gases (GHGs) displaces federal common law nuisance claims seeking reduction of GHGs to address global warming. The decision reinforces the Court’s prior decision in Massachusetts v. EPA that the Clean Air Act authorizes federal regulation of GHGs and places US EPA, as opposed to the courts, front and center in the debate over control of GHG emissions.

In 2004 eight states, New York City and several private land trusts filed suits in the US District Court for the Southern District of New York against five major electric power companies alleging that the defendants were the "largest emitters of carbon dioxide in the United States," and their emissions substantially and unreasonably interfered with public rights in violation of the federal common law of interstate nuisance or, alternatively, state nuisance law. The plaintiffs alleged that these emissions were a public nuisance for contributing to global warming and sought injunctive relief requiring the defendants to cap and reduce GHG emissions by specific percentages each year for at least a decade.

The district court dismissed both suits as involving non-justiciable political questions. On appeal the Second Circuit reversed and found that plaintiffs had stated a claim under the federal common law of nuisance because US EPA had not promulgated any rule regulating GHGs. The Second Circuit found that until US EPA exercised its authority to regulate GHGs, displacement of the claim by the Clean Air Act could not occur.

The US Supreme Court was divided on whether the plaintiffs had standing to bring this claim and affirmed the lower court’s exercise of jurisdiction by default. The Court was united, however, in its conclusion that "the Clean Air Act and the EPA actions it authorizes displace any federal common law right to seek abatement of carbon-dioxide emissions from fossil-fuel fired power plants." In Massachusetts v. EPA, the US Supreme Court clearly identified carbon dioxide as "air pollution." The Clean Air Act directs US EPA to identify categories of sources that contribute significantly to air pollution and are reasonably expected to endanger public health or welfare. Once US EPA identifies those categories, it must regulate the existing sources and establish performance standards for emissions from new and modified sources in each category. The Court found that these provisions of the Act provide an adequate avenue for the plaintiffs to petition US EPA to initiate rulemaking and to seek judicial review of US EPA’s regulatory decisions. Under this framework, the Clean Air Act "speaks directly" to the issue of carbon dioxide emissions from power plants, displacing federal common law public nuisance suits and leaving no room for courts to issue ad hoc decisions through common law suits.

The Court disagreed with the Second Circuit’s conclusion that federal common law could not be displaced until US EPA had actually exercised its jurisdiction over carbon dioxide emissions by issuing regulations. The Court found that it was Congress’s delegation of authority to US EPA that displaces federal common law, not US EPA’s exercise of that delegation. Citing the Massachusetts decision, the Court concluded such a delegation had occurred here for GHG emissions, thus placing the burden of balancing regulatory policies on US EPA, not the courts. If US EPA decides against regulating a particular source category in making these policy choices, the courts may not step in and force regulation under common law theories.

While the Supreme Court’s decision removes federal nuisance law as a mechanism for plaintiffs to seek to impose emission controls on GHG emitters, the decision leaves open the possibility for that relief under state nuisance law. The Court indicated that the availability of state law claims would depend upon the preemptive effect of the Clean Air Act, an issue that remains open on remand. Disposition of these issues will provide yet another important indication of the role courts will play in the continuing regulation of greenhouse gas emissions, if any.

CNX Deal Bellweather for Future Utica Valuations?

CONSOL Energy Inc. (NYSE: CNX) announced this morning that it sold a fifty-percent JV interest in nearly 200,000 Ohio Utica Shale acres to Hess Corporation (NYSE: HES) for $593 million. This equates to $6,000 per acre (without a discount applied). The purchase price includes an up front payment of $59 million and $534 million in a “drilling carry” whereby HESS pays for half of CNX's share of investment.

Is this transaction value unique to the acreage or do you believe it is representative of pricing on future Utica transactions?

Will WTI Discount Hamper Unconventional Resources Growth?

Historically, cash flow from legacy assets has helped many companies fund investment in unconventional resources in such plays as Eagle Ford. However, the recent discount to WTI has put a crimp in that cash flow (despite the small bump to $85.44 yesterday) and could result in CAPEX deficits for some companies who made assumptions about higher oil prices (a potentially dangerous mistake in a high cost environment). Will external funding be needed to bridge the gap? Will it be available? Will hedges suffice (probably not for many)? Will companies have to divest assets to fund development or will they make new offerings of equity?

What are your thoughts on how price discounts will influence CAPEX budgets and unconventional development?

ConocoPhillips Separation Looks Good for Shareholders, with a Few Legal Hoops Remaining

ConocoPhillips announced separation into separate E&P and R&M companies today. The spin-off is likely during the first half of 2012. ConocoPhillips' major businesses are well positioned in their respective markets, so the resulting spin-off companies should look strong from a financial perspective. See my article on Spin-Off transactions.

ConocoPhillips was a top performer among integrated oil companies during 2010. Leading analysts project that the company will earn $7.75 per share and dividends will rise by 10% annually in 2011 - 2012.

THE LEGAL DETAILS:

The ConocoPhillips board approved the separation yesterday.

A ruling from the IRS is required to ensure this transaction qualifies for tax-free treatment (though meeting the requirements does not appear to be an issue).

Neither FTC nor shareholder approval is required.

FTC and DOJ Revise HSR Form and Filing Requirements with Special Focus on Energy MLPs

The Federal Trade Commission (FTC) and the Department of Justice (DOJ) have announced major revisions to the Hart-Scott-Rodino (HSR) Report Form and the Premerger Notification Rules.

See http://www.ftc.gov/opa/2011/07/hsrform.shtm

The revisions are expected to come into effect in early August, 30 days after publication in the Federal Register.

The changes sweep away the requirements for parties to provide information including:

(i) Copies of documents already filed with the Securities and Exchange Commission;

(ii) Economic code "base year" data; and

(iii) Detailed breakdowns on all the voting securities to be acquired.


Despite the FTC’s aim to streamline the filing process, in some areas the filing burden has arguably increased. In particular, some controversial changes survived an 11-month consultation, albeit in a watered-down form.

In new Item 4(d) of the Form, all parties will be required to disclose all "confidential information memoranda" prepared by or for officers or directors of their ultimate parent companies in the year before the date of filing. This extends to studies, surveys, analyses and reports prepared by investment bankers, consultants and other advisers.

Perhaps more significantly, the revised Form provides a broad definition of a new term, "associate," to define entities under common management with the acquiring person, but not controlled by the acquiring person. The FTC has been concerned about the lack of information available about families of entities that fall outside the scope of the HSR Rules, and the antitrust ramifications of acquisitions involving them. (Master Limited Partnerships in the energy industry are highlighted in particular.) The new reporting demands apply to entities under "common investment or operational management" with the filing party and place detailed notification requirements upon them. The change means that private equity and investment funds could now be caught by disclosure requirements.

Under new Item 6(c)(ii), an acquiring party must report associates' holdings of voting securities and non-corporate interests in the target, where they are of five percent or more but less than 50 percent. This requirement extends to entities that have six-digit NAICS industry codes that overlap with the target's. Similarly, Item 7 will require information about "associate" entities.

The method of reporting revenue has also been revised (Item 5). All manufacturers – whether domestic or foreign – will be required to report revenue from sales of their products only under 10-digit NAICS codes. Sales of products that are only sold, and not manufactured, by the parties will continue to be reported under wholesaling or retailing codes.

Other minor revisions have been made to complete the changes made to the HSR Rules in 2005 that related to unincorporated entities.

The revisions will be published in the Federal Register within the next few days and will take effect 30 days after the date of publication.

EPA and Coast Guard Announce Agreement to Jointly Enforce US and International Air Pollution Requirements

The US Environmental Protection Agency (US EPA) and the US Coast Guard (USCG) recently announced an agreement (MOU) to jointly enforce US (Act to Prevent Pollution from Ships) and international air pollution (MARPOL Annex VI) requirements for vessels operating in US waters. These requirements establish limits on nitrogen oxides (NOx) emissions and require the use of fuel with lower sulfur content, in the latest efforts to protect human health and the marine environment by reducing ozone-producing pollution. The most stringent requirements apply to ships operating within 200 nautical miles of the coast of North America.

See http://www.epa.gov/compliance/resources/agreements/caa/annexvi-mou062711.pdf

In US EPA’s words, "[t]oday’s agreement forges a strong partnership between EPA and the US Coast Guard, advancing our shared commitment to enforce air emissions standards for ships operating in US waters. Reducing harmful air pollution is a priority for EPA and by working with the Coast Guard we will ensure that the ships moving through our waters meet their environmental obligations, protecting our nation’s air quality and the health of our coastal communities."

These sentiments were echoed by USCG leadership. "This agreement demonstrates the Coast Guard’s long-standing commitment to protecting our nation’s marine environment," said Rear Adm. Kevin Cook, Director of Prevention Policy for the USCG. "Aligning our capabilities with EPA enhances our commitment to the marine environment while minimizing the impact on shipping."

By way of background, MARPOL was developed through the International Maritime Organization (IMO), the United Nations agency dealing with maritime safety and security, as well as the prevention of marine pollution from ships. MARPOL is the main international agreement covering all types of pollution from ships. Air pollution from ships is specifically addressed in Annex VI of the MARPOL treaty, which includes requirements applicable to the manufacture, certification, and operation of vessels and engines, as well as fuel quality used in vessels in the waters of the United States. Since January 2009 all vessels operating in US waters must be in compliance with MARPOL Annex VI regulations, but enforcement has lagged.

See http://www.epa.gov/oecaerth/civil/caa/annexvi-mou.html

The purpose of the MOU was to establish terms by which US EPA and USCG can work together to implement and enforce Annex VI requirements. While the MOU does not add any new compliance requirements, it does signal that enforcement of the requirements has become a top priority. US EPA and USCG also sent a letter to the maritime industry notifying them of the MOU, and to advise that US EPA and USCG are taking measures to promote compliance, including investigating potential violations and pursuing enforcement actions with penalties for violations. The central provisions of the MOU relate to vessel inspections, certification, examination and investigations. Importantly, the MOU also discusses enforcement by criminal prosecution and penalties.

More information is available on US EPA's website.

See http://www.epa.gov/otaq/oceanvessels.htm#emissioncontrol

This development signals upcoming enforcement on the part of both agencies. Shipowners, ship operators, shipbuilders, marine diesel engine manufacturers, marine fuel suppliers and marine insurance providers should be prepared to deal with increased enforcement and prosecution of air pollution laws.

Outside Service Providers Are Not Liable Under Federal Securities Laws, Says US Supreme Court

Can an investment adviser be held liable in a private action under Securities and Exchange Commission (SEC) Rule 10b-5 for false statements included in its clients' mutual funds' prospectuses? On June 13, 2011 the US Supreme Court said "no" in Janus Capital Group, Inc. v. First Derivative Traders. That answer brought a huge sigh of relief from not only investment advisers but also other outside professional service providers.


BACKGROUND

Janus Capital Group, Inc. (JCG) is a publicly traded company that created the Janus family of mutual funds, which are organized in a business trust as the Janus Investment Fund. The Janus Investment Fund retained JCG's wholly owned subsidiary, Janus Capital Management LLC (JCM), to serve as its investment adviser. JCG, which issued prospectuses, was sued in federal district court, along with JCM, on allegations that both entities violated federal securities laws because statements in prospectuses for certain individual Janus funds were misleading.

The district court dismissed the case, rejecting the argument that JCM could be liable whether or not it drafted the misleading prospectuses. The US Court of Appeals for the Fourth Circuit reversed, holding that "although the individual fund prospectuses are unattributed on their face, the clear essence of plaintiffs' complaint is that JCG and JCM helped draft the misleading prospectuses."


SUPREME COURT WEIGHS IN WITH BRIGHT-LINE RULE

The Supreme Court granted certiorari to address whether JCM, as an advisor, could be held liable in a private securities action for false statements included in the prospectuses.

Justice Thomas delivered the Court’s opinion, which Justices Roberts, Scalia, Kennedy and Alito joined. The Court focused on the word "make." Rule 10b-5, promulgated by the SEC pursuant to authority granted under §10(b) of the Securities Exchange Act of 1934, prohibits "mak[ing] any untrue statement of a material fact" in connection with the purchase or sale of securities.

According to the Court, "for purposes of Rule 10b-5, the maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it. . . . One who prepares or publishes a statement on behalf of another is not its maker." The Court looked to speechwriting for comparison, noting this "rule might best be exemplified by the relationship between a speechwriter and a speaker. Even when a speechwriter drafts a speech, the content is entirely within the control of the person who delivers it. And it is the speaker who takes credit – or blame – for what is ultimately said."
The Court rejected the argument that both JCM and JCG might have "made" the misleading statements within the meaning of Rule 10b-5 because JCM was significantly involved in preparing the prospectuses: "This assistance, subject to the ultimate control of Janus Investment Fund, does not mean that JCM 'made' any statements in the prospectuses. Although JCM, like a speechwriter, may have assisted Janus Investment Fund with crafting what Janus Investment Fund said in the prospectuses, JCM itself did not 'make' those statements for purposes of Rule 10b-5."

Had the Court not created much needed clarity with a bright-line rule, many service providers – accountants, bankers, lawyers, investment advisers and the like – who are involved in preparing documents disseminated to investors would have remained at risk. The Court had previously held that there is no secondary "aiding and abetting" liability under Rule 10b-5 against those who do not "make" a statement, but contribute "substantial assistance." And now, given the Court's opinion in Janus, service providers can rest even easier, with a better understanding of what it actually means to "make" a statement under Rule 10b-5.

FCPA-Inspired Bribery Act Projected to Hit the Oil and Gas Industry Hardest

The UK Bribery Act is scheduled to take effect on July 1, 2011, and according to a recent study by Ernst & Young, it will hit the oil and gas industry the hardest.

Ernst & Young's news release revealed some troubling statistics regarding bribery prosecutions under the US Foreign Corrupt Practices Act (FCPA) since its inception in 1977. In the study, Ernst & Young analyzed 118 FCPA cases involving 242 companies (including subsidiaries) and 167 prosecutions (an additional 30 are still pending) to determine which industries were most likely to be prosecuted. The data revealed that oil and gas companies were the most likely to be prosecuted under the FCPA, accounting for 18 percent of all prosecutions. Life sciences and consumer products were the second and third most prosecuted industries, accounting for 13 and 12 percent of prosecutions, respectively. Criminal fines were the most common outcome of an FCPA investigation in all three sectors.

Ernst & Young noted in the release that it expects the oil and gas industry to see the harshest impact of the UK Bribery Act, not because the sector is somehow predisposed to greater corruption, but because the sector operates in different parts of the globe. David Lister, a director at the firm’s Fraud Investigations and Dispute Services team, explained "There is no suggestion that individuals and companies within the oil and gas sector [or other sectors on the list] are intrinsically more corrupt than their counterparts in other sectors. Rather, it is the nature and locations of their businesses that exposes them to additional risk."

According to Ernst & Young, it elected to examine the historical data on FCPA prosecutions to forecast the impact of the UK Bribery Act because the Act’s provisions are similar to the FCPA and prohibit similar conduct. It is not exactly comparing apples to apples, however, because the UK Bribery Act, as written, is stricter than the FCPA, criminalizing the following three major areas that are not covered by the FCPA.

1. Bribery of private individuals and companies – The UK Bribery Act extends the prescribed conduct to include private commercial bribery, e.g., bribery between private individuals and companies, where a foreign official is not involved.

2. Offerors and acceptors of bribes are equally culpable – The FCPA only criminalizes the offer or payment of a bribe. The UK Bribery Act punishes not only the offer and payment of a bribe, but also the acceptance of a bribe.

3. Facilitation payments – Unlike the FCPA, the UK Bribery Act contains no exception for facilitation payments – monies paid to expedite the performance of a routine governmental action by a foreign official to which the payer is legally entitled – but rather, specifically prohibits their use.

Companies doing business in both the UK and United States should take note of the differences between the UK Bribery Act and FCPA, and will need to revise their existing compliance programs to reflect the more expansive provisions of the UK Bribery Act and the distinctions between the two.

Global Cooling: A Cautiously Optimistic View of the Next Two Years

Global oil demand experienced some modest destruction last month (about 3.5%) and the IEA and EIA both released declining demand projections which many believe will continue through the third quarter of 2011. However, many stock analysts remain bullish on energy because of expected overall growth in demand attributable to Asia, former Soviet bloc countries (FSU), and Latin America. Projections put crude prices at around $105/bbl (Brent) at 2011 year end, $110/bbl (Brent) and gas at $5.25/mcf next year with those prices holding through 2013, so there is good reason to be optimistic.

One of the only variables in this scenario that could cause material demand destruction in the sector is taxation.

Globally, fewer countries are subsidizing gasoline now than they were five or ten years ago because the cost simply became too high and more countries are placing higher taxes on fuel. In the U.S., though unlikely this year, the looming threat of Obama-driven taxes on oil and gas as well as his proposed removal of development incentives for the industry (e.g., IDC deductions) could contribute to substantially higher prices at the pump.

What does this all mean? There are so many factors involved in the global commodities markets that it is difficult to make generalizations. However, taxation is one factor where generalization is simple:

Increased taxation will push up consumer prices and increase demand destruction.

“Taxation” of course means increased direct taxes on energy companies. It also means the removal of tax incentives for domestic development. Further, “taxation” means any legislation that has the effect of increasing costs or inhibiting development, thereby driving up prices (e.g., restrictions on U.S. offshore production, onerous anti-fracing legislation, etc.).

From an international perspective, don’t underestimate the fact that the areas with the greatest demand growth also have much higher rates of population growth and rapid urbanization and motorization. This means exponential demand on supply.

So what price is too high?

Today the economy is less sensitive to price increases than it was during the 1970s when spikes in oil prices contributed much of the inflationary pressures on consumers. Nonetheless, the stress on supply from increasing global demand (especially volatile global demand since China, while representing 11% of global production accounts for more than one third of all demand growth since 2005, and Latin America 7% of global production but 15% of demand growth) and the environmental movement (pushing increased taxation and restrictions on production) have the potential like never before to force unusually high prices.

Increased taxation could be the “tipping point” that creates a demand-destructive, high price scenario.

I would like to hear from you.

What are your perspectives on the near term?

What sorts of strategies are you, your clients, vendors and customers using based on their vision of the next few years?

Please leave a comment below.

Another Stinker: New Corporate Tax Proposal Lurks in Halls of Congress

Legislative analysts are buzzing about a new corporate tax proposal coming soon to a Congress near you. The proposal will center around the taxation of "pass-through" entities (like S corporations) that have revenues of more than $50 million.

It involves reducing the corporate tax rate to 28% (the median corporate effective tax rate for companies in the "Russell 3000" was around 32% last year) and eliminating certain deductions (i.e., reducing the rate and broadening the base much in the way the state of Texas did with the so-called "margin" tax). This proposal would presumably be extended to MLPs and LLCs.

The eliminations or changes would include: (i) modification of accelerated depreciation, (ii) elimination of the domestic production deduction, (iii) taxing foreign earnings on a current basis, and (iv) other Obama Budget proposals.

Who would be most adversely affected by the proposal if it becomes law? Low cash and low effective tax rate companies, which will actually see an increase in their taxes due to a loss of available deductions. According to Standard & Poor's and Bloomberg, the energy sector had an overall cash tax rate of 12% and an effective tax rate of 32% last year. This places energy companies within the "middle" of this scenario. However, the possible impact on cash flow and funding could be significant on an indirect basis even for non-pass through companies since many funding sources are pass-throughs.

On the surface, lowering tax rates seems like a good idea. However, it is the elimination of deductions which will make life difficult for many companies, especially those in capital intensive businesses.

The U.S. combined corporate tax rate is over 39%, making it the second highest in the world (second only to Japan)! We must go much further than lukewarm tax reduction! This is the reason literally billions remain unrepatriated outside the U.S. (it seems the new proposal might contain a repatriation holiday but this is just a patch on a broken system).

When are the folks in Washington going to learn that U.S. companies cannot continue to remain competitive with such high rates?

Energy companies desperately need their cash to reinvest in new technology, exploration and rising costs. When combined with the impact on prices due to restrictions on domestic production, Congress is simply restricting the growth of domestic energy jobs and forcing Americans to pay more for their energy. Even if not directly impacted by the proposal, the indirect impact will be felt by many companies through funding sources and increases in the cost of many services.

Don’t Believe The Hype: Tax Increase on Oil and Gas Companies Unlikely

A few days ago House Speaker Boehner told ABC news he was open to the idea of raising taxes on oil and gas companies. Boehner said that while “everybody wants to go after the oil companies” for gas prices that are climbing above $4 per gallon in many regions of the country, the industry also has “got some part of this to blame.”

“Listen, they’re gonna pay their fair share in taxes, and they should,” Boehner said. Boehner also said he does not believe “the big oil companies need to have the oil depletion allowances” and that “we certainly oughta take a look at” proposals to do away with some industry incentives.

Naturally, this has created a lot of buzz. However, a meaningful tax increase on oil and gas companies remains unlikely. Here’s why…

What you haven’t heard as much about is that Boehner’s spokesman quickly made clear that the congressman’s comments were not a change from his previous position, which is generally representative of many House Republicans and contains no real commitment to tax increases. Despite the hype following Boehner’s comments, there’s virtually no support among House Republicans for raising taxes on energy companies along the lines of the Obama proposals:

OBAMA ENERGY TAX HIKES

Proposed Tax/10 Year Federal Tax Revenue
Elimination of domestic
manufacturing deduction / $18.3B

Eliminate expensing of
intangible drilling costs / $12.5B

Eliminate percentage
depletion for oil and
natural gas wells / $11.2B

Increase geological and
geophysical amortization
period for independent
producers to seven years / $1.4B


In fact, far from tax increases, the House is likely to consider two bills next week that promote domestic production of oil and gas. Legislative analysts are also quick to point out that the Senate has voted on some of the tax increases favored by Obama and other Democrats twice in the past year and both times they failed to win even a simple majority (never mind 60 votes). Back in February a Senate vote on raising taxes on oil and gas companies received only 44 votes.

Unless something dramatic happens in the short term, those votes aren’t going anywhere.

Let me hear your opinion on which way the legislative wind is blowing! Please give us your comments.

China Unplugged

I recently returned from two weeks in China where, among other things, I participated in the China-U.S. Energy Summit. China is a veritable ant hill of activity. As anyone who reads a paper (or a blog) or watches the TV news already knows, China is booming. Besides the constant honking from Chinese drivers, the one constant during my trip was the sound of construction. Not surprisingly, China is also replete with newly minted millionaires and billionaires who have made their money from the expanding economy. Like their western counterparts, wealthy Chinese are eager to expand and diversify their portfolios. However, Chinese culture, and a traditional distrust of anything but "hard asset" investments, has lead many wealthy Chinese to place money into real estate. Of course, as recent experience shows, real estate is not all it's cracked up to be as an asset class. It should be a "no-brainer" then for these folks to want to invest in oil and gas right?

Wrong.

To my surprise, even some of the wealthiest and most sophisticated Chinese investors were unaware that private oil and gas investment was even available. A history of state (mainly military) control over natural resources has left would-be oil and gas investors ignorant of the potential upside of such an investment. Add to that the substantial restrictions on individual Chinese citizens for converting their currency, and you have a frustrated, yet potentially huge source of capital for new oil and gas development projects.

The good news for companies seeking capital is that there are some exceptions to the restrictions on private Chinese foreign investment, and potential investors are intrigued by the potential of oil and gas projects. For the companies with the patience to develop the long term relationships Chinese investors demand, literally billions await.

The Clock Has Started Ticking: Guidance to the UK Bribery Act 2010 Published Today

The UK Government has today confirmed that the Bribery Act 2010 (the Act) will come into force on 1 July 2011 and has published the much anticipated final version of its Guidance for commercial organizations about how they can reduce their exposure to bribery offences under the Act. A Quick Start Guide has also been published that sets out the key points.

For the purposes of the Act, a bribe is effectively the giving or receiving (or the offer or promise to do so) of a financial or other advantage with the intention of bringing about the "improper performance of a function or activity". The Act consolidates existing offences of offering or receiving a bribe, bribery of foreign public officials and introduces a new corporate offence of failure by a commercial organization to prevent a bribe being paid or received on its behalf. It will be a defense for an organization to show that it has "adequate procedures" in place to prevent such bribery. The long-awaited Guidance is important as it provides clarification in relation to what will constitute "adequate procedures".

The final version of the Guidance is formulated around six general principles:

• proportionate procedures;
• top-level commitment;
• risk assessment;
• due diligence;
• communication; and
• monitoring and review.

These principles largely follow those contained in the draft Guidance, previously published. As emphasized by Lord Chancellor Kenneth Clarke in his announcement today, following these six general principles and combating bribery is very much about adopting a common sense approach to addressing the organization’s exposure to bribery.

The Government also appears to have heeded concerns raised in consultation on the draft Guidance and has attempted to minimize those concerns. The clear emphasis in the final Guidance is that a proportionate approach to the implementation of "adequate procedures" is very much all that is necessary. Small businesses and organizations operating in low risk areas will require only modest procedures to mitigate their risks under the Act. In contrast, large scale, multinational organizations operating in high risk areas will be under a more onerous obligation to ensure that their duty to implement adequate procedures is properly discharged.

Helpfully, the Government has also given further clarification in relation to the following areas:

• Corporate Hospitality: One of the main criticisms leveled at the draft Guidance was that it did not provide clear advice on what level of corporate hospitality could be provided without exposing the organization to an investigation and potential prosecution. The final Guidance seeks to address these concerns and wants to reassure businesses that "bona fide hospitality and promotional, or other business expenditure which seeks to improve the image of a commercial organization, better to present products and services, or establish cordial relations" is not prohibited by the Act. The Government does not intend for the Act to prohibit "reasonable and proportionate" hospitality and promotional expenditure incurred in "good faith" for these purposes and that prosecutors would take into account the standards or norms applying in a particular sector when considering whether bribery had taken place. The Guidance makes clear however that it is still for businesses to establish and disseminate appropriate standards for hospitality and promotional or other similar expenditure. The Quick Start Guide states that tickets to sporting events, taking clients to dinner, offering gifts to clients as a reflection of your good relations or paying for reasonable travel expenses in order to demonstrate your goods or services to clients will not amount to bribery as long as they are proportionate to your business. Lord Chancellor Kenneth Clarke has assured businesses that the Act does not stop them getting to know their clients by taking them to events like Wimbledon, Twickenham or the Grand Prix.

• Facilitation Payments: As widely anticipated, the final Guidance makes it clear that facilitation payments (small payments paid to facilitate routine Government actions) are still unlawful, but says that it recognizes the problems that businesses face in some parts of the world and in certain sectors. The Quick Start Guide states that businesses can continue to pay for legally required administrative fees or fast-track services as these are not facilitation payments. The Guidance also recognizes that the common law defense of duress is likely to be available where individuals are left with no alternative but to make payments in order to protect against loss of life, limb or liberty. Separate prosecution guidance has also been issued today, stating that prosecutions will normally be instigated unless there are public interest arguments to the contrary. Large or repeated payments, or payments that were planned for or were accepted as a standard way of conducting business are stated as factors tending in favor of a prosecution.

• Commercial Organizations: Only a "relevant commercial organization" can commit the corporate offence under the Act. A "relevant commercial organization" is defined as a body or partnership incorporated or formed in the UK irrespective of where it carries on a business, or an incorporated body or partnership which carries on a business or part of a business in the UK irrespective of the place of incorporation or formation. The key concept here is that of an organization which "carries on a business". The Courts will be the final arbiter as to whether an organization "carries on a business" in the UK taking into account the particular facts in individual cases. As regards bodies incorporated, or partnerships formed, outside the UK, whether such bodies can properly be regarded as carrying on a business in any part of the UK will be answered by applying a common sense approach. The Government anticipates this to mean that organizations that do not have a demonstrable business presence in the UK would not be caught. It would not expect, for example, the mere fact that a company’s securities have been admitted to the UK Listing Authority’s Official List and therefore admitted to trading on the London Stock Exchange, would qualify that company as carrying on a business or part of a business in the UK.

• Associated Persons: A company will only be guilty of failing to prevent bribery if a bribe was paid by a person associated with it. A person is associated with a business if that person performs services for or on its behalf, which is to be determined by reference to all the relevant circumstances and not just by reference to the nature of the relationship. The final Guidance seeks to address concerns that businesses could be liable for third parties over whom they have no control. It states that associated persons could include employees; agents; contractors; suppliers where they are performing services rather than simply acting as a seller; joint ventures where the bribe is paid for a member of the joint venture and with the intention of benefitting that member; and subsidiaries if the bribe was made to benefit the parent company. The Guidance makes it clear however that indirect benefit is not sufficient to constitute an offence.
The Guidance also provides 11 case studies to assist organizations to identify what procedures they should introduce to prevent acts of bribery within their organizations and for which they may be culpable.

Is the final Guidance helpful? I believe it is, and the risk-based approach will be welcomed by most organizations. However, it does not (and in all fairness, could not) provide all the answers. Businesses will still have to be pragmatic in their assessment of their risk and take a common sense approach to the adequate procedures that are required to minimize those risks.

The final Guidance places great emphasis on "proportionality", "common sense" and "public interest". As the cuts in public expenditures begin to bite, it is anticipated that "prosecutorial discretion" will be exercised sparingly to target the minority of organizations that are responsible for the most serious bribes or for allowing the continued practice of corruption to exist within their business. However, every organization that is touched by this Act needs to review its risk profile and decide upon the antibribery and corruption program it requires in order to protect itself from enforcement action.

Japan's Nuclear Woes Make Bi-Partisan Energy Bill Unlikely

Problems with nuclear power plants in Japan make it less likely Congress will pass significant energy-related legislation before the next election. Republicans and Obama found common ground on nuclear as part of energy policy, so it would have been critical for a bipartisan energy bill. However, in light of recent events in Japan, it will be much more difficult to promote the use of nuclear power.

Republicans have advocated streamlining the approval process for nuclear power plants, making them easier and cheaper to build. After what has transpired in Japan, it will be nearly impossible to advocate a less rigorous approval process. Nonetheless, Republicans in the House of Representatives have stated they will attempt to (A) pass individual, targeted bills rather than comprehensive legislation, and (B) bring to a vote bills to open more federal land and waters to oil and gas drilling, (C) promote the use of natural gas vehicles, (D) block a variety of EPA rules, and (E) obtain approval for the Keystone pipeline, allowing oil produced in Canadian oil sands to be transported to Gulf coast refineries.

Obama and the Democrats have adopted a “clean” energy standard that would require a shift away from coal to nuclear and renewable energy. Again, since nuclear was going to lay the groundwork for a bipartisan energy bill, the odds of grand bargain have diminished.

A factor that could raise the odds of an energy bill is higher gasoline prices. Gasoline prices have been on the rise and may reach levels where they become a political issue since many analysts tie presidential approval ratings (in part) to gas prices.

Offshore Safety: Repackaging RP75

Although most Americans don't know it, Macondo is nothing new and neither is the importance of safety as a driving force in offshore operations. A defining event for offshore safety management was the Piper Alpha incident that occurred in the North Sea in 1988. The loss of 147 lives and the destruction of the platform unequivocally demonstrated that the offshore industry needed to improve its safety management practices. The industry has been focused on improving safety ever since.

Yesterday the American Petroleum Institute (API) announced it is establishing a "Center for Offshore Safety" (to be based in Houston) upon the recommendation of the Presidential Oil Spill Commission.

The Center's purpose is to promote the implementation of "Recommended Practice for Development of a Safety and Environmental Management Program (SEMP) for Offshore Operations and Facilities" or "RP75".

RP75 was first issued in the year 1993 and the latest update was published in May 2004. RP75 is a recommended practice, not a regulatory requirement. It describes how offshore operators can create a Safety, Environmental Management Program. RP 75 incorporates input from many organzations including BOEMRE, the Coast Guard, the Offshore Operators Committee, the National Ocean Industries Association, the Independent Petroleum Association of America, and the International Association of Drilling Contractors.

RP75 was recently incorporated into federal regulations by BOEMRE.

To the public, the Center appears to be a hallmark of good government regulating an industry gone bad. In fact, the BOEMRE regulations adopt what has largely already been developed by industry in the form of RP75. The difference is that the elements of RP75 incorporated into the new regulations are no longer mere recommendations.

New regulations mean new compliance costs. The question is how much those costs will be and how will companies monitor and report on compliance? Will the Center step in to assist companies in doing so? That remains to be seen. It is still unclear what form the Center will take, how it will operate, and how it will be funded.

Does your company envision participation in or providing funding assistance to the Center? If so, what are your company's plans? Tell us what you think about the Center and the implementation of RP75 in the new regulations.

Political Risk: What Higher Gasoline Prices Mean for U.S. Legislation

Higher gasoline prices are starting to put pressure on consumers just as many people are starting to feel better about the economy. What does this mean for the near future relative to new energy legislation? For now, prices aren't high enough to warrant serious concern, but keep your eyes on the horizon.

Higher energy prices impose an effective “tax” on households and businesses, leaving fewer funds available for spending and investment.
This poses a threat to the current recovery and could significantly set back an improving labor market. Higher prices also impact headline inflation (inflation measures the rate of change of prices, not their level). Politicians, especially Democrats, hate news about unemployment and inflation. This means the oil and gas sector is a prime target for Democrats' legislative efforts, especially in light of the ever-closer presidential election. It also explains why the Obama administration has come back four times with proposals for new taxes on the industry. Since most consumers have no clue about the relationship between oil and gasoline prices (the "gas crack") we are an easy target.

Many analysts believe that gas prices would probably have to stay closer to four dollars per gallon to create sufficient political pressure to force Congressional action. Never mind the fact that there is little Congress can actually do to impact the price of gasoline (besides increase it by imposing even more taxes). Nonetheless, high gas prices create political pressure to be seen as "doing something."

The rumbling has already begun.

Last week Senate Democrats called for Obama to release the Strategic Petroleum Reserve to help drive oil prices lower, though it's unlikely he will do so at current prices. Democrats will also demand an FTC investigation of price manipulation (blaming increases on some sort of cabal). Expect these types of proposals to increase in frequency (and volume) as we near the next presidential election cycle.

In the near future, Republicans will continue to pressure the Obama administration to force BOEMRE to change its behavior (which has virtually stopped new drilling in GOM). Interior Secretary Ken Salazar testifies before Congress tomorrow and could announce that a few permits will be forthcoming. However, even if BOEMRE relaxed the standards for permits, the resulting new production would represent a drop in the bucket of world oil supply and have little, if any, short-term impact on prices.

As prices increase further, there will be more calls for an energy bill. This means another bite at the apple for Democrats; another opportunity to use the industry as a whipping post and an excuse for new taxes and new regulations.

Brace yourself.

The Risky and Profitable Business of Investing in Spin-Off Companies

Investments in spin-off companies are often profitable (depending on their timing, of course). These transactions can take many different forms (spin-off IPO, carve-out, split-off, etc.). Marathon Oil Corporation’s decision to spin off its refinery business, Marathon Petroleum Corporation, for example, is one of many spin-offs in 2011’s transaction pipeline. Other recent and pending spin-offs include ConocoPhillips’ divestiture of its 20% ownership interest in Lukoil, Lundin Petroleum and Petrofrac’s spin-off of EnQuest PLC, and Norse Energy’s spin-off of Panoro Energy, to name a few.

What is a “spin-off” really? Provided certain rules under the Internal Revenue Code are met, spin-offs are a tax-free way for a company to divest a business (compared to an outright sale). And while a company’s specific circumstances may alter the outcome, the basic requirements to qualify for spin-off treatment include:

1. The parent company must control the “spun-off” company through either 80% or more of the total combined voting power of the company and 80% of all of the classes of shares entitled to vote.

2. The spun-off company cannot be used to distribute earnings and profits of the parent company.

3. The spin-off must have a legitimate business purpose.

4. The parent company and the spun-off company must have been involved in an “active trade or business” for the 5 year period leading up to the transaction closing date (and must continue to do so immediately after the spin-off).

5. There must be a “continuity of interest” (ownership) among the parent company and the spun-off company after the closing.

6. The parent company must distribute all of the stock it owned in the spun-off company.

Once a company chooses to spin off part of its business, there is a lag time between announcement and when the transaction becomes effective. This is because certain tax, legal and regulatory steps are required. Company lawyers must draft documents to legally divide the business and file the necessary paperwork (e.g., an SEC Form 10 registration).

Historically, in a spin-off transaction, the parent company’s stock does well, outperforming industry averages, in these months leading up to the announced transaction, but often not nearly as well in the months following the closing. Making a short term gain on parent stock in a prospective spin-off, therefore, means investors should understand how likely the company is to meet the legal requirements for completing the transaction because this can impact the speed and possibly the “steam” behind a pre-closing run-up.

Spun-off companies, by contrast, often tend to have negative share price returns in the months following a transaction. For example, take Pride International’s (PDE) 2009 spin-off of Seahawk Drilling (HAWK). According to some industry analysts, Seahawk experienced a -60% share price return in 2010. Spun-off companies can make attractive acquisition targets and are valued as longer term investments, however, because spun-off companies (especially smaller cap companies) have relatively high and absolute share price returns over the long term. A word of caution, however: analysts say that energy industry spin-offs have historically underperformed when compared to similar size transaction in other industries.

Have you been involved in a spin-off transaction? Please share your thoughts on spin-offs with us.

Obama Tax Hikes on Oil & Gas Now Unlikely

Earlier this week Senate Republicans voted unanimously against an amendment that would have offset the revenue loss associated with repealing a controversial proposal in the health care bill by raising taxes on oil and gas companies.

This amendment included a number of tax increases, the most important of which would have the effect of (1) raising the corporate tax rate on oil and gas companies by denying them a more favorable rate than other manufacturers pay, and (2) reduce oil and gas companies' ability to claim a credit against foreign taxes paid for purposes of calculating their U.S. tax burden.

This vote is the best indicator that a tax "Obamination" on the industry will have little chance of becoming law in the next year to two years.

Enemy Mine: Munitions Cause Explosive Situation in Iraqi Hydrocarbons Development

Estimates put the number land mines scattered across Iraq at 25 million or more (most in the southern part of the country). Yet despite their obvious danger to human life and their impediment to economic development, you won’t find Hollywood celebrities on camera in these areas asking for your donations or thoughtfully nodding while a village chieftain explains the plight of his people. That’s because many of these mines are concentrated in areas being developed by foreign oil companies.

The Iraqi Oil Ministry and Iraqi NGOs describe the mine problem as “catastrophic.” Yet despite the fact that oil production represents the country’s best hope for raising the Iraqi people out of poverty, international organizations are not contributing enough to the de-mining effort and the government can’t seem to get its act together. Why?

There are nearly a dozen national and international agencies working to get rid of munitions in Iraq. Sources within the energy community have told me, however, that cooperation among these groups has been problematic, based on a perceived bias by non-Iraqi NGOs, in particular, against cooperation with the petroleum industry. The result: the burden has fallen on the service companies to make their areas of operation safe for development. Without the effective support of the government and NGOs, oilfield companies must turn to private firms for help.

Outside of Kurdistan, all development is being let by the Iraqi government on a service contract basis. This means that oil companies don’t share on any of the upside of oil prices, but instead receive a low, flat fee per barrel produced.

Since the Iraqi government did not take mines into account until after the bid rounds closed on current contracts, it made no allowance for delays and cost increases attributable to de-mining activities. Foreign oil companies that have signed contracts to develop Iraq's oil reserves may therefore be unable to meet deadlines due to the danger of land mines. This theoretically places their whole contract at risk.

Service companies, already on thin margins (because many of these contracts are considered brownfield developments in established fields) stand to get the worst end of this situation. With a relatively impotent government and little cooperation from international non-profits, they have had to turn to contract assistance. The impact on margins is obvious.

Iraq could hold the greatest potential for growth in global oil production. With 115 billion barrels of oil, Iraq has the world’s third-largest proven reserves, behind only Saudi Arabia and Iran. Some geologists believe that Iraq’s reserves are even greater than that, as many oil fields have yet to be fully explored. There are few, if any, places that have as much oil that’s untapped and close to the surface (and thus relatively economical to extract) as Iraq does. But oil production in Iraq has fallen woefully short of its potential. The government has announced double digit projections for mmboe production. These numbers are far from realistic, and, more to the point, should the Iraqi government fail to resolve issues like de-mining, continued development under a service contract model could make new projects unprofitable, and untenable, for IOCs.

Tell me what you think (or what you have heard) about these and other operational issues on the ground in Iraq!

Welcome to "Legally Speaking"

I am very honored to be associated with one of the energy industry's finest publications, Oil and Gas Financial Journal. The purpose of this forum is to bring you up to date on current legal and compliance matters and, more importantly, solicit your input on issues facing the energy community.

Legal issues are nothing new to an industry as heavily regulated as ours. They are part of the constantly shifting global environment in which we operate.

What makes 2011 any different?

The answer is in the scope and complexity of the legal environment and the speed with which it is changing. From post-Macondo BOEM regulations to the landmark Pre-Salt legislation in Brazil, and beyond, 2011 brings fresh challenges and opportunities on a scale and at a speed that would make anyone's head spin.

Here at "Legally Speaking" my goal is to stop some of the spinning and give you a practical, direct point of view on legal and compliance matters affecting you.

Your experiences and perspectives are invaluable. Please contribute by giving me your comments. Who knows, you might even get a few tidbits of knowledge without having to pay legal fees!

I look forward to our conversation. -Aaron Ball