well-developed plays like the Permian, STACK/SCOOP and
Appalachia, existing gathering agreements may constrain or
limit take-away options or make the access available only on
expensive non-market terms, placing more strains on owner
cash flows.
The relationship between upstream producers and midstream
gatherers has been put to the test during the downturn. Gathering fees from fixed pricing in midstream contracts were once
viewed as regular, expected and almost annuity-like revenue
source by midstream gatherers. These fees have become less
certain as they have resulted in significant financial burdens
on upstream producers in a low-price environment. In many
cases, upstream producers have approached their midstream
gatherer counterparties seeking relief. Some midstream gatherers have agreed to adjust pricing. Some have not. In extremis,
some upstream producers have attempted to use the bankruptcy
process to rid themselves of burdensome midstream dedications,
with mixed results. In one much publicized example, the bankruptcy court in the Sabine case (Sabine Oil and Gas Corp. v. HPIP
Gonzales Holdings LLC (In re Sabine Oil & Gas Corp.), 547 B.R.
66 (Bankr. S.D.N. Y. 2016)) determined that a midstream dedication did not run with the land, and as such, could be rejected
by the upstream producer debtor, a result that brought into
question the treatment of midstream contracts that many
thought would survive bankruptcy.
Interestingly, the low-price environment and other dynamics
have in some cases resulted in more-favorable deal terms for
some upstream producers in negotiations with midstream
gatherers, especially in hot plays like the Permian. Midstream
gatherers are paying premiums to upstream producers to be
able to transport their production, sometimes in the form of
cash and/or equity. In June 2017, several news outlets reported
a transaction between a midstream gatherer and an upstream
provider in which the midstream party agreed to pay the upstream producer a significant cash amount up front and to
carry the producer on a significant portion of its capital expenditures in connection with the construction of a gathering
system and processing plant that will be used in the transportation of the producer’s future production. It will be interesting
to see if this trend continues.
It is important for investors to understand the landscape
surrounding access to market for the venture, which can vary
greatly depending on the location of the assets.
FOCUS ON THE EXIT
Finally, investors should focus on the eventual exit of their joint
venture investment. Private equity investors generally have
relatively short-term investment strategies, and expect to have
flexibility in their ability to exit the investment when it makes
financial sense for them to do so. Aside from the usual joint
venture exit challenges that arise from the fact that each joint
venture involves parties that may have different intentions for
the investment, exiting a joint venture in the upstream space
can be challenging.
Investors will want to retain flexibility over the timing of
their exit, whether during the initial development phase or the
later operational phase. Practically, it may be more difficult to
exit during the development phase. Because producers typically
want more control over the development of their assets than
a financial investor, the investor looking to exit during the development stage may find their potential buyers limited to a
subset of other private equity or financial buyers, rather than
the full suite of financial and strategic acquirers who may be
interested in the deal at other stages of its lifecycle. In addition,
producers can be much more sensitive to transfers by an investor
during the development phase, as a new party may not have
the same views as the producer regarding the build out and
development of the venture.
One unique aspect of joint ventures in the upstream space
is that, as mentioned previously, producer counterparties are
generally chosen to operate the jointly-owned assets. But on
exit, savvy investors understand that potential buyers will put
a premium on being able to take over the operatorship of the
properties, and will want to focus on how to capture that premium when the non-operator investor looks to exit its investment. Such a right may be more palatable to a producer during
the operational phase when the development has been substantially completed than it may be during the development
phase.
CONCLUSION
As private equity investors consider moving into or expanding
their exposure to upstream oil and gas joint ventures, they
should ensure they understand the full suite of risks and issues
involved, including those addressed in this article. Assessing
counterparty risks, market access and the desired exit outcomes
can increase the investor’s odds for finding an upstream joint
venture “palace of wisdom.”
ABOUT THE AUTHORS
Marc Rose is a partner and Jeremy
Pettit is an associate in Sidley Austin
LLP’s private equity and energy transactional practice located in the firm’s
Dallas, Texas office. Rose and Pettit
represent private equity funds and
energy companies in mergers and acquisitions, joint ventures
and investments.
This article has been prepared for informational purposes only and
does not constitute legal advice. This information is not intended to
create, and the receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this without seeking advice
from professional advisers. The content therein does not reflect the
views of the firm.
