David Sweeney and Andrew Lehman, partners in the oil and gas practice at Akin Gump, have different – but complementary – specialties. Sweeney focuses on acquisitions and development, while Lehman works on mergers and acquisitions. We spoke to them about the recent surge of deals in the oil and gas sector, and how recent regulatory developments in the United States and abroad could impact the industry’s outlook going forward.
CCBJ: Let’s start with a bit of background about yourselves and your practices.
David Sweeney: I’m an oil and gas lawyer. I was in-house for about three years. I handled international oil and gas operations in the U.K. and the Netherlands, and then some places in Africa, like the Ivory Coast, Ghana and Sierra Leone, as well as Vietnam and Mexico. Now that I’m at Akin Gump, I split my time about 60-40, domestic U.S. and international. I focus on the operational side as well as on acquisitions and divestitures (A&D).
Andrew Lehman: I am a straight-up M&A lawyer. My practice centers on enterprise-level transactions, mergers and acquisitions of fully operational businesses, with a healthy component of structured-equity deals, which are similar to debt financings. They’ve become a popular capital solution product, especially in the midstream – and sometimes upstream – sectors of the oil and gas industry.
Earlier this year, sources projected approximately $50 billion in M&A for the back half of 2018. What has fueled this surge of activity, and is there anything special about these deals that our readers should be aware of?
Lehman: Enterprise-level public company deals have become prominent lately. There have been a number of them announced in recent weeks. We’ve seen relatively high, stable commodity prices – especially oil prices – for a sustained period of time this year. That led to public companies being able to repair their balance sheets, deleverage in certain circumstances, and make themselves more financially capable. And that put them in a position to make strategic acquisitions. Most of these acquisitions are being made using their stock as transaction currency, so there is not really a cash liquidity drain on the buyer.
Sweeney: From the asset side, sustained higher prices have made the assets, to some degree, more valuable, but then there’s the cost side as well. That’s an interesting area where you haven’t seen quite the same kind of rebound. I do a fair amount of work for service providers and I don’t know that they’re seeing material increases in margin yet. Anecdotally, anytime you have one of these dips, the service sector tends to trail the upstream sector. So not only have companies had time to repair their balance sheets but also, looking forward, they have a positive outlook, because service prices have been kept fairly low.
I suspect that going forward it’s about fundamentals. We are starting to see some service providers being able to increase their rates a bit. So the cautionary note in all of this is to focus on fundamentals, to make sure that the cash flow projection that has looked so good over the past few years is actually realistic for the future.
How are investors reacting to this surge in activity?
Lehman: Well, speaking from the perspective of institutional investors, at least on the midstream side of the equation, where there’s been a decent amount of activity, the investors have largely been private equity groups with established portfolio companies. What they’ve been doing is basically using their existing portfolio companies to acquire other midstream entities that have complementary asset footprints or operations.
The midstream sector, as distinguished from the upstream side, has not had a ready exit valve, which it normally does. For a long time, master limited partnerships, MLPs, were a typical means by which a private equity group with midstream portfolio companies would seek an exit. MLPs were traditionally very acquisitive creatures, constantly relying on acquisitions to boost cash flow, which would then boost their distributions, their limited partners. But MLPs have largely gone quiet, in terms of being the profile buyer population – which has turned the profile buyer population into these larger portfolio companies within certain private equity groups.
Sweeney: There’s a relatively large amount of cash out there, in the upstream space specifically. But there’s a good amount of capital chasing the same deals, and people are wary of driving prices up to the point that they are arguably sowing the seeds of their own failure again. The oil price drop of 2014 wasn’t that long ago. So capital has gotten more creative about how it’s deployed. We’re seeing capital providers take direct positions in assets that maybe they wouldn’t have done before. We’re seeing a number of hybrid debt-equity structures.
What did the recent sanctions on Iran’s dual exports mean for the industry, and how do you expect them to impact M&A?
Sweeney: I expect limited impact, to be honest. Conventional wisdom would tell you that renewed sanctions on Iran means less supply, which equals greater demand and higher prices – but to be completely frank, look at the U.S. and how unconventional oil sources have changed the picture, how you’ve seen, say, Brent prices decoupling from WTI. I suspect that the U.S. is acting more like a closed loop. There may be less for export, and to be sure, renewed sanctions on Iran will have some impact. But I think that alleviating transportation of capacity constraints in the Permian Basin would probably have a bigger impact on the U.S. market. As far as the world market goes, though, it’s a much more complicated story.
What does the rest of the regulatory landscape look like in this industry?
Sweeney: Many people are probably going to look to Washington, to the current administration and what’s happened in the midterms, and wonder how it will impact the deregulatory proclivity of the Trump administration. But to be completely frank, I think it’s wiser to look at what happened in Colorado with their fracking regulations. I think the regulatory landscape is going to continue to be driven more at the state and local level.
Lehman: Agreed, Colorado is probably the best example of the local initiatives that take place. Proposition 112 – which would have approved the country’s largest mandatory buffer between new wells and homes, schools and waterways – ultimately failed to pass, but private equity investors who have been active in Colorado are very cognizant of the fact that while that referendum didn’t pass this time, it isn’t necessarily gone either. These kinds of situations, where a regulatory change in a local jurisdiction could have a very large potential impact on the industry, are more important, I would say, than sanctions on Iran; Colorado is a major oil and gas producing area within the United States. And if you have a similar initiative somewhere else in the U.S., all of a sudden there is going to be a risk premium associated with any kind of investment in that place.
So how are you both advising clients on financing for deals and projects?
Lehman: In the midstream sector, a general sense of cautious optimism exists after what happened a couple of years ago. Many of the clients I deal with are actually the equity provider – a private equity group that’s putting preferred equity into a midstream operation or potentially upstream operation. The thing that’s changed more than anything else is really related to this need to have a very clear picture of the localities where the asset footprint of the business they’re investing in is. My clients are very sensitive about certain kinds of potential regulatory changes that could impede the underlying operations of the business they're investing in – locally and statewide.
Sweeney: It can depend on what type of investors you’re talking about. Everybody’s got a different point of view. So if you boil it down into one word, to me it’s fundamentals. I don’t want to build a teetering house of cards where a stiff breeze will blow the whole thing down, because if you live in this industry, there are many stiff breezes.
David Sweeney is a partner with Akin Gump. He advises clients on a broad range of oil and gas, coal, and other natural resource and infrastructure transactions. Reach him at [email protected].
Andrew Lehman is a partner with Akin Gump whose practice focuses on mergers & acquisitions, structured equity transactions, joint ventures, management equity arrangements, financial sponsor investments, and general corporate counseling. Reach him at [email protected].
Published January 3, 2019.