Despite the lip service paid to renewables, fossil fuels are far and away the leading source of global energy consumption. In the first part of LB’s global energy focus, we analyse the current trends in coal, natural gas and oil
In December 2009 Copenhagen replaced beleaguered golf star Tiger Woods as the most popular search term on Google — a fact that the United Nations Climate Change Conference boasted proudly on its homepage — as, of course, the Danish capital played host to the environmental summit. In finding ways to conserve it and make it cleaner, energy is now officially top of the global agenda.
The second part of this energy report will concentrate on alternative energy (renewables and nuclear power), but the focus of this feature will be the conventional energy sources of coal, gas and oil. The fact remains that fossil fuels represent the core of most firms’ energy practices. ‘Certainly, renewable energy is a growing segment,’ says Doug Glass, energy partner at Akin Gump Strauss Hauer & Feld in London. ‘But it is still a relatively small percentage of the whole.’
According to the BP ‘Statistical Review of World Energy, June 2009’, in 2008 80% to 90% of total global energy consumption derived from the combustion of fossil fuels, although growth for each of the fossil fuels slowed in the same year. For the third consecutive year, coal accounted for the majority of primary energy consumption growth, with global coal consumption rising by 3%. The figures are heavily dominated by China, which is responsible for a staggering 43% of global coal consumption and is still developing its power infrastructure.
The statistics show that, despite the slowdown, energy strategy remains core to economic development, and fossil fuels are the cheapest way to meet demand. However, 2008 was still a notoriously turbulent time for energy markets.
Forget the hype
There were two main reasons behind the slowdown in fossil fuel consumption in 2008: the difficult financial climate, which led to a reduction in energy demand, and the growing political appetite for renewables policies. Renewable power capacity expanded to 280GW globally in 2008, a 75% increase on 2004 levels according to Paris-based global renewable energy policy network, REN21. While the figures seem impressive, renewable energy still only represents 5% of global power capacity and 3% of global power generation. Nevertheless, the renewables market is increasing. The REN21 ‘Renewables Global Status Report 2009’ also highlighted that more renewable energy than conventional power capacity was added in both the EU and the US for the first time.
‘In an environment where investment in renewables is increasing – underwritten by incentives, feed-in tariffs, tradable certificates etc – the investment case for development of conventional baseload power has diminished rapidly,’ says Alex McLean, head of energy and projects at Dublin-based Arthur Cox.
Outside of the EU and the US, however – and some lawyers have said even within those jurisdictions – the renewable sector has not been the success story some might have hoped for. In fact, even with government support, lawyers suggest that conventional energy projects were more able to fulfil the stricter lending criteria imposed by banks than alternative energy projects during the downturn, and have fared better than green projects. ‘Banks’ credit committees are looking to apply stricter tests before providing the money needed by many projects in the field,’ says Doron Ezickson, head of McDermott Will & Emery’s international energy group. ‘So they are looking more closely than ever at less well-proven technologies. The net effect is probably that the renewables industry was more adversely affected than conventional energy sources.’
‘Investment in renewables is increasing, while the case for development of conventional baseload power has diminished rapidly.’
Alex McLean, Arthur Cox
The consensus is that the incentives for renewables projects are not as clear-cut as expected and, as the systems in place (such as carbon trading) are continually evolving, the end result is that investors aren’t convinced. ‘Much has been written about the potential for a boom in renewables,’ Glass says. ‘But for the most part, incentives have not materialised. They have not been as attractive as hoped and the actual release of funding in the form of stimulus, from the US in particular, has not happened as quickly as anticipated.’
However, the oil and gas markets have suffered too. Approximately six months after the July 2008 peak of $147 per barrel, oil prices fell to below $35 a barrel.
Clean coal
In April 2009, the UK government announced approval for a new generation of coal-fired power stations, but only if energy companies can prove that they can reduce their emissions in the interim. The condition is dependent on the success of new carbon capture and storage (CCS) technology. CCS is a technique aiming to mitigate fossil fuel emissions building up in the atmosphere by capturing carbon dioxide and storing it away in sources such as oil and gas fields or rocks. Despite the hype surrounding CCS, it’s still in its infancy. ‘Carbon capture has some way to go,’ says Julian Nichol, projects partner at Simmons & Simmons. ‘The technology has not yet been financed in the international markets and the issue around new technology risk is one of the biggest obstacles facing banks at the present.’ The main reason for perceived economic risk is simple: nowhere in the world has a CCS scheme been rolled out on a commercial level.
‘CCS technologies are not economically viable on a standalone basis,’ says Alex McLean, head of energy and projects at Arthur Cox. ‘The extent to which projects will be implemented on a large scale depends on the extent to which either such measures will be supported or carbon will be taxed.’
Of course, the current economic climate makes state support problematic. In addition to issues on economic viability, there are basic questions on the potential of the technology to work. CCS will not stop emissions completely, and a 2007 Massachusetts Institute of Technology (MIT) study, ‘The Future of Coal’, suggested that fitting carbon capture to even the most efficient type of coal plant would reduce its efficiency, resulting in a need for 27% more coal.
The uncertainties surrounding CCS have not stopped the UK government from eyeing it as a core part of the country’s energy mix going forward, and infrastructure is already changing to encourage its adoption. ‘In the UK, every section-36 planning permission for conventional power plants now contains a CCS-ready requirement,’ says Doron Ezickson, head of McDermott Will & Emery’s international energy group. ‘Even though there is no clear guidance as to what that involves, it seems more a matter of when, rather than if, CCS becomes a central part of conventional power developments.’ If the technology is successful, law firms can look forward to a steady flow of work while regulatory frameworks are drawn up and new risks investigated. And most industry experts are optimistic that it will succeed. Ezickson adds: ‘There is an inevitability about its progress in the absence of a willingness to invest even more billions than are currently envisaged in nuclear power, which is the only feasible alternative.’
Crunched
According to Alex Msimang, projects and energy partner at oil heavyweight Vinson & Elkins: ‘The onset of the credit crunch coincided with a plunge in crude oil prices, which temporarily reduced the perceived attractiveness of conventional oil and gas production – that was probably a greater driver for any move away from conventional oil and gas than the tax incentives on renewables.’ 2009 was predominantly quiet on the transactional front, in part due to recent oil volatility, as well as the difficult credit markets, but firms are starting to record a pick-up in activity and 2010 looks like it will be strong.
‘There are many small independent companies who took on oil concessions when prices were higher and the economy was stronger, and made commitments to drill wells and conduct other exploration activities,’ says John LaMaster, co-head of oil and gas at Dewey & LeBoeuf. ‘Now that the capital markets and credit markets have dried up, these companies are finding themselves unable to fund those commitments, and so they have become in some cases distressed sellers.’
‘The principal regulatory challenge in the energy sector over the next ten years will be to develop a clear and stable framework.’
Owen Clay, Linklaters
It’s not just the smaller players that need liquidity. In December last year, Exxon Mobil announced that it was buying XTO Energy in a deal worth $41bn, while ConocoPhillips plans to raise $10bn from asset sales over the next two years, and Devon Energy intends to sell its international oil and gas assets. Cash-rich Chinese and Indian oil companies will also be on the prowl, and for firms with a broad international client base, 2009 was a sign of things to come. Vinson & Elkins, for example, certainly hasn’t seen a downturn on the oil and gas side, recently advising Sinopec International Petroleum Exploration and Production Corporation on its $8.8bn acquisition of Addax Petroleum Corporation – China’s largest cross-border acquisition to date and a real indicator of China’s position in the energy market.
Resource nationalism
The climbing price of oil during the first five years of the 21st century encouraged protectionist policies as countries realised that they didn’t need to encourage international investment and extraction. In perhaps one of the most high-profile cases, in 2006 Venezuela’s president Hugo Chavez issued oil companies operating outside the Orinoco tar belt with an unpalatable ultimatum: enter into joint venture agreements with state-owned company Petróleos de Venezuela, which would see the oil operators become minority partners, or watch as all operations became completely nationalised. Most recently, Brazil has been battling to ensure state oil company Petrobras holds exclusive rights in its offshore oil fields. ‘We are seeing a rise in resource nationalism,’ says John LaMaster, co-head of oil and gas at Dewey & LeBoeuf, ‘whereby sovereigns and national oil companies desire to assert greater control over their national resources.’
It’s not just South America that has gripped more tightly onto its natural resources rights. Even Canada announced that it was increasing royalty rates in the Alberta oil sands in 2007, a decision reversed in 2009 as it tried to encourage investment during the downturn. ‘Production-sharing or concession agreements for natural resources are very prone to arbitration if a political change occurs in the host country,’ says Markus Piuk, energy partner at Schönherr. ‘A certain degree of political risk will always persist.’
However, law firms remain optimistic that political risk can be mitigated. ‘Various international mechanisms stand for the certain stability of a country’s legal environment,’ says Andrey Astapov, managing partner of Ukraine-based AstapovLawyers. ‘In one case, for instance, an arbitration tribunal found that the provisional application of the Energy Charter Treaty against the Russian Federation stood, despite the recent official refusal of the Russian Federation to ratify the Convention.’ The case was, of course, the Russian government’s 2007 expropriation of Yukos Oil Company. Despite Russia saying that it had not ratified the Energy Charter Treaty, arbitrators ruled that the country didn’t opt out and therefore was still bound by its rules, paving the way for shareholders of the disbanded oil company to seek an estimated $100bn in damages from the Russian government (see feature, ‘Over a barrel’, on page 24).
However, oil clients aren’t always so lucky. ‘In large measures, it depends on the extent to which the government of the host country is prepared to ignore the rule of law,’ says Jonathan Rod, global chair of project finance at Latham & Watkins. ‘If the state is intent on expropriating assets, and has the political strength and will to ignore its courts and the rulings of international arbitrators, there is little that can be done once the project has reached completion.’
Hot spots
According to the BP Statistical Review, for the first time Organisation for Economic Co-operation and Development countries were overtaken by non-OECD economies in energy consumption, and, importantly, China alone represents nearly three-quarters of global growth. Overall, 87% of global energy consumption growth derived from the Asia-Pacific region, demonstrating the industrialisation of developing countries.
‘The countries with the fastest-growing demand are, not surprisingly, China and India,’ says James Dallas, energy partner in Denton Wilde Sapte’s Dubai office. ‘And they are very active in the pursuit of long-term security of supply and will continue to be the engine room for growth in demand.’
China currently fields a wealth of international names, but India is closed to international firms, with non-nationals prohibited from practising law in India. Firms are optimistic that that will change and have positioned themselves well for the potential liberalisation; most recently, Clifford Chance has allied with AZB & Partners, Allen & Overy has formed a non-exclusive relationship with Trilegal, and Clyde & Co has associated with ALMT Legal. In energy terms, the attractiveness of the Indian market is high. Not least because, as Hemant Sahai, managing partner of Hemant Sahai Associates, points out, India requires an additional 150GW of generation capacity to meet its energy demands, and most of this will have to be met through fossil fuels. The Indian government is working hard to create an enabling environment for this to happen. ‘As part of its strategy to mitigate the effects of the recession, the government adopted a policy of actively promoting investments in the infrastructure space to facilitate the flow of capital into the sector,’ Sahai says. ‘Energy also continues to be a priority area for Indian banks.’
‘Security and diversity of supply and the replacement of aging assets combine together to ensure that there is a great deal to do.’
Doron Ezickson, McDermott Will & Emery
The CIS is another strong area for oil and gas activity and this is set to continue, according to Doran Doeh, managing partner of Denton Wilde Sapte’s Moscow office. ‘The big unknown is eastern Siberia,’ he says. ‘Most Russian production is from fields discovered in the Soviet era, and technologies have improved to such an extent that there may be a lot more oil and gas to be found.’
Among other countries, the often-cited developing energy hotspots of Africa and Brazil look promising, but also Western, fully industrialised countries are looking to secure supply, and firms are expecting a sustained energy push for some time to come.
‘I would anticipate the next surge in demand to arise from the UK, Europe, Houston and New York,’ Ezickson says. ‘Security and diversity of supply and the replacement of aging assets combine together to ensure that there is a great deal to do, and this is likely to remain the case for the foreseeable future.’
Ezickson also points out that the key challenge for energy lawyers is to keep pace with the regulatory and public law principles in a changing world.
Regulation stations
The fallout from Lehman Brothers has seen an unparalleled global push towards establishing stricter regulatory controls within the financial sector. As Greg Hammond, corporate partner at Akin Gump, suggests, it is a scrutiny that has been present in the energy space for decades.
‘The energy industry has been responding to increased regulation for more than 20 years in the form of sustainable business practices and transparent reporting practices,’ he says. Following the collapse of Enron and other energy conglomerates, pressure on the sector has remained high, and most lawyers have experienced little difference in regulatory intensity over the past 12 months – except for commodities, where it has been hit as much as other financial commodities. There will be a step up however, as countries look to harmonise regional energy policies. In the EU, for example, there will be a greater encouragement to reach a regional common goal, as seen in the eventual agreement on the European Third Energy Package (ETEP) in early 2009.
‘The final ETEP includes measures for increased regulatory oversight and co-operation,’ says Craig Tevendale, dispute resolution partner at Herbert Smith. ‘It imposes a requirement for record-keeping relating to operational decisions and trades. The goal is to improve transparency in the European energy market and to facilitate investigations into market abuse by regulators.’
The drive towards full market liberalisation is not limited to Europe and other Western countries. Although China is off limits (the country’s – and the world’s – largest oil business is state-owned PetroChina), India is further along the path to reform and has become highly active in overseas markets. Most notably, in March 2009 Indian public sector company Oil and Natural Gas Corporation (ONGC) won its takeover battle with Imperial Energy, acquiring the Russia-based company for $2.8bn – India’s fifth-largest M&A to date and a real sign of its growing dominance in the market. India has also embarked on the opening up of its generation, transmission and distribution sectors (current foreign participants in the oil market include BP, Petronas and Shell) and has created an independent regulatory framework. ‘Serious liberalisation started post-Enron,’ Sahai says. ‘It threw up the urgent need for deregulation and the opening up of the energy sector.’
As more countries follow suit, law firms will be lobbying for more clear-cut global guidelines to ensure coherent codes of practice. ‘The principal regulatory challenge in the energy sector over the next ten years will be to develop a clear and stable framework for companies to make long-term investment decisions,’ says Owen Clay, co-head of Linklaters’ energy and utilities group. At a time when, ‘there needs to be a complete overhaul of existing energy infrastructure to meet governments’ security of supply concerns and climate change obligations’.
The security issue is of course the most worrying for the conventional energy sector. While the BP Statistical Review may proclaim that ‘in 2008 the world was no longer supply constrained, as production growth exceeded that of consumption for all fossil fuels’, the fact remains that fossil fuels will not last indefinitely, and reside in some of the world’s most politically unstable countries (see box, ‘Resource Nationalism’, page 43). Copenhagen’s inability to reach an agreement on the solution to the environmental question has brought the global community to yet another impasse. But despite the apparent disharmony, making fossil fuels cleaner will continue to unite international energy policy. LB
Top ten announced Global M&A deals 2009 – Oil and Gas sector
|
Date |
Target company |
Target legal adviser |
Bidder company |
Bidder legal adviser |
Deal value |
|
December |
XTO Energy Inc |
Latham & Watkins (advising Jefferies & Company); Skadden, Arps, Slate, Meagher & Flom
|
ExxonMobil Corporation |
Cleary Gottlieb Steen & Hamilton; Covington & Burling; Davis Polk & Wardwell
|
$40.36bn |
|
March |
Petro-Canada |
Goodmans (advising Deutsche Bank; RBC Capital Markets); Macleod Dixon; Torys
|
Suncor Energy Inc |
Blake, Cassels & Graydon; Shearman & Sterling |
$18.4bn
|
|
October |
Nippon Mining Holdings Inc |
Mori Hamada & Matsumoto; Simpson Thacher & Bartlett (advising Bank of America Merrill Lynch; Daiwa Securities America Inc) |
Nippon Oil Corporation |
Davis Polk & Wardwell; Morrison & Foerster (advising J.P. Morgan); Nishimura & Asahi; Rodrigo Elias & Medrano; Shearman & Sterling; Sullivan & Cromwell (advising Mizuho Financial Group)
|
$12.18bn |
|
June |
Addax Petroleum Corporation |
Fasken Martineau; Fraser Milner Casgrain; Osler, Hoskin & Harcourt |
Sinopec International Petroleum Exploration and Production Corporation
|
Stikeman Elliott; Vinson & Elkins |
$8.8bn
|
|
February |
Italgas SpA |
|
Snam Rete Gas SpA |
Clifford Chance |
$5.41bn
|
|
May |
Crescent Point Energy Corp |
McCarthy Tétrault |
Crescent Point Energy Corp |
Burnet Duckworth & Palmer |
$4.33bn
|
|
April |
JSC Gazprom Neft (20% stake)
|
Dewey & LeBoeuf (advising Eni) |
Gazprom |
Cleary Gottlieb Steen & Hamilton |
$4.1bn
|
|
November |
Encore Acquisition Company |
Baker Botts |
Denbury Resources Inc |
Baker & Hostetler; Simpson Thacher & Bartlett (advising J.P. Morgan)
|
$4.01bn
|
|
October |
Harvest Energy Trust |
Burnet Duckworth & Palmer |
Korea National Oil Corporation
|
Bennett Jones; Vinson & Elkins |
$3.87bn
|
|
March |
Compañía Española de Petróleos SA (32.5% stake)
|
Uría Menéndez |
International Petroleum Investment Company
|
Gómez-Acebo & Pombo Abogados |
$3.8bn
|
|
Notes: Based on announced deals, including lapsed and withdrawn bids Based on dominant geography of target, bidder or seller being global Based on the sector of either target, bidder or seller being oil and gas exploration and production
Source: mergermarket
|
|||||