Worldwide: The Fall In Crude Oil Prices: Headline Issues To Watch

Oil price movement through 2014 and into 2015 is a consequence of market fundamentals. Europe's continued economic woes, paired with the slowdown in China's economy, have led to a fall in demand for oil.

At the same time, the growing U.S. shale-oil boom (over which OPEC has no control) and the pick-up in drilling in Libya have led to an excess of supply. However, in the past few months the issue has switched from how quickly oil prices have fallen, to how much further they have to fall.

Price movements suggest that the relatively stable (and high) prices of the last few years have given way to a new era of volatility, where comparatively small changes in market fundamentals will lead to significant price swings.

The commodities markets thrive on volatility, as this is where opportunity lies. Oil, more than most commodities, is price inelastic. Significant investment in the oil market from hedge funds and commodity-index funds is also thought to have contributed to market volatility. But by its very nature, oil trading is rife with uncertainty: most of the world's oil reserves are located in geopolitically sensitive regions. Predicting future demand would need a crystal ball to foretell global economic performance. The opportunities this 'new normal' situation presents are complex and multifarious, as are the risks.

It is simplistic, however, to see low oil prices in exclusively negative terms. Lower oil prices will affect market participants differently, depending on their function and position in the market. Integrated businesses may face risks and opportunities simultaneously in different parts of their business. Lower prices may also stimulate demand among consumers and businesses with a high dependency on energy, and so will be seen as a positive development. Refiners, depending on their contractual positions, may also benefit from the low price of crude product and a lag in the price reduction for refined products. For crude producers, however, low prices mean reduced revenue and pressure on profitability, especially for those with higher extraction and capital costs.

Insolvency and Restructuring Some producers facing lower cash flows with no reduction in debt expenses and operating costs are likely to succumb and seek bankruptcy protection. Others may be better able to restructure their debt outside a formal insolvency process. Moreover, those service providers whose businesses rely on a more sustainable price for oil or gas will be in belt-tightening mode over the next year. While acquisitive businesses with strong balance sheets may see these challenges as opportunities.

Markets are increasingly global and 'borderless', and the energy sector is no different. In the United States, expect to see an increase in filings in New York, Delaware and Houston, as well as in Pennsylvania, Ohio and West Virginia, and anywhere there is a concentration of oil and gas businesses. The UK and Singapore are also likely to see an increase in insolvencies and arbitration proceedings, as well as Hong Kong for shipping cases.

Bankruptcy and restructuring in a regulated industry, as parts of the energy industry are, coupled with legal complexities such as the U.S. Bankruptcy Code's "safe-harbor" provisions, can create their own challenges. In this environment, although it is important to know your contract terms and legal rights, it is equally vital to recognise that the issues affecting a contract and the outcome may depend significantly on where the bankruptcy is filed.

Although any number of questions may arise in a given bankruptcy case, we have identified 12 priority issues that companies in the oil and gas sector are likely to face in the coming year. These 'top 12' focus on U.S. bankruptcies, but the same issues are equally relevant to proceedings in other jurisdictions around the world, even if the terminology may differ.

Top 12 Considerations for Oil and Gas Companies

  1. "First day" issues: terminating contracts; preventing the assignment of assets; cessation of performance; using collateral to reduce exposure; reporting terminations to regulators and mitigating loss.
  2. Application of "safe harbors": application to contracts or netting agreements of the "safe harbor" provisions of the U.S. Bankruptcy Code; impediments to exercising early termination rights; valuing provisions if terminating contracts; assessing whether it is necessary to conduct an auction or to obtain price quotes; possible qualification of contracts for the special protections of the Bankruptcy Code for forward contract merchants and swap participants; preparing for the possibility of negotiating and litigating termination issues and values with the debtor.
  3. Cash flows, balance sheets, offshore assets: assessing the current value of oil and gas reserves and the cash flows that can be obtained from them; considering how a particular entity's balance sheet can be fairly represented; ascertaining whether there are offshore assets outside the jurisdiction of the bankruptcy court and determining how far the bankruptcy court's jurisdiction reaches.
  4. Deliveries to the debtor: can anything be done about deliveries made to the debtor in the month before the bankruptcy filing, or will the creditor only get pennies on the dollar? If product is in transit to the debtor, can the seller have it returned before it gets there? What entities have superior rights over product in transit?
  5. Storage at the debtor: recovering product stored at the debtor's facilities and the exercise of contractual or proprietary rights to collect it; where there is a particular through-put agreement, where does a debtor entity's interest in product begin and end?
  6. Cross-affiliate set-off and netting: where there are contracts with the debtor and its affiliates, can a creditor net or set-off amounts between or among them?
  7. Secured creditor rights: as a secured creditor, protecting and preserving rights of lien; assessing rights under an inter-creditor agreement as a secured creditor and hedge provider to the debtor having a lien shared with the debtor's lenders; obtaining a share of the collateral; protecting against the debtor using the same collateral for debtor-in-possession (DIP) financing; securing "adequate protection".
  8. Critical vendor programmes: considering whether to participate in the debtor's critical vendor programme; considering whether it is possible to enter into new transactions under an existing master agreement; objecting to the debtor's proposed programme where a creditor is not designated as a "critical vendor".
  9. Claims process and timing of distributions: the possibility of specialised claims filing and claims resolution protocols; the timetable for any recoveries on claims from the debtor; the time available to the debtor to assume or reject a contract; the time for which the debtor will be able to maintain bankruptcy protection; when should a creditor consider selling its claim?
  10. Preference claims and fraudulent transfer actions: assessing vulnerability to preference claims and fraudulent conveyance actions arising from transfers made by an insolvent counterparty on the eve of a bankruptcy filing; formulating defences.
  11. Doing business with the debtors: considering whether court approval is needed to enter into contracts with the debtor or modify contracts that are in place, or else whether these are "ordinary course transactions"; protecting lien rights under an operating agreement; considering whether a creditor can purchase assets from the debtor directly or whether there must be a special bankruptcy process, such as a court-supervised auction; what due diligence and access to the assets can be expected before a sale; are there any particular considerations for purchasing upstream, midstream and downstream oil and gas assets through a bankruptcy case?
  12. DIP financing: can a particular creditor provide DIP financing and if so, what are the requirements and risks?

It is critical to coordinate your positions and properly identify claims and risks when the family of debtor entities is dispersed around the globe.

The interplay between the core insolvency issues and labyrinthine intricacies of the U.S. Bankruptcy Code, the peculiarities of the regulated energy markets, and the potential cross-border exposure and conflicts of laws are likely to create headaches for many in the coming year. But for those who can navigate these issues with proactive understanding, pre-emptive action and sufficient liquidity, there is not only the opportunity to minimise risk, but also to maximise reward when energy prices rebound.

Default Management and Litigation When a client is faced with a potential default against an open contract, an experienced commodities lawyer will normally ask: "where is the market price relative to the contract price?"

An adverse price differential will often drive a counterparty to look for a way out of a contract, lawfully or otherwise. Beyond that, the price differential will very often be the most appropriate starting point for assessing damages for breach of contract.

Producers, refiners and pure traders face the increased risk of price-led default. Naturally, price is not the only possible cause of a default. For instance, sellers and buyers alike may find themselves in difficulty if related contracts fall into default or if credit lines are constricted or withdrawn. But by taking action early, the prospects for dispute avoidance, mitigation or successful litigation can be significantly improved.

All parties to open contracts should assess their position and follow best practice, including:

  • An urgent review of contract terms: this allows you to identify potential threats or gaps early, so that steps can be taken to avoid or mitigate problems. Early, proactive reviews make more sense than a reactive response to a problem that has already arisen.
  • Adhere to contract terms: a purchaser looking for the exit will seize on any opportunity, especially a breach.
  • Respect the technicalities of any notice provisions under the contract: these are not confined to matters that might amount to a breach. For example, a put option might be invalidly exercised and so lost if the requirements for giving notice are not met in time. Similarly for a buyer, the opportunity to prevent an automatic contract renewal might be missed for want of proper notice.
  • Prevention/impediment: if it is necessary to give notice of an event that might impede or prevent performance, such as under a force majeure clause, ensure the terms of the clause are respected.
  • New contracts: be alive to the above issues when agreeing fresh terms.

If a default is in prospect or has occurred, it is important that the situation be properly managed. At a minimum, this will entail:

  • Paying close attention when preparing correspondence: it is crucial to manoeuvre yourself into the strongest position possible, as early as possible.
  • Undertaking immediate and properly informed analysis of the problem: this allows you to assess the options early, including termination and mitigation.
  • In case of a default or serious breach, limiting correspondence and communication with the breaching party until you have fully assessed the situation: this reduces the risk of a compromising statement being made. Special care is needed with apparently routine operational messages.
  • Keeping careful records of all communications: this includes notes of telephone conversations or recordings if permissible, and gathering all relevant documents. You should avoid creating prejudicial documents that might be discloseable later.
  • Checking any applicable time-bars or notification requirements, to ensure the right to make a claim is not lost: these should be met even if a settlement might be achieved. Take care to respect any requirement for "friendly negotiation" before starting proceedings.
  • Considering the mitigation options: ensure that reasonable steps to avoid or reduce loss are properly considered and taken. That could mean entering a new contract with the defaulting party.
  • Investigating the options for a commercial settlement: this can offer a saving in costs and preserve commercial relations for the future.

Regulatory Enforcement Apart from the impact of increased international regulation on trading activities generally, governments and regulators across the world have made clear their increased supervision of market players, both upstream and downstream.

It is likely that enforcement action and investigations will continue, as increased price volatility provides fertile ground for potentially manipulative trading practices. Enforcement is, and will continue to be, big business for major international regulators. Hence, low oil prices should not prompt companies to scale back their investment in internal compliance education and monitoring, rather it should mean an increased internal vigilance.

Employment / Contractor Services A considerable slow-down in the offshore service sector is already in progress, with some businesses needing to reduce staff costs dramatically.

The same is true in producing, refining and, in some cases, trading businesses. Some commentators predict a reduction in shale exploitation until prices rebound to support the expense of such operations. The impact of this would be felt across a range of support industries, not only in the energy sector.

The proper management of employment issues and contractors can throw up specific demands and risks, depending on the jurisdiction(s) in question. These should be assessed at the planning stage before action is taken.

In addition, at a time when many market players are shedding staff, it is worth being mindful when negotiating exit terms that ex-employees may turn out to be crucial witnesses whose future cooperation you may need.

Storage Low prices offer an opportunity for those who can store product until prices recover. The commercial risks are obvious, not least the difficulty of knowing when that recovery will begin. But the potential gains are significant.

Storage facilities will be keen to capitalise on their ability to offer services to those wanting to sit on stocks, but tanking and pipeline capacity is finite, and in some regions it is already stretched.

One solution is floating storage, and the present climate provides openings for those with suitable units or tank vessels. Storage facilities may seek to enlarge their capacity, and those able to acquire and expand existing facilities can capitalise on the low price environment.

Recent experience suggests that care is needed in preparing and managing storage contracts, as some facilities seek to balance the needs of their customers with their own desire to turn increased profits from throughput and storage.

Furthermore, the present situation should reinforce the importance of corporate emergency response planning and preparedness. Accidents and physical emergencies, such as explosions and pollution events, can occur at any time. But they are more likely to occur at times of corporate stress, with issues such as spending cuts and loss or demotivation of staff often contributory factors. Similarly, the expansion of temporary or converted storage carries special risks, not least potential liabilities for pollution.

Conclusions If your business operates in the market for crude oil and its products, evaluating your contractual and commercial positions early will improve your chances of avoiding or reducing difficulties and for exploiting opportunities.

In addition, remember that the adverse impact of mishandled emergencies may not be just physical: it could be financial, regulatory, reputational, or a combination of these. To minimise these risks, you need to be thoroughly prepared to deal swiftly and effectively with the fallout from emergencies that affect others, such as the sudden collapse of major counterparties.

As the low oil price continues, there is much for businesses in the sector to consider. You can stay up to date with these vital issues in future alerts, which will focus on particular areas in more detail.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions