Navigating joint ventures in the oil and gas industry

Navigating
joint ventures in the
oil and gas industry
Introduction
Transaction trends in the oil and gas industry — the JV
Oil and gas merger and acquisition activity was strong in 2010 and has continued in 2011,
with credit markets opening and big oil flexing its financial strength. Total global industry
transaction value topped US$266 billion in 2010, up 33% from 2009. The number of deals
went up 13% and deal value rose strongly in each of the four industry segments, with total
upstream transaction value reaching a record high. Transaction activity is expected to be
similarly brisk in 2011.
Furthermore, independent players in the capital-intensive oil and gas industry began
partnering more vigorously with major oil companies. The past 18 months have seen a
significant ramp-up in oil companies’ planned investments in unconventional oil plays, with a
marked increase in joint ventures. The past year saw a dramatic uptick in Asian companies
investing in North American energy projects. In 2010, public and national players from
countries such as China, India and South Korea invested a total of US$17 billion in energy
ventures — the majority of them joint ventures — in the United States and Canada. It is
expected that joint ventures will continue to be extremely active for the remainder of 2011.
Notably, 37% of oil and gas companies in the April 2011 Ernst & Young Capital Confidence
Barometer indicated that they are seriously considering a JV in the next 12 months.
Today’s joint venture transactions, however, come in so many shapes and sizes that it can
be difficult to decide on the optimal arrangement. For example, private equity partners have
come into play — several funds are dedicated to the oil and gas industry — small independent
oil companies are partnering with one or many major oil companies, and public and national
oil companies from all over the world are entering the US oil and gas market. All offer exciting
combinations of resources, assets, capital, expertise and labor. The right joint venture can
optimize these to shape a dynamic growth strategy.
In this paper, we explore the rationale behind utilizing a joint venture (JV). We look at the JV
lifecycle and, in particular, what JV partners need to do to ensure that the JV process is a
successful one for the partners and for the JV itself. Also highlighted are new and proposed
US federal income tax laws that will dramatically affect the US oil and gas sector, including
negating some of the benefits of entering into a JV transaction.
Why consider a JV?
JVs are a well-established feature of the oil and
gas industry. They are typically less risky and are
easier to unbundle than full organizational mergers.
With the scale of organizations within the oil and
gas industry, antitrust concerns and the importance
of national energy security, JVs are a useful way
of gaining the benefits of collaboration without the
economic and political risk associated with a merger
or other business combination.
There are a number of drivers behind why JVs are used so
extensively within the US oil and gas sector:
• Capital intensive: upstream projects can be too big for a single
company (even a super-major) to finance on its own. Many of the
larger liquid natural gas (LNG) and deepwater projects fall into
this category.
• Supply chain optimization: downstream supply chains may be
optimized across disparate geographies by pooling assets. Many
of the refining JVs are based upon supply chain and market
supply optimization for the various participants.
• Market positioning and portfolio optimization: pooling assets
may allow the JV to develop a market-leading position in a
particular geography (downstream) or product (chemicals)
and enable a portfolio to be optimized across both asset pools,
generating a value uplift from prioritizing larger assets. In an
increasingly cost-focused climate, economies of scale are critical
to success and partnering may help achieve this.
• Regulatory requirement: some countries require foreign
companies to partner with local entities if they are to enter
that market.
• Political sensitivity or energy security: this means that
JVs — as opposed to acquisitions and takeovers — may be
more appropriate.
• Risk concentration: the risk profile attached to large-scale
exploration and production (E&P) projects is such that no single
company may wish to take full exposure.
• Access to technology: complex or frontier developments may
require proprietary technology that requires the owner to have
a stake.
• Access to resources: the legal owner of resources may not
have the capital or technological ability to develop them to their
maximum potential. Entering into a JV may also allow access to
complementary assets or reserves.
Navigating joint ventures in the oil and gas industry
1
Past, current and future trends
The past few years have seen high numbers of oil
and gas JVs being entered into, particularly in
the upstream segment, where the cost, risk and
technology issues clearly favor a collaborative
approach on the largest projects.
Oil and gas JVs 2008 – 2011
Number of JVs
70
60
50
40
30
20
10
0
2008
Upstream JVs
Downstream JVs
2009
Midstream JVs
Oilfield services
2010
2011
through
15 May 2011
Source: IHS Herold
The increase in the number of JVs in the last 18 – 24 months could
be attributed to a number of different factors, including, in part,
the recovery in oil prices, increased access to the credit markets,
advances in technology and an increased global emphasis on
exploration and development.
Management of JVs is both risky and time-consuming. Significant
research has been carried out on the subject of JVs and their
performance. The results are mixed, with many studies suggesting
that they have high failure and inefficiency rates: e.g., 30 – 70%
of JVs have problems of inefficiency and bad performance, and
about 50% of the JVs fail due to high cost (Kogut, 1988; Bleeke
and Ernst, 1993). Other studies, however, show a failure rate of
30 – 61%, and show that 60% failed to start or faded away within
five years (Osborn, 2003). Properly structured, however, JVs offer
exciting combinations of resources, assets, capital, expertise and
labor, and the right JV can optimize these to shape a dynamic
growth strategy.
2
Oil and gas companies can be positioned somewhere along each of
the following four continuums:
Asset/reserve seekers
Asset/reserve holders
Low access to capital
High access to capital
Lagging technologists
Leading technologists
Low appetite for risk
High appetite for risk
If an oil and gas company is on the right-hand side of all four
continuums, then it may have no need to partner and may wish to
proceed with a project as a sole venturer. If, however, it is positioned
toward the left-hand side of any of these continuums, then it may
well be appropriate or even necessary for it to partner.
In general, during a downturn and/or a flight from risk in the capital
markets, companies may move significantly to the left on the capital
access continuum, and may also have a low appetite for risk on the
continuum. Conversely, as has been the case during the last 18 – 24
months, companies have moved significantly to the right on both
the capital access continuum and the appetite for risk continuum.
The recovery in the oil price to around US$100 per barrel has
generally meant that there are now a broader range of potential
projects that have become economically viable. These projects are
in locations remote from the markets that they will supply, and,
consequently, large-scale capital investment is generally required
to develop and commercialize them. Again, these types of projects
favor a collaborative approach.
These factors likely have provided the necessary stimulus for JVs to
return to the levels that we have seen in previous years. In the April
2011 Ernst & Young Capital Confidence Barometer, it was revealed
that 37 % of oil and gas companies are seriously considering a JV in
the next 12 months.
Navigating joint ventures in the oil and gas industry
The oil and gas sector is no
stranger to joint ventures.
Today’s JVs, however, come in
so many shapes and sizes that
it can be difficult to decide on
the optimal arrangement.
3
JV types
JVs typically utilized within the oil and gas industry broadly fall into
one of three categories:
• The full asset JV
• The full business JV
• The marketing alliance
Full asset JV
Full business JV
Marketing alliance
A JV entered into with regard to a
specific set of existing asset(s) or to
develop asset(s). These have tended
to occur around upstream JVs,
pipelines, refineries and increasingly
now with LNG projects. The upstream/
full asset JV is the most commonly
occurring type.
A JV entered into to combine the
resources of entire businesses to
create marketing, supply chain,
production and scale synergies. These
have historically tended to occur with:
A JV entered into with the intent of
jointly marketing product(s), e.g.,
motor fuels retailers and convenience
stores joining forces to combine their
consumer offerings.
Exploration
Refining
Development
• Downstream, chemicals and
midstream businesses
• Oil field services companies within
the upstream sector
Exploration
Exploration
Development
Upstream
Upstream
Production
oil/gas
Production
oil/gas
Production
oil/gas
LNG liq./re-gas
Pipelines
LNG liq./re-gas
Pipelines
LNG liq./re-gas
Midstream
Midstream
Midstream
Transportation
Transportation
Transportation
Distribution
Retail/
wholesale
Refining
Downstream
Petrochemicals
Development
Upstream
Pipelines
4
These types of JVs tend to occur in specific areas within the oil and
gas sector. The lined boxes within each JV category highlight the
areas that are more prevalent within the three main subsectors,
upstream, midstream and downstream. This can be summarized in
the graphic below:
Distribution
Distribution
Retail/
wholesale
Downstream
Retail/
speciality
Petrochemicals
Distribution
Refining
Distribution
Retail/
wholesale
Downstream
Retail/
speciality
Navigating joint ventures in the oil and gas industry
Petrochemicals
Distribution
Retail/
speciality
JV phases and issues
If JVs go wrong, then JV partners may lose money, credibility,
proprietary technology, assets and management focus. In the
following sections, we look at some of the key areas to focus on
at each stage of the JV lifecycle to ensure that the major pitfalls
are avoided.
The four key phases in the JV lifecycle can be summarized
as follows:
JV planning
Define the commercial
rationale and
identify partner(s)
JV formation
Build the legal and
commercial structure
JV operation
Operate and manage
the JV on an
ongoing basis
JV dissolution
Wind up the JV
37% of the oil and gas
executives surveyed believed
that they would be making
an increased number of
strategic alliances over the
next 12 months.
Navigating joint ventures in the oil and gas industry
5
JV planning
Once a decision has been made that a JV is the
appropriate vehicle for a particular project or asset,
there are a number of stages and processes that
should be gone through.
Commercial analysis of the JV
Commercial analysis and modeling of the JV is a key step and
should contain a number of scenarios with sensitivity analyses
around key variables. These variables can be, in part:
• Financial (i.e., oil price, interest rates, inflation)
Defining the scope of the JV
• Production/recovery-related (i.e., bpd, throughput)
The first step is to clearly define the scope of the assets that will
be the subject of the JV. Where the asset is upstream acreage or a
particular oil/gas field, this step may be relatively straightforward.
However, if the assets are a collection of existing businesses that
form part of a broader business or supply chain, defining the scope
may be more complex. It is, however, critical that the boundaries of
the JV arrangement are clearly articulated and are understood by
all of the JV partners and contained within the JV agreement. This
process should include not only the definition of the physical assets
but also the definition of the markets and potential customers that
the JV is aiming to serve. This is especially important where a JV
could potentially be in competition with the venturing partners’
other business interests.
• Geopolitical (i.e., implications of a change in government,
tax regimes)
By thorough modeling of the financial implications of a range of
scenarios, JV partners will understand the possible implications for
the JV in terms of net present value and internal rate of return. This
will help ensure that all partners are aware of and have considered a
range of potential scenarios for the JV and are realistic about their
expectations. By considering and discussing upside and downside
scenarios in an open and honest manner, partners can anticipate
potential difficulties and discuss how they would respond if that
scenario should occur. These scenarios and anticipated outcomes
can even be built into the legal agreement and can provide
protection against future litigation, which may be costly for all sides
and damaging to the business.
Defining the legal, tax and financial structure
Consideration needs to be given to the appropriate legal, tax and
financial structure that the JV will assume. Prospective JV locations,
jurisdictions, legal and tax-efficient operating structures should be
evaluated to discover, at an early stage, operational restrictions
imposed by applicable laws and regulations. If multiple options are
being considered, such due diligence can be utilized to assess the
pros and cons of each of the proposed locations and jurisdictions
to produce a tabular comparison, with risk rating scores and
weightings. Part of this process should involve a consideration of the
tax implications for both the JV and the venturing partners, where
the JV will be domiciled for tax purposes and where its main centers
of operation and management will be located. This analysis should
also include an assessment of the tax implications of the potential
legal structures under consideration.
6
Navigating joint ventures in the oil and gas industry
Defining the business strategy and plan
A business strategy and development plan should be prepared
for early discussion with potential JV partners. The plan may
change over time as a result of discussion and negotiation with
JV partners, but it is important that there is a clear, early view
of the assets, geographies, markets, outstanding commitments,
investment case/timings and growth targets on which to base
discussions with JV partners and potential partners. This plan
should also cover areas such as the proposed JV governance model
and decision-making process. It is critical to get the balance right
between allowing JV management enough autonomy to effectively
manage the business while allowing the JV partners to maintain
control over the operations and effectively determine the longerterm strategy and commitments of the JV.
Partner identification and selection
JVs are often complex, long-term arrangements. Trust, therefore, is
critical to the success of the relationship. The early signs of whether
your company and its partners are compatible will be evident during
the negotiation process.
A business strategy and
development plan should be
prepared for early discussion
with potential JV partners.
Don’t overlook the cultural
aspects of a JV. Culture isn’t
restricted to countries.
Partner selection is a critical step and one that will determine the
success of the JV. When JVs fail, it is often because of a breakdown
in the relationship between the JV partners. This can be caused
by a lack of trust, differing strategic objectives, and unrealistic
or nonaligned expectations of what partners can expect from
each other. Clarity and thoroughness of planning at this and the
JV formation stage can mitigate the risk of disagreement in the
JV operation stage. This is especially true when international oil
companies are partnering with National Oil Companies (NOCs). Each
needs to be aware of the others’ aims and limitations. Shareholders
and governments may have very different strategic aims and views
on an investment, i.e., NOCs may well have social welfare obligations
that may seem alien to an international oil company.
The number of partners in a JV can be a critical determinant of the
success. Smaller numbers of partners make it easier to manage the
decision-making process and to align objectives and the strategic
direction of the JV.
It is important for JV partners to carry out due diligence on each
other across a range of areas, including key financials, credit
status, technical capabilities, management strength, existing
commitments, outstanding litigation and prior JV performance.
When a number of partners are being considered, it may be
appropriate to have a scoring process covering all of the required
partner criteria to assist in the selection process.
Navigating joint ventures in the oil and gas industry
7
JV formation
The JV formation process will see the development,
negotiation and finalization of many of the outputs
of the JV planning phase.
Detailed location planning
Planning and implementation reports on the chosen, or short-listed,
tax and legal environment(s) that will host the JV will need to be
completed. Reports should cover aspects such as:
• Required licenses
• Necessary regulatory approvals
• Environmental impact assessment requirements
• Governing law
• Corporate law and compliance requirements of any JV company
and any shareholders or stakeholders in a JV
• Local employment law analysis
• Local asset, property and land ownership rights and requirements
• Applicable company law stipulations (such as nationality of
general manager, board voting and shareholder voting and
retaining of profits in-country)
Financing of the JV
Details of the JV financing will need to be discussed, agreed upon
and finalized. This will include:
• Exact definition of contributions from each partner
• Value of contributions from each partner
• Capital structuring of JV (e.g., use of debt)
The implications of the proposed financing will need to be assessed:
• Does the proposed jurisdiction allow the contemplated form
of financing?
• Can security be enforced in theory? In practice?
• Is there, in fact, a working, transparent, local banking system that a
foreign investor can keep working capital in without fearing for it?
• What are expropriation laws, protections and remedies?
All of these questions will need to be considered and addressed.
Financial reporting for the JV
The integration of the JV financial reporting with the partners’
statutory reporting requirements will need to be considered.
There may be a need for the JV to provide local accounts for
statutory reporting purposes, International Financial Reporting
Standards (IFRS) and US or other Generally Accepted Accounting
Principles (GAAP) accounts to meet the reporting requirements of
the JV partners. The proportion of the JV investment and operator
responsibilities of each of the venturing partners will determine
whether the JV will need to be treated as an equity investment or
consolidated within the partners’ accounts. Clearly the need for
consistency with the JV partners’ accounting requirements will be
greatest where the accounts need to be consolidated.
Critical reporting issues, such as oil and gas reserves recognition by
the various partners, will need to be discussed and clarified and the
principles, if not the quantities, agreed.
There may be critical areas of the JV that are of particular
interest to the partners that may require additional due diligence
to be carried out on behalf of some/all of the partners. One such
example is the production management processes and output of
a production sharing agreement. Where such issues exist it may
be necessary for partners to consider putting in place additional
assurance processes and mechanisms, such as a Statement of
Standards for Attestation Engagements No. 16 (SSAE 16), to
provide all JV partners with a high level of comfort regarding the
robustness of the process and output.
• What is the tax treatment of debt financing?
• Does a limited resource project financing model work under the
legal system?
• Is leveraged financing possible?
• Does the applicable law allow the free and easy taking of security
in certain properties?
8
Navigating joint ventures in the oil and gas industry
Management of legacy risk issues
Dissolution options
Where the JV is formed from existing assets, there will need to
be a clear mechanism for ring fencing liability, risk issues, and tax
contingencies that pre-date the formation. These items may include
ongoing litigation, environmental cleanup liabilities and outstanding
human resources (HR) liabilities (pension funding, redundancy
costs, etc.). These legacy items will need to be attributed to the
appropriate JV partner who “owns” the potential liability and
detailed within the JVs legal agreement.
The JV partners need to be clear about what the JV dissolution
strategy and options should be. There is a range of mechanisms
that exist to enable partners to buy each other out should the
need arise — e.g., “Russian roulette” or “Texas shoot-out” clauses
(see page 13). However, other scenarios should be considered and
included within the legal framework of the JV. These scenarios
could include, in part, the following:
Use of proprietary technology
Where the JV will use proprietary technology owned by one of
the partners or the JV itself, the legal agreement between the
partners should cover the usage of this technology. In addition to
any patents or trademarks that exist, the agreement should identify
the licensed users and the geographies where this technology can
be deployed. Suspicions over perceived or real intellectual property
theft are a common cause of friction between partners, but by
dealing with these issues in a pre-emptive, thorough manner, the
risks in this area can be largely mitigated.
Dispute settling mechanism
It is important that there is a clear dispute escalation and resolution
process understood and agreed to by all of the partners. This may
include defining escalation mechanisms in the JV itself, involving
the partners as stakeholders and also referencing local and
international laws.
• The inability of one or more of the partners to meet a cash
call or unanticipated liabilities
• A number, but not all, of the partners wanting to sell the
JV in its entirety
• Putting the JV into liquidation should the need arise
Implementation of a partner review process
As part of the ongoing JV review process, partners should
consider the implementation of a regular review process where
the performance of the partners is discussed and appraised in the
context of the management of the JV. This will enable issues to be
discussed, raised and resolved on a timely basis — as opposed to
going unsaid and potentially escalating into larger issues that lead
to a breakdown in the working relationship.
The JV partners need to
be clear about what the JV
dissolution strategy and
options should be.
Navigating joint ventures in the oil and gas industry
9
JV operation
Ensuring that the JV is structured and set up
correctly is critical to the success. However, it is
equally important that the JV performs in line
with the partners’ plans and expectations. Many
of the problems that occur with JVs stem from
performance issues that undermine the initial
rationale for creating the JV.
Organization design
Creating the new JV management structure, policies, procedures
and culture will be critical to success. Where the JV involves
the combination of existing assets and organizations, this will
involve decisions regarding whether to harmonize around the
partners’ existing policies, procedures and cultures or instead
create a completely new set. The organization design needs to
be sympathetic to the employees and ensure that they all feel
part of the new organization. Change should be managed and
communicated proactively. This will be more difficult where there
are overlapping or duplicated roles and a need to simplify and
reduce the structure and number of employees engaged in the
business. Positioning senior and middle management from all the
partners within the new organization is a critical activity. If one
organization is seen to dominate the new management structure
with little senior representation from the other partner, this may demotivate and destabilize staff from that partner. It is important to
recognize and understand corporate culture differences within the
partners’ organizations. This will help the new leadership team to
effectively manage and communicate with the new organization.
It is important to bring the new leadership team together,
create a shared identity, vision and purpose, and then
focus on communicating and sharing this with all levels of the
new organization.
Where the JV is a new organization, starting with a blank piece
of paper can potentially avoid legacy issues and inefficiencies.
However, designing and populating the organization will
consequently be more time consuming, and there may well be
protracted partner discussions as to the appropriate operating
structure and candidates for the key leadership roles. Where part
or all of the JV’s management is provided by the venturing partner,
due consideration needs to be given to either the duration and
type of secondment or the transfer of employment contracts and
employer obligations. Where management secondments to the
JV are in place, succession planning for key roles needs to be an
integral part of the HR management processes.
10
Design/harmonize business processes,
technology and infrastructure
Where the JV is a combination of existing assets, decisions will
need to be made regarding whether there are overlapping assets in
terms of office locations, information technology (IT) applications/
infrastructure and business processes. Where the JV businesses
will operate relatively discretely from each other, this may be less
of an issue — i.e., the combination of a sales and a production
organization into a new JV may simply require that interface
processes are put in place but the core processes, systems and
office locations may remain unchanged.
Where there is a need to integrate two vertically integrated
businesses to realize synergies, certain issues will need to be
addressed early in the JV operation phase. The combination of
two vertically integrated organizations will result in a potential
overlap in a number of areas: functional support (e.g., HR, finance,
IT, legal, real estate management, procurement), IT applications/
infrastructure, office space, supply chain, suppliers and contractors.
Such overlaps will need to be identified and plans put in place to
rationalize the new organization and consolidate the overlaps.
Where the JV is a new organization, however, all of these areas will
need to be either developed or provided by the partners. Where
the partners will be providing services to the new JV, contracts for
the provision of these services and remuneration/consideration will
need to be agreed upon, put in place and monitored.
Creating the new JV
management structure,
policies, procedures and
culture will be critical to the
JV’s success.
Coal seam gas: broadening the energy mix
Meeting partners’ financial and tax
reporting requirements
Appropriate involvement of partners in
decision-making process
The JV partners are likely to have different reporting requirements
and time frames for fiscal and tax reporting. The JV partners
may also have Sarbanes-Oxley, IFRS or other regulatory
reporting requirements that, even though they may not be
specifically relevant or necessary for the JV itself, need to be
taken into consideration. All of these requirements will need to be
communicated to both the other JV partners and the JV itself.
JV partners will need to establish clear rules for maintaining
control over the strategic direction of the JV and over key
operational decisions that will significantly impact the JV. However,
they must allow the JV management enough freedom to manage
the organization on a day-to-day basis and not be weighed down by
an overly bureaucratic and cumbersome decision-making process.
This can be a difficult balance, and there will need to be a clear and
well-understood delegation of authority between the JV partners
and JV management.
As previously mentioned, there may be key areas of the JV’s
operation that may need to be subjected to additional assurance.
This may take the form of a SSAE 16, JV partner right of audit or
annual rolling audits with each of the JV partners taking turns to
assure a specific process/output.
A clear program of audit and reporting requirements, formats
and timings will need to be agreed to and established. The timings
of cash calls and distributions will also need to be carefully
considered and agreed to in relation to the partners and the JV’s
reporting timetable.
The JV partners need to establish a regular series of governance
oversight meetings with both the JV management team and
with each other to monitor progress, track performance against
strategic goals and review and update the agreed upon strategy.
Partner capital management
Where the JV receives capital funding from the partners in terms of
either capital injection or assets, there needs to be a clear plan for
the proposed timings and values of the partner capital investment
in the JV and proposed timings for capital repayments.
The capital repayment obligations need to be carefully evaluated
against the cash flow projections for the JV to ensure that they are
realistic and achievable.
Navigating joint ventures in the oil and gas industry
11
New US federal income tax laws
may affect the US oil and gas sector
Proposed US federal income tax legislation
may have a negative impact on the industry
(including JV transactions within the US oil
and gas industry)
The US Government’s proposed budget for fiscal year 2012
(Proposed Budget) includes the proposed repeal of certain
federal income tax incentives currently available to certain
oil and gas companies. On February 14, 2011, the Obama
Administration released its Proposed Budget, which incorporated
a number of provisions that, if enacted, would significantly affect
the US oil and gas industry, and could dramatically affect JV
transactions within the US oil and gas industry. In part, these
provisions would:
• Repeal expensing of intangible drilling and development costs
• Repeal percentage depletion for oil and natural gas wells
• Repeal the domestic manufacturing deduction for oil and
natural gas companies
• Increase the geological and geophysical amortization period
for independent producers to seven years
• Repeal the exception to passive loss limitations for working
interests in oil and natural gas properties
In addition to provisions that would directly affect the US oil and
gas industry, the Proposed Budget includes certain provisions
that, if enacted or eliminated, may have a negative impact on the
financial condition and results of operations of certain oil and gas
companies, including, in part, the reinstatement of the Superfund
taxes, repeal of the last-in/first-out method of accounting for
inventories, modification of the rules for dual-capacity taxpayers
and certain other international reform measures.
12
As many of the aforementioned incentives currently available
to investments in US oil and gas plays play an integral role in
a project’s overall return, the repeal of all or a portion of the
incentives could dramatically impact JV transactions within the
US oil and gas industry. The US oil and gas industry was on the
defensive for the better part of the 111th Congress, fighting
numerous congressional attempts to eliminate tax provisions
that benefit the industry in order to offset the cost of other
provisions. Although the repeal of such measures has not
been provided for in recent legislation, the situation requires
continued monitoring to determine whether such proposals may
be included in future legislation.
New bonus depreciation provisions
aim to spur growth by encouraging
capital investment
On December 17, 2010, President Obama signed into
law H.R. 4853, the Tax Relief, Unemployment Insurance
Reauthorization, and Job Creation Act of 2010 (the Act).
Although it affects all industries, the Act generally extends and
modifies the bonus depreciation provision under Section 168(k)
of the Internal Revenue Code of 1986, as amended (the Code),
and provides for the temporary 100% expensing of certain
qualifying capital expenditures. These provisions have — and will
continue to have — a significant effect on the capital–intensive
US oil and gas industry. The Act adds Section 168(k)(5) to the
Code, under which certain taxpayers may qualify for a first-year,
bonus depreciation percentage of 100% — effectively allowing
immediate expensing — with respect to qualified property if certain
requirements are met. The Act also extended the application of
the 50% bonus depreciation allowance for certain properties.
It is expected that cost recovery incentives relating to bonus
depreciation should accelerate plan and equipment purchases in
2011 to take advantage of the 100% first-year bonus depreciation
allowance. The changes should also provide some assurance to
companies and act as a catalyst to spur growth by encouraging
capital investment.
Navigating joint ventures in the oil and gas industry
JV dissolution
JV dissolution may be a planned milestone event
when a certain JV goal has been achieved or it may
be a response to circumstances. Either way, it should
be an event that has been foreseen, the options
considered and provision for it contained within the
JV’s legal framework.
There are a number of scenarios or options that the JV partners
may have to consider.
Sale to a third party
This is perhaps the most straightforward of the options: the JV
partners agree to sell the JV in its entirety to a third party. Where
the JV is a stand-alone entity, the impact on the partners will be
minimal. Where the JV has significant linkages into one or more of
the JV partners’ businesses, it will be more complex. These linkages
could involve the provision of certain services (e.g., technical
support, research and development, IT) to the JV, or the JV could
be integrated into the supply chains of one or more of the partners.
The nature of the business relationships between the JV and the JV
partners will need to be carefully assessed and planned for in the
sale process to ensure that the sale does not damage either the JV
partners’ businesses or the JV itself.
Legal assistance will be needed in the sales process, as there will be
a suite of documents to provide for the share sale and purchase, the
transfer of obligations, possible renegotiation of the joint operating
agreement, possible amendments to the finance agreements
and an assignment of guarantees, support documentation, direct
agreements and rights and obligations.
Separation of the JV with a
return of assets and business
to the JV partners is
potentially the most complex
JV dissolution mechanism.
Sale to one of the partners
Sale to one of the partners is a common outcome with many JVs.
Often the sale process is governed by a “Russian roulette” or a
“Texas shoot-out” clause. A Russian roulette clause allows one
JV partner to make an offer for another partner’s share of the
business, but the partner that has received the offer may then
purchase the other partner’s share under the same terms as those
that were offered for the purchase of its share. A Texas shoot-out
clause initiates a process where JV partners submit written sealed
bids for the purchase of the JV and the highest bidder wins.
Once again, consideration will need to be given to how integrated
the JV is with the JV partners’ businesses and how ongoing
relationships between them should be governed.
Separation of organization with sharing of
assets to partners
Separation of the JV with a return of assets and business to the JV
partners is potentially the most complex dissolution. The longer the
JV has been operating, the more likely it is that there will have been
a “blurring” of the JV partners’ original inputs.
There will need to be discussions and subsequent agreement
around which assets (people, technology, licenses and property) go
to which partners, valuation of those assets, and the appropriate
settlement mechanism. These are likely to be complex and
time-consuming negotiations. Again, where the businesses are
integrated within the partners’ businesses, the process will be more
complex, and partners will need to consider the potential impact on
their core businesses of reintegrating the JV’s assets back within
their organizations.
Consideration of this option should be part of the partner
discussions, and provisions for how it would be managed should be
contained within the JV agreement if there is more than a remote
likelihood that this is a potential dissolution scenario.
Navigating joint ventures in the oil and gas industry
13
Summary
JVs are an inherent part of the oil and gas industry and are likely to remain so for the
foreseeable future. When managed well, they can deliver real value to all stakeholders.
However, when things go wrong, they have the potential to destroy shareholder value,
with arbitration and legal proceedings being a costly, time-consuming distraction for the
management of both the JV and the partners.
There are a number of critical success factors for JVs:
• Transparency, openness and honesty between the partners
• Thorough financial and tax planning
• Consideration of all potential dissolution scenarios
• A robust legal agreement that contains provision for all of the above
14
Navigating joint ventures in the oil and gas industry
Ernst & Young’s JV services
Ernst & Young has significant experience supporting
JVs throughout the JV lifecycle. An overview
of the services we provide in each of the phases
is contained below:
JV planning
Ernst & Young services
JV planning
Ernst & Young services
Defining the scope
of the JV
Financial, operational, commercial and tax
due diligence
Detailed location
planning
Market risk and quantitative
advisory services
Commercial analysis
of the JV
Valuation
Financing of the JV
Debt advisory
Financial and business modeling
Capital markets advisory
Financial, commercial and tax due diligence
Defining the legal and
financial structure
Defining the business
strategy and plan
Tax structuring
Supply chain optimization
Financial reporting and IT advisory
Statutory audit and reporting
Organization and governance
Tax compliance and advisory
Financial and business modeling
SOX/J-SOX*/internal controls advisory
Transaction integration
Dispute advisory expertise with regard
to clarity of business plan
Partner identification
and selection
International tax structuring
Financial reporting
for the JV
Coordination of the partner
selection process
Management of legacy
risk issues
Environmental, financial, tax and human
resources due diligence and advisory
Dispute settling
mechanism
Dispute advisory
Dissolution options
Transaction carve-out services
Transaction integration services
Environmental, financial, tax and human
resources due diligence and advisory
Implementation of a
partner review process
Internal audit
Risk advisory
*Japan’s Sarbanes-Oxley
Navigating joint ventures in the oil and gas industry
15
Ernst & Young’s JV services (continued)
JV planning
Ernst & Young services
JV planning
Ernst & Young services
Organization design
Organization design advisory
Sale to third party
Valuation
Design/harmonize
business processes,
technology and
infrastructure
Governance advisory
Investigations and dispute monitoring
Risk advisory
Environmental, financial, tax, operational
and human resources due diligence
and advisory
Post-deal integration
Supply chain and tax efficiency
Shared services planning
Finance transformation and consolidation
Performance management
Transaction carve-out service
Sale to one of the
partners
Cost reduction
Financial reporting advisory
Transaction integration
Tax advisory
Transaction carve-out services
IT design
Separation of
organization with sharing
of assets to partners
Risk advisory
SOX/J-SOX* advisory
Appropriate involvement
of partners in decisionmaking process
Risk advisory
Partner capital
management
Debt advisory
Governance advisory
Internal audit outsourcing
Capital markets advisory
*Japan’s Sarbanes-Oxley
16
Investigations and dispute monitoring
Environmental, financial, tax, operational
and human resources due diligence
and advisory
IT effectiveness
Meeting partners’
financial and tax
reporting requirements
Valuation
Navigating joint ventures in the oil and gas industry
Valuation
Investigations and dispute monitoring
Environmental, financial, tax, operational
and human resources due diligence
and advisory
Transaction integration
Transaction carve-out services
Navigating joint ventures in the oil and gas industry
17
Ernst & Young’s Global Oil & Gas Center contacts:
For more information about our service lines and our principal oil and gas-focused service
offerings, please contact the below-referenced individuals, or your local Ernst & Young office.
Dale Nijoka
Global Oil & Gas Leader
+1 713 750 1551
[email protected]
Sanjeev Gupta
Asia-Pacific
+65 6309 8688
[email protected]
Marcela Donadio
Americas
+1 713 750 1276
[email protected]
John Avaldsnes
Europe, Middle East, India and Africa (EMEIA)
+47 51 70 67 40
[email protected]
Enrique Grotz
Argentina
+54 11 4515 2655
[email protected]
David Barringer
Middle East
+973 3961 7303
[email protected]
Russell Curtin
Australia
+61 8 9429 2424
[email protected]
Jeff Sluijter
Netherlands
+31 88 407 8710
[email protected]
Carlos Assis
Brazil
+55 21 2109 1606
[email protected]
Alexey Loza
Russia/CIS
+7 495 641 2945
[email protected]
Barry Munro
Canada
+1 403 206 5017
[email protected]
James Newlands
South Africa
+27 21 443 0489
[email protected]
Raymond Ng
China
+86 10 5815 3332
[email protected]
Andy Brogan
United Kingdom
+44 20 7951 7009
[email protected]
Ernst & Young
Assurance | Tax | Transactions | Advisory
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How Ernst & Young’s Global Oil & Gas
Center can help your business
The oil and gas industry is constantly
changing. Increasingly uncertain energy
policies, geopolitical complexities, cost
management and climate change all present
significant challenges. Ernst & Young’s
Global Oil & Gas Center supports a
global practice of over 8,000 oil and gas
professionals with technical experience in
providing assurance, tax, transaction and
advisory services across the upstream,
midstream, downstream and oilfield service
sub-sectors. The Center works to anticipate
market trends, execute the mobility of our
global resources and articulate points of
view on relevant key industry issues. With
our deep industry focus, we can help your
organization drive down costs and compete
more effectively to achieve its potential.
© 2011 EYGM Limited.
All Rights Reserved.
EYG no. DW0101
1106-1264588
This publication contains information in summary form
and is therefore intended for general guidance only. It
is not intended to be a substitute for detailed research
or the exercise of professional judgment. Neither EYGM
Limited nor any other member of the global Ernst & Young
organization can accept any responsibility for loss
occasioned to any person acting or refraining from
action as a result of any material in this publication. On
any specific matter, reference should be made to the
appropriate advisor.
www.ey.com/oilandgas
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