Energy Disputes

In 2018, the government introduced MEES to improve the energy efficiency of private rented property. In this six-part series, we discuss the impact the MEES Regulations will have on landlords and tenants before and after 1 April 2023, and the actions landlords should take as a result.

We are delighted to present this year’s CMS Oil and Gas Disputes Survey. Once again, we have reached out to a wide cross section of senior legal managers and senior in-house counsel representing key players to get their views on the main drivers of disputes and dispute management within the global oil and gas industry. As part of our in-depth survey, we have also focused on what legal experts are doing to manage the risk of conflicts arising within their operations and to mitigate the prospect of disputes. The survey represents the views of over 50 industry professionals covering all corners of the globe: Europe, the Middle East, Asia-Pacific, Africa, Latin America, and North America. We are grateful for their valuable insights into how and where disputes arise and how they are managed in different markets across the industry. Given the multiple international regions covered by our report, with their different regimes and differing priorities and issues, it’s not surprising to see a broad range of views being conveyed by the survey participants. There are however some common areas of concern that respondents in all regions have highlighted in terms of the impact they have on triggering industry disputes. These include the potential for supply chain issues to lead to a dispute, a concern which will only have been heightened by Russia’s invasion of Ukraine.

Risk profile, technical and regulatory complexity and financial constraint naturally all heighten the potential for disputes. The CMS Oil and Gas Disputes Survey suggests that two types of geographic locations bring with them an increased risk of disputes. First, mature basins where: (i) exploration and production (E&P) is more technically challenging; (ii) projects are financially marginal compared to less mature ‘mega fields’ with a long remaining life; and (iii) there is a proliferation of medium sized oil companies with fewer relationships to maintain elsewhere. These mature basins are reported as having a greater capacity to raise contentious clashes. United Kingdom has the highest chance of energy disputes arising There are likely many contributing factors. The United Kingdom Continental Shelf (UKCS) is one of the three geographic locations that represents the highest chance of a dispute arising, according to The CMS Oil and Gas Disputes Survey participants. A high proportion of respondents have operations in the UKCS region and our data indicates that a significant number of these see it as high risk. As the market has matured and with hydrocarbon reserves diminishing in more mature fields, operators have been forced into deeper waters where E&P is more technically complex and expensive. If workscopes require to be adapted because projects do not unfold as anticipated on the ground, cost overruns can quickly become a real concern and the chance of a dispute heightens, both with contractors trying to work to tight budgets and co-venturers required to fund what may be cutting edge or marginal projects. The profile of asset ownership in the UKCS has also changed over time. The UKCS region is now inhabited, in part, by smaller and medium sized independent players looking to develop and maximise recovery from smaller or mature interests. These oil companies are often are financed and structured in a way that is very different from the super-majors that traditionally dominated the UKCS.

It is notable that in The CMS Oil and Gas Disputes Survey, respondents singled out projects and joint ventures as the aspects of their activities that bring the highest risk of disputes arising. As far as joint venture disputes are concerned, in more benign times, when oil prices were considerably higher, when the global economy was growing, and before the oil and gas market became more fragmented, industry players would have been perhaps more likely to avoid disputes with a joint venturer or resolve issues quickly. Disputes with a joint venture partner over a relatively small matter in a single jurisdiction might jeopardise a more luc­rat­ive glob­al re­la­tion­ship. The wider commercial imperatives would often vastly outweigh the gains from a legal battle. Duncan Holland, Head of Legal at Cairn Energy says: “In years gone by when the oil price was closer to $100, the banks were freer with their lending, people were less constrained, and disputes were more easily resolved. People would just meet in the middle.”Now that the market is more segmented and with both larger companies and independent players having tighter financial resources, the incentive to launch disputes seems to be greater. Relatively speaking oil companies simply have more to lose. “Fifteen years ago, there were very few joint venture disputes,” comments Phillip Ashley, a CMS Energy Disputes Partner. He says that in certain regions, the frequency of these kinds of disputes seems to have grown as assets are divested to smal­ler en­tit­ies and private equity-backed companies - that have tighter profit margins. They also have less ex­tens­ive fund­ing arrangements meaning that it may be less straight­for­ward for them to simply ‘meet in the middle’. Also, many of these smaller companies do not have the kind of extensive portfolio that traditional oil and gas companies would have had. As a result, there may be less need to balance relationships across multiple joint venture interests. Moreover, some joint venture agreements were put into place decades ago, when exploration in a particular area commenced. That means that they incorporate approaches to accounting and governance which are no longer reflective of today’s market. In some cases the existing contractual arrangements have not fully anticipated the challenges associated with continuing to produce from a mature asset, or those that arise as production winds down and the oil field infrastructure moves closer to decommissioning. These historic contractual arrangements often also do not account for asset ownership by companies that are structured in a very different way to the companies that carried out the original exploration work. Valerie Allan, a CMS Energy Disputes Partner, says that court records show a marked increase in joint venture cases. It is perhaps not surprising that respondents identified projects as the other key area of risk as regards the potential for disputes to arise. E&P projects require significant financial investment, sometimes (for example, in drilling exploration wells) with no guarantee of any return. The work is often being undertaken in a difficult physical environment and, despite extensive planning, in many cases (such as exploration wells) there will be no certainty as to the result. Technical complexity means there is always the potential for things to go wrong, and that complexity is increasing, for example, in mature basins where new technology is required to deliver barrels from deeper, higher pressure wells. Particularly where projects are to bring new or additional production online, there will be real commercial pressures to achieve first hydrocarbons as quickly as possible in order to facilitate a return on investment. Added to that, the continuing low oil price puts significant pressure on margins, driving downcontractor rates in an increasingly competitive market and leaving little contingency for unexpected events.

What are the key risks that the industry is facing? Where are you seeing the most potential for disputes? It is largely about the financial situation. Across the industry, we are seeing more disagreements even with parties in joint ventures, where there may not be a huge amount of money at stake, but companies are seeking to preserve cash and not be tied into work commitments.  What operations are most likely to lead to disputes and how are you approaching topical issues such as force majeure?  We are in a different world where some long-term contracts and work commitments of operators don’t make sense anymore and it’s not going to change in the next 12 to 18 months, which is increasingly leading to disputes. Force majeure has taken up a bit of time in the last few months. If you physically can’t operate, then force majeure is pretty clear, but as restrictions are then relaxed in some parts of the world while remaining in others, it can become quite complex. Particularly in the oil and gas industry where people and equipment can be moving around the world. How do you see the impact of climate change policies and priorities?  Governments, shareholders and regulatory bodies in many countries are looking at in­creased reg­u­la­tion in the immediate and near-term future and that will be a key issue when looking at new projects.  How is the typical in-house legal team addressing these risks in today’s climate? And how might this compare to five or 10 years ago? I think there is a general trend to more quickly use external counsel, because there used to be more disputes resolved amicably. The temperature has increased. We don’t necessarily end up in court, but we have the potential to do so. People can be emotive about disputes and it can become more tense. What you want is for ex­tern­al coun­sel to see through that and see what the underlying issue is. And so it’s about being able to cut through all that noise in these disputes and seeing where the strong points and the weak points are and asking: ‘is this worth pursuing’? We need lawyers to be commercial while un­der­stand­ing all the key moving parts.  Where do you feel that the industry can improve its management of risk and disputes?  People can keep better records. A lot of problems arise out of meetings where people disagreed about certain things and the two parties have records that are wildly dif­fer­ent. Also, clearer drafting at the outset. Often you have complicated agreements and people are keen to get them concluded and signed, even though there is often vague language trying to deal with highly complex situations. You need to have these discussions early to try and deal with some of the problems before they arise. It’s easier to reach agreement on a lot of these issues when things are amicable.

Even if the oil and gas industry faces more risk and is prone to more ten­sions, clashes and disagreements, it does have the means of tackling these concerns. Over 91% of The CMS Oil and Gas Disputes Sur­vey re­spond­ents indicated that there is room for improvement in managing dispute-related risks. Just as the industry is evolving and shifting according to economic, geopolitical and social changes, so too are the means of addressing risks and minimising the chances of dis­agree­ments.

The three geographic locations identified as highest risk in terms of the prospects of a dispute arising were: Africa (28% of respondents, and 60% of those who operate in that region); the United Kingdom Continental Shelf (UKCS) (37% of all respondents, and 50% of those who operate in the UKCS); and Latin America (17% of total respondents and 40% of those who operate in the region).

A collection of inter-related activities and business relationships pose a considerable challenge to oil and gas industry players. Projects and supply chains are complex, while joint ventures can be tested by financial constraints and tighter profit margins. At the same time, oil and gas businesses are at the forefront of attention from many host states and regulators as a result of (i) the current increasing focus on ESG issues and environmental targets and (ii) the need for the relevant government to use oil operations as a source of state revenue. In some regions, those chal­lenges are accompanied by local content laws and nationalistic policies which add to the complexity. In a generally harsh global business environment made worse by the COVID-19 pandemic, it is logical, that industry players would be wary of disputes and their possible consequences.

What are the key risks that the industry is facing and where are you seeing the most potential for disputes? Today, I believe that the main challenge consists of aligning the necessary reduction of risks, costs and impacts of existing operations with the desirable increase of productivity and generation of cash for new investments. For the longer term, I think the main challenge that all operators will face is how do you transform your hydrocarbon business into something greener. You can do this by just having another portfolio with other energies or just by implementing certain changes in your own oil and gas assets. How do you see the force majeure term being applied in the current climate? What you don’t know is how a pandemic is viewed by the courts and by the arbitral tribunals. There’s a lot of jurisprudence regarding force majeure clauses, but I think the new component here is the pandemic. I think that arbitrators and courts will have sympathy for the ones who are suffering with a pandemic. Let’s see how they react. How litigious or cooperative is the industry right now? I think the industry itself is quite litigious, but I think that litigation is expensive. I think that parties are less willing, because of the financial crisis, to enter into proceedings to solve problems. I think they will pause and look at the benefit of having an arbitration versus the cost of it, and what they’ll gain from it. You have to look at the long-term prospects.