Oil Prices: Cause and Effect 1

Briefing note 10 March 2015

Oil Prices: Cause and Effect The global price of oil had been relatively stable at about US$110 a barrel for the last 4-5 years. However, the increased shale oil production in the US combined with lower global demand for oil has recently led to a plunge in oil prices. Oil prices have fallen significantly since June 2014.

The decline, together with uncertainty about where oil prices will settle, has created sudden downward pressure in the oil & gas sector and has given rise to a need to re-visit business planning and strategy, at least in the short term. Some of the key themes that we have seen and expect to continue with the increased volatility in oil prices are set out below.

Impact on oil exporting  defaults by oil-producing countries in their contractual countries obligations Key issues The fall in oil prices will have a  debt and loan defaults  Impact on oil exporting significant impact on countries (like  sovereign debt refinancing countries Venezuela, Nigeria and Russia) for  oil-producing countries seeking to  Review of current project which oil exports make up a large increase their "take" of revenue arrangements proportion of their income. under petroleum agreements at  Long term LNG contracts Venezuela, which was already the expense of oil companies, against a strengthening US suffering the effects of inflation, will including through expropriative dollar likely need prices of US$120 per actions  Merger and acquisition barrel if it is to fund important social It would be prudent to consider what opportunities programmes and Nigeria has had to provisions should be included in devalue its currency as a result of the future contracts with sovereign states common. The Institute of International falling oil prices. Russia's woes are as protection from the relevant risks. Finance estimates that the flow of well documented – it has announced Bilateral or multilateral investment petrodollars which was estimated at that it will no longer proceed with the treaties could prove very useful in US$500 billion in 2012 may fall to South Stream gas pipeline project, reducing expropriation risk. US$100 billion in 2015 if oil prices are the rouble has fallen dramatically below US$78 a barrel. amid continued falling oil prices and A further consequence for "petro- the effect of sanctions and its 2015 dollar" countries or emirates (such as In a lower oil price environment, oil- budget, which was based on oil prices Qatar, Abu Dhabi, etc.) with sale producing countries will come under of US$100 per barrel, is being re- contracts benchmarked against the increasing pressure to offer more evaluated. price of oil in US dollars is that their net proceeds will be diminished. This attractive fiscal terms, starting with If oil prices continue to fall, or stay at may lead to a curbing in the funding countries with high marginal cost the current levels for a sustained of sovereign wealth funds and their fields. On 22 January 2015, for period, this could lead to: international investment plans. The example, the UK government announced a consultation to support  significant budget deficits acquisition of non-core assets like football clubs may also become less investment in North Sea oil and gas

2 Oil Prices: Cause and Effect

projects through the introduction of a  being more selective with their abuse, an interconnected gas single basin-wide investment new investments - investment in transmission pipeline system and a allowance. This came on the heels of projects only being sanctioned if large and efficient short term and a reduction on 1 January 2015 of the they are viable at an oil price futures market with buyers and sellers "supplementary charge" assessed on under US$70 per barrel competing for positions. oil companies' adjusted ring fence  stress testing the terms of their profits from 32% to 30%. These existing supply contracts Merger and acquisition changes were driven largely by  refinancing their debt in relation opportunities concerns that low oil prices could to projects Volatility in oil prices has traditionally permanently damage North Sea  exerting pressure on oilfield resulted in increased M&A activity in production, which already faces some service contractors and other certain areas. of the world's highest production suppliers to reduce prices costs and, increasingly, high Assets will come onto the market as decommissioning expenses. companies look to review their Long-term LNG contracts portfolio and dispose of their less Review of current project against a strengthening profitable assets. For example, Total arrangements US dollar recently announced that it plans to accelerate its 2015-2017 assets sale With oil and gas producers as well as LNG contracts are typically long-term programme of US$10 billion by sovereigns reviewing their balance contracts and traditionally linked to oil disposing of US$5 billion of assets in sheets and spending plans in light of prices. In Asia, where LNG demand 2015. the lower oil and gas prices, this could accounted for three-quarters of global We also expect M&A activity and lead to a number of projects which demand last year, the higher oil prices consolidation in relation to small and are anticipated to be sustainable only over the last 4-5 years had increased medium sized companies. Low prices at higher oil prices being restructured, the cost of importing oil-linked LNG could put these companies into a scaled down, slowed down or even for Asian utilities which have not been "distressed situation" that forces them abandoned. able to pass on the higher cost to end-users. US LNG exports to Asia to either sell assets to raise cash or This is particularly so in relation to based on the Henry Hub gas price make such companies attractive and projects in "new frontier" regions like index are becoming more frequent, cheap targets for opportunistic buyers. the Arctic and east Africa. We have but this index has a history of volatility, We would also expect such small and seen examples of this most recently caused by the extremes in North medium sized companies to look to in the announcements that Statoil are America weather. LNG buyers in Asia merge and consolidate with each looking to delay development of its have, as a result, been seeking to other. The recommended offer by Johan Castberg project, Chevron develop a viable alternative pricing Ophir Energy for Salamander Energy putting on hold its plans to drill in the mechanism to create a stable "Asian" which was announced in November Beaufort Sea and Statoil, Dong LNG pricing mechanism. Although the 2014 may be a sign of other such Energy and GDF Suez all handing fall in oil prices could make oil-linked deals to come. back licences for oil exploration off LNG contracts attractive, this The oilfield services industry which, Greenland. Energy Aspects, a assumes that oil prices will be as noted above, suffers when low London-based consultancy, estimates sustained in the long term at the lower prices reduce oil company spending, that more than 12% of global oil level, which may not be likely. has also seen some significant production would be uneconomic at activity. In November 2014, the current oil prices. In order for Asia to develop a stable and reliable Asian pricing index, it is second-largest oil-field service We expect the lower oil prices to important that there are deregulated company, Halliburton Co., bid about result in companies: markets (including in natural gas US$35bn to acquire No. 3 Baker Hughes. France’s Technip also bid in  actively looking to restructure upstream, transportation and trading), the same month for a smaller services their existing projects a transparent market with limited government intervention or scope for firm, offering US$1.83 billion to buy Paris-based CGG.

Oil Prices: Cause and Effect 3

We have seen private equity US$9 billion it has earmarked for this investment in the sector increase purpose. during the last 4-5 years of high Finally, we may also see some stable oil prices. With the lower oil significant M&A transactions by major prices hitting their anticipated return oil companies with significant liquidity. on investment, private equity players The acquisitions by BP of Amoco, may be facing their first real exposure Chevron of Texaco and Exxon of to the volatility of the sector and start Mobil in the 1990s were made at a to re-evaluate their investments in this time of low oil prices. sector, resulting in possible disposals. While no one can accurately predict Conversely, low oil prices also the price of oil going forward, 2015 is present investment opportunities in likely to see some continued the oil and gas sector. Carlyle has challenges and new opportunities in indicated that it intends to raise the oil and gas sector. between US$3-4 billion this year for energy investments to add to the

Contacts

Steven Fox Tracey Renshaw Kathy Honeywood Partner, London Partner, Perth Partner, London T: +44 20 7006 4827 T: +61 892625 505 T: +44 20 7006 1524 E: steven.fox E: tracey.renshaw E: kathy.honeywood @CliffordChance.com @CliffordChance.com @CliffordChance.com

Geraint Hughes John Wilkins Sze-Shing Tan Partner, Singapore Partner, London Counsel, Singapore T: +65 6410 2212 T: +44 20 7006 2466 T: +65 6661 2027 E: geraint.hughes E: john.wilkins E: sze-shing.tan @CliffordChance.com @CliffordChance.com @CliffordChance.com

This publication does not necessarily deal with every important topic or cover Clifford Chance, 10 Upper Bank Street, London, E14 5JJ every aspect of the topics with which it deals. It is not designed to provide © Clifford Chance 2014 legal or other advice. Clifford Chance LLP is a limited liability partnership registered in England and Wales under number OC323571 Registered office: 10 Upper Bank Street, London, E14 5JJ We use the word 'partner' to refer to a member of Clifford Chance LLP, or an employee or consultant with equivalent standing and qualifications www.cliffordchance.com If you do not wish to receive further information from Clifford Chance about events or legal developments which we believe may be of interest to you, please either send an email to [email protected] or by post at Clifford Chance LLP, 10 Upper Bank Street, Canary Wharf, London E14 5JJ Abu Dhabi ■ Amsterdam ■ Bangkok ■ Barcelona ■ Beijing ■ Brussels ■ Bucharest ■ Casablanca ■ Doha ■ Dubai ■ Düsseldorf ■ Frankfurt ■ Hong Kong ■ Istanbul ■ Jakarta* ■ Kyiv ■ London ■ Luxembourg ■ Madrid ■ Milan ■ Moscow ■ Munich ■ New York ■ Paris ■ Perth ■ Prague ■ Riyadh ■ Rome ■ São Paulo ■ Seoul ■ Shanghai ■ Singapore ■ Sydney ■ Tokyo ■ Warsaw ■ Washington, D.C.

*Linda Widyati & Partners in association with Clifford Chance.