Resources

Oil & Gas Industry—Are You Prepared to Deal With COVID-19?

March 11, 2020

Oil pumps

The price of oil—already hammered by market conditions—took another stumble in the wake of the COVID-19 outbreak with no immediate relief in sight. Accordingly, the Oil & Gas Industry must prepare for the looming wave of oncoming legal issues, which will affect every sector of the market. This alert contains recommended actions for industry stakeholders.

Merger and acquisition volumes will likely decrease, led by increased debt exposure and continued decline in the price of oil. Contracting parties should examine the termination, damages, and remedies provisions in their recent or in-process asset sale agreements and mergers/combinations, both to ensure they can enforce the deal or know their rights and liabilities in terminating it. Many such agreements contain force majeure or “material adverse change” clauses that may provide relief from a deal that no longer makes economic sense.

Of course, many of the deals that do happen will likely be liquidation asset sales and consolidations of distressed companies, which can be great opportunities for buyers. In such deals, due diligence is paramount for buyers. A cash-strapped seller might not be operating its leases and facilities to industry standard, which can lead to all manner of undisclosed liens, regulatory non-compliance, environmental contamination, and loss of title. Buyers should not overlook such deal-killing defects for the sake of a quick closing.

Producers and service providers will all need to assess counterparty risks as volatile conditions are expected to continue for some time. Producers with bank debt will also need to monitor their loan documents for signs of covenant default and consider when to approach lenders, and what actions to take—including avoiding or enforcing statutory liens.

As companies closely evaluate bankruptcy as an option to seek debt relief, creditors should closely monitor their debtors’ financial situation. They should also examine their rights and positions under any upcoming bankruptcies and decide what actions to take in any such cases, including participation through an official committee, filing proofs of claim, and continuing to provide goods or services to a debtor-in-possession. In many instances, these decisions must be made very early after the bankruptcy cases are filed.

Operators and service providers should closely examine the extent of their rights and obligations under their existing master service agreements, drilling contracts, and gathering/marketing contracts. Stacking rigs and reducing production schedules may cause operators to default on such contracts, which often contain significant drilling commitments and supply volume requirements, along with stiff penalties for the breach thereof. Today’s volatile market conditions can make it difficult to choose whether to terminate or continue operating under such contracts without careful evaluation.

Operators should also re-familiarize themselves with the remedies available to them under joint operating agreements, like production revenue offsets, operator’s liens, and deemed non-consent. Non-operators may fail to pay their joint interest billing or cash-calls, and carrying those costs can put a lot of financial stress on the operator.

Exploration and production companies should also carefully review the lease maintenance provisions of their oil and gas leases. They may want to shut in certain wells to decrease production rates, which may or may not be authorized under the shut-in royalty clause. Many leases also contain drilling obligations, the breach of which can cause lease termination. Companies will have to grapple with deciding to spend capital to drill in a bad market or let their valuable leases expire. Likewise, lessors will have to determine whether to enforce such drilling obligations or renegotiate with their lessee in the hope of better market conditions in the future.

While the extent of COVID-19 remains unknown, it is certainly exacerbating existing problems within the Oil & Gas Industry and having adverse impact on revenue. Further, the decrease in prices is likely to make contract performance uneconomical in many cases. Proper preparation will enable prudent companies to navigate the downturn in the market.

If we can be of assistance in helping your company navigate any of these issues, please contact Israel R. Silvas at 214.698.7812 (ISilvas@Dykema.com), Brandon Durrett at 210.554.5276 (BDurrett@Dykema.com), Aaron Kaufman at 214.698.7821 (AKaufman@Dykema.com), or your Dykema relationship attorney.

As part of our service to you, we regularly compile short reports on new and interesting developments and the issues the developments raise. Please recognize that these reports do not constitute legal advice and that we do not attempt to cover all such developments. Rules of certain state supreme courts may consider this advertising and require us to advise you of such designation. Your comments are always welcome. © 2020 Dykema Gossett PLLC.