The fall in global oil prices since mid-2014 has put pressure on industry finances, encouraging companies to consider both acquisitions and asset divestitures. In joint venture arrangements, changes in the ownership of assets are often contractually subject to pre-emption clauses which grant other stakeholders, including governments, the right of refusal. Political and regulatory trends, relations between government and industry, and the characteristics of assets themselves are all key variables that can affect the exercise of pre-emption rights. Failure to thoroughly consider these political factors prior to an acquisition or divestiture may expose companies to the potential loss of strategic assets or new revenue streams, or incur unexpected legal costs and delays to projects.
Structural changes in the global oil market, including increasing competition from national oil companies (NOCs) and a near-halving of oil prices since mid-2014, have encouraged a number of international oil companies (IOCs) to consider selling assets in order to raise funds and reduce costs. In response to expectations that lower oil prices will persist, French oil giant Total confirmed in February that it would sell USD 5.5 bn worth of assets, and in March, US-based Chevron announced an increase in the value of assets it planned to sell to USD 15 bn by 2017, double the original amount. According to EY, the value of mergers and acquisitions in the sector rose by 69 percent in 2014 compared to the previous year, with a strong level of activity expected to continue in 2015.
The challenges companies have faced during this period of active deal making highlight the need to evaluate political, regulatory and legal risks that can emerge once an acquisition or divesture is made public. Provisions in some contracts that grant existing stakeholders first rights to any asset being transferred to new ownership can present an obstacle to deals, and have been highlighted by Royal Dutch Shell’s planned USD 70 bn acquisition of BG Group, announced in April. In a prospectus document outlining the deal, BG group warned that the possible exercise of pre-emption rights by its partners in existing joint ventures in Brazil, Tanzania, Kazakhstan and elsewhere, was an important consideration for the merger. These rights can be exercised by both private companies and governments, subjecting parties to politicised as well as financial decision-making processes. In May BG stated that the Kazakh government might make a claim to the company’s interest in the giant Karachaganak gas and condensate field in the event of a change in ownership. IOCs with a stake in the Kazakh field had already agreed to reduce their stakes in 2012 to accommodate the entry of the state-owned KazMunaiGas (KMG).
In the past decade, the growing role of governments as minority or majority partners in joint ventures through national oil companies and other parastatal organisations has afforded them greater opportunity to use their right of first refusal to increase their share in upstream, downstream and midstream projects. To date, instances in which governments have exercised their pre-emption rights have largely affected divestitures, but these are equally demonstrative of the exposure of acquisitions to politicised non-market variables and legal obstacles.
The Kazakh government’s exercise of pre-emption to block the transfer of a stake in the Kashagan field to an Indian company in 2012-2013 demonstrates how geo-political relations and government agendas can impact economic decision-making.
Discovered in 2000, Kazakhstan’s Kashagan oilfield was described as the largest find outside of the Middle East in three decades and was expected to provide transformative economic benefits for the country. However, technical challenges resulted in significant delays and tens of billions of dollars’ worth of cost overruns, increasing tensions between the Kazakh government and Western IOC stakeholders including Royal Dutch Shell, Eni, Total , ExxonMobil and ConocoPhillips. In 2008, the Kazakh government doubled its equity stake in Kashagan at the expense of other shareholders and renegotiated production sharing contracts, following more than a year of contentious talks and worsening relations between IOCs and authorities in Astana.
ConocoPhillips announced in 2012 that it had reached a deal to sell its 8.4 percent stake in Kashagan to India’s ONGC Videsh for USD 5 bn as part of a wider realignment of the company’s operations. However, the government exercised its pre-emption rights to block the deal and Conoco’s share in Kashagan was initially transferred to state-run KMG, before being sold to China National Petroleum Co (CNPC) in 2013 for the same price.
The deal reflected deepening political and economic ties between Astana and Beijing. Prior to the Kashagan deal, China had already emerged as a major investor in the Kazakh oil sector and the wider economy, with Chinese President Xi Jinping agreeing to USD 30 bn in investments during a 2013 visit to Kazakhstan.
The state-owned Nigerian National Petroleum Corporation’s (NNPC) failed attempt to block the transfer of a minority interest in the Eastern Niger Delta’s onshore OML 25 block highlights concerns about the opaque politicisation of the pre-emption process, and the legal disputes and delays to investments this can create.
Despite Nigeria’s vast oil resources, regulatory uncertainty – stemming in part from the long-delayed Petroleum Industry Bill – and challenges tied to security, corruption, aging infrastructure and oil theft, are among the factors that have led a number of Western IOCs to reduce their exposure to the country. In 2014, Nigeria-based Crestar led a consortium of local companies that submitted the winning bid for a 45 percent interest in the OML 25 block being sold by a joint venture of Shell, Total, and AGIP, in partnership with NNPC. In October of that year, seven months after the deal had been announced, NNPC unexpectedly announced it planned to exercise its pre-emption rights to acquire the block. OML 25 was the only one of four blocks being sold off by Shell at the time to be targeted by the state oil company NNPC, and it was the first time since Shell began its onshore divestment programme in 2010 that the NOC attempted to block a sale.
According to press reports, Petroleum Minister Diezani Allison-Madueke ordered NNPC to take action because Crestar’s chairman, Osten Olorunsola, was a former senior petroleum ministry official whom she dismissed in June 2013. The attempted intervention ultimately collapsed because Nigerian officials lacked the financial resources to match the consortium’s USD 435 mn winning bid. A federal court ruled in March 2015 that the government’s pre-emption rights had expired months before NNPC attempted to intervene.
Although the dispute was eventually resolved in Crestar’s favour, the legal proceedings generated months of uncertainty and a court initially blocked the transfer of the assets in question. Crestar and its partners had already deposited 100 percent of the purchase price in an escrow account in anticipation of completing the deal.
Understanding a country’s previous efforts to exercise its pre-emption rights or to increase state participation in the sector can also help investors understand potential political risk exposure. Prior to the OML25 dispute, in June 2011, NNPC announced that one of its subsidiaries would assume operatorship of several onshore blocks that Shell, Total and Eni were divesting from. The development was not intended to affect the then-ongoing sale of OMLs 30, 34, 40 and 42, but according to press reports the companies that were due to acquire the blocks bid on the assumption that they would secure operatorship. The bidding companies were concerned by NNPC’s action, which would grant the state-run firm greater responsibility over operational management and oversight. However, the move was consistent with plans for NNPC to increase output under its control and develop the capacity to eventually compete with privately held companies for acreage, something that remains significant amid ongoing reviews of the Petroleum Industry Bill and NNPC’s role in Nigeria.
The failed attempt by two Chinese companies to acquire a share in an Angolan oilfield in 2009 was tied to broader concerns within government over Beijing’s growing business presence in the country. Angola’s exercise of its pre-emption rights is further evidence of the need to consider the wider geopolitical relationship between the countries involved, and the importance of domestic political dynamics and perceptions towards foreign investment.
Angola’s offshore and deepwater fields have attracted major investment from IOCs and NOCs. In 2009 US-based IOC Marathon reached an agreement to sell a 20 percent interest in the unexplored offshore Block 32 to two Chinese companies, China Petroleum & Chemical Corporation (Sinopec) and China National Offshore Oil Corporation (CNOOC). However, Angola’s national oil company Sonangol announced it would exercise its right of first refusal to block the deal and purchase the stake for the same USD 1.3 bn price. Chinese negotiators allegedly intervened to press Angola not to prevent the transfer, but unconfirmed reports suggested that Luanda blocked the deal amid concern over Beijing’s growing economic influence in the country.
Sonangol did not offer a full account of its decision, but there were widespread reports of growing frustration in Luanda over Chinese commercial practices, including the use of Chinese workers instead of locals. Angolan officials were reportedly still resentful of Sinopec’s 2007 decision to pull out of a joint venture with Sonangol to construct a major refinery, a key priority of the government at the time. There was also reports of growing unease over issues not directly tied to the energy sector, including allegedly poor quality roads built by Chinese firms and the terms of Chinese loans.
Angola’s decision to block the sale illustrates the importance of understanding local sentiment surrounding an investor’s home country. The vast potential of China’s market and its large pre-existing footprint in Angola failed to outweigh local concerns regarding diversification, concerns that were exacerbated by negative perceptions surrounding the performance of other Chinese investments in the country. The Angolan government’s decision also highlights the importance of an understanding of the broader strategic priorities of the government, which had seemingly become increasingly uneasy over growing Chinese investment.
The threat of pre-emption often materialises late in the deal cycle and can result in prolonged uncertainty and delay as legal and bureaucratic procedures run their course. Although governments typically meet the winning bid price, the uncertainty itself can have negative financial implications for all parties involved. If governments are successful in acquiring all or part of the assets in question, bidders can lose out on strategic assets that may have formed an essential part of wider corporate strategy, particularly in the case of acquisitions. The loss of proven and even potential revenues from underexplored blocks can have serious financial implications for companies attempting to acquire new assets. Pre-emption can also serve to reinforce negative perceptions about the regulatory environment in a given country, and undermine wider investor appetite.
- Wider political, legal and regulatory trends
Governments that have a recent history of expropriation or have adopted resource nationalist policies will be more likely to exercise pre-emption rights. Any precedent of violating contract sanctity elsewhere in the extractive sector, or in other key industries involving foreign participation, would also indicate higher risk. For example, in May 2015 the government in Indonesia approved legislation that allows state oil company Pertamina to acquire stakes in expiring concessions, increasing uncertainty among upstream investors. The development reinforced a broader resource nationalist trend which has seen Indonesian authorities clash with miners over export controls and taxes, as well as introducing more stringent local content obligations. Regimes that are under growing internal and external pressure to boost local participation in the industry and maximise domestic benefits are more likely to see pre-emption as a useful tool in meeting these pressures.
- Government relations
Ownership and control over oil and gas rights is often a politically sensitive national issue. Pre-emption is more likely when governments view assets in the context of broader geopolitical strategy. This can involve transferring ownership of assets to a foreign party as part of a wider political engagement strategy or preventing mergers or acquisitions in response to bilateral tensions. Abu Dhabi confirmed in April 2015 that it granted Japan’s Inpex a stake in a major onshore oil field that produces 1.6 mn barrels of crude per day. The decision was seen in the context of a larger strategy by Abu Dhabi to increase the presence of Asian players in the oil sector, given that they now represent the country’s largest customers.
- Relations between government and industry
Poor relations between the government and asset owners or venture partners will fuel distrust and increase the prospects of intervention or exercise of pre-emption rights.
- Asset characteristics
The financial and technical requirements of the assets themselves are also important considerations. If state-owned oil companies lack the capacity to develop or maintain assets independently, their ability to secure financing or partner with technically competent firms will influence government interest in stakes being divested.