Editor: Please tell our readers about your respective practices.
McLaurin: I began practicing law in the mid-1970s and have witnessed the ups and downs of the oil and gas industry. I focus primarily on M&A transactions and financing in the energy sector and on joint ventures where companies partner up to develop a particular field or area. I am board certified in oil, gas and mineral law in the state of Texas and resident in Jones Day's Dallas office. A big plus for me in my practice has been the opportunity to work with colleagues across the Firm - Jones Day's culture really is One Firm Worldwide.
Vallee: I am a partner in Jones Day's Houston office, and my practice is best described as an energy M&A practice. I represent energy clients and private equity sponsors in mergers and acquisitions, joint ventures and corporate governance matters in most sectors of the energy industry, but primarily in upstream and midstream oil and gas transactions. I'm a child of the Texas oil industry: growing up, my family had a trucking company based in Beaumont, Texas that predominantly serviced the oil and gas industry throughout Texas.
Editor: How large a percentage of the state's GNP do oil and gas comprise?
McLaurin: The projection for 2010 is about 11 percent while manufacturing is another 12.25 percent, which I mention because there is frequently a relationship between the oil and gas industry and manufacturing.
Vallee: People may be surprised to learn that the Texas economy is quite diverse, even in Houston, where energy is still "the business." In Houston, vibrant healthcare, shipping and aerospace industries are all important contributors to the Texas and national economies. However, there are three major areas where energy companies are located in Houston: downtown, the "Energy Corridor" in West Houston and in The Woodlands; so, you don't often forget the importance of the energy industry in Texas.
Editor: Kathleen, please tell our readers about some of your recent engagements.
McLaurin: This year has been interesting because, among other things, we've signed up another deal in the Permian Basin, which a few years ago was thought to be a reservoir that had seen its peak. The historic Permian is not shale, but part of the formation is shale, and thanks to advances in technology, people are taking a second look. It is a very hot play right now, as is the Eagle Ford Shale in south Texas.
Editor: Is this owing to the use of horizontal drilling?
McLaurin: Somewhat, yes. In addition, both the Permian and the Eagle Ford Shale contain "oily" shale. These days most companies would like to have more oil and less gas in their portfolios, because gas prices have been very depressed since the crash. The Eagle Ford Shale starts at the Rio Grande and continues on a northwest diagonal. West of a certain line up that diagonal is more oil; most of that sweet spot has already been leased.
Editor: Jimmy, you have had an outstanding record of M&A deals in the energy industry. Would you tell our readers about one such deal?
Vallee: Thank you. One of the more notable transactions that I was recently involved in was an upstream joint venture between Atlas Energy and India's largest company, Reliance Industries, in which Atlas sold Reliance a 40 percent, undivided interest in approximately 300,000 acres of its Marcellus Shale acreage. Atlas received approximately $340 million in cash and a seven-and-a-half-year drilling carry valued at approximately $1.4 billion. At the time, this transaction represented the highest per acre value of any transaction done in the Marcellus, eclipsing a previous large deal between Anadarko and Mitsui. I believe this transaction to be a real "win-win" for both parties, as the deal significantly advanced Atlas's drilling program in the Marcellus and provided Reliance with an excellent "jumping off" point for its U.S. energy investment program. It was also a transaction that really showed the strengths of Jones Day, as we had a buyer based in India, U.K. law issues, oil and gas properties located in Pennsylvania and the need for sophisticated, energy M&A lawyers - so, lawyers from our New Delhi, London, Pittsburgh and both Texas offices all played key roles in the transaction.
Editor: The Marcellus field is a remarkable field in terms of its breadth and depth, isn't it?
Vallee: Yes, absolutely. It's essentially a super-major gas field, with some estimates stating that there is a quadrillion cubic feet of natural gas there. Kathleen mentioned how there have recently been significant advances in technology, especially in horizontal drilling. These advances have made shale plays, such as the Marcellus, economically viable and led to a modern-day land rush for acreage. Everybody has known for years that the Marcellus was there, but the technology did not exist until recently to economically develop these unconventional gas resources.
McLaurin: I should add that what makes the Marcellus particularly attractive despite the topographical and weather-related challenges is that Appalachian gas has historically traded for more because it's closer to the large markets, so transportation costs are reduced.
Vallee: Very good point. For much of the first half of my career, we were trying to figure out how to site LNG terminals in that the Northeast United States or build additional pipeline capacity to carry gas from the Texas and Louisiana markets to the Northeast. To have such a large source of natural gas so close is really a dream come true for people in the Northeast.
Editor: It seems we are on the cusp of realizing all the potential there is in shale in this country.
Vallee: I think so, too. As Kathleen mentioned earlier, the Texas plays that are taking off are the "oily" plays. But, as natural gas prices improve, more shale development will occur all around the country. And, the United States does not have a monopoly on shale - there are shale plays all over the world. As we gain experience in the development of unconventional gas resources, we will see many similar types of plays in other parts of the world.
McLaurin: In the U.S. alone we have the Barnett, the Haynesville, the Bakken (in the Dakotas), the Marcellus, the Eagle Ford and the Fayette. All of those have come online within the last ten years - the Eagle Ford just in the last two. An in-house oil company friend of mine told me several years ago that working in shale is not a geology play: it is an engineering play. With every well, companies get better at increasing production. Jimmy is right: people have long known that the shale was there. What's changed is the efficiency of our extraction methods. As our knowledge improves, so, too, will the profitability and viability of shale as a source.
Editor: One of the downsides of shale is the controversy over what effect it may have on groundwater.
McLaurin: The Safe Drinking Water Act has an exemption for frac water, but at the moment there is proposed legislation in Congress to remove that exemption. The bills are still in committee, and I believe the accidents that have occurred in the Marcellus will likely result in increased regulation in this area.
But, we should keep in mind that the water we are talking about is thousands of feet below groundwater, and that it is already briney and full of heavy metals, even before the arrival of any frac. There is no doubt the stuff that is coming up with the production must be handled correctly. We have not had in this region the accidents that have occurred elsewhere.
Editor: Have you experienced much activity with energy-related partnerships in terms of their purchases of other firms and raising capital or other of their activities, and how has this business been affected by the recent downturn?
Vallee: Jones Day has been involved in all aspects of master limited partnerships (MLPs), including formation, capital raising and mergers and acquisitions. MLP activity peaked in mid-2007, prior to the crash. For the past few years, MLPs have been active in stabilizing their balance sheets, and many MLPs became sellers during that time. But, I think we are starting to turn a corner. Capital raising has increased, and I believe we will soon see more buyers out there. Private equity has certainly come on strong in the energy sector in a way we haven't previously seen them involved.
Editor: Have the tax advantages of MLPs disappeared with the downturn?
Vallee: It is a trade-off. You have the tax benefit of being able to distribute capital more tax efficiently to your owners - but there is also the flip side, which is that you are required to distribute all "available cash" to your owners! And, in some cases, especially for upstream MLPs, this can be detrimental because it may be more advantageous for companies to redeploy that capital in their drilling programs rather than distribute it to equity holders.
McLaurin: Yes, if you have to distribute out all of your cash and the capital markets are frozen, you've got problems. That said, at the same time, we are seeing a lot of activity with other types of partnerships, such as joint ventures.
Editor: Please discuss the SEC's new disclosure rules regarding proven developed and proven undeveloped reserves.
McLaurin: The SEC is allowing companies to disclose a broader and less certain category of reserves thereby increasing their asset base, allowing them ultimately to report more reserves.
Vallee: In talking with our clients, I've found that many of them do not seem to be taking advantage of these new rules as aggressively as they could. There is still uncertainty about how the rules will be applied, and so many are still taking a conservative approach and disclosing reserves exactly the way they did before the changes in the SEC disclosure rules.
McLaurin: When a company is selling assets, it will include a "3P" report: proved, probable and possible reserves. In the last year, I have seen cases in which the seller includes undeveloped resources - acreage that no reservoir engineer is willing to credit with anything, but for which the seller is trying to get some value and credit. When you are doing an M&A deal, especially an asset deal, youwill see people push aggressively to get value for their reserves.
Editor: Do you believe that the U.S. needs a national energy policy which would cover wind power, solar energy and possibly a national grid?
Vallee: I think we do need a national energy policy that focuses on domestic natural gas. That is the one energy source that we seem to have abundantly in the United States. We need to take advantage of natural gas as a key energy source in the short term to bridge us to the future, where I think all forms of energy have a role to play in supplying our nation's energy demand.
McLaurin: I, too, believe we need a national energy policy in order to reduce our reliance on foreign sources of oil. Electric utilities all across this country are sitting on aging generation plants, but it is difficult to make a decision to invest a lot of capital until we figure out what exactly as a country we are going to do. For example, I don't believe there has been a nuclear generation facility built in this country since the 1970s. But, without some idea of how we are going to reward people for making investments in alternative or renewable energy, it is hard to make a business decision to work in a new direction.
Published August 30, 2010.
