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Oil and Gas Transactions: Market Trends 2021/Q1 2022

July 06, 2022

By: Justin F. Hoffman and Thomas Blackwell BAKER BOTTS L.L.P.

This article discusses market trends in oil and gas transactions from 2021 through the first quarter of 2022, including (1) notable transactions; (2) deal trends with respect to capital markets, mergers, and acquisitions (M&A), and master limited partnerships (MLPs); (3) disclosure trends; (4) legal and regulatory trends; and (5) an outlook for oil and gas transactions going forward.

Overview

Deal activity increased in 2021 as widely available vaccines allowed for the loosening of travel restrictions and contributed to a rebound in demand, leaving industry professionals relatively optimistic heading into 2022. Production had declined substantially in 2020 following underinvestment in the oil and gas industry that commenced in 2019 and accelerated with the price collapse caused by the COVID-19 pandemic. However, as economic activity returned, production was unable to keep pace with demand as oil prices strengthened throughout 2021. At the same time, upstream oil and gas companies continued to emphasize return of capital and free cash flow generation in response to investor demands for fiscal discipline overgrowth, resulting in nearly flat production growth into 2022. Meanwhile, under pressure from investors focused on the effects of climate change, energy capital investment remained largely focused on investments in the energy transition. M&A in the upstream sector in 2021 was characterized by multibillion-dollar, low-premium consolidations of public companies.

With a backdrop of rising demand and global inflationary pressures, the March 2022 Russian invasion of Ukraine drove global oil prices up to levels not seen since 2008, though prices backed off from those highs in the following weeks. On the natural gas side, the Ukraine situation and Western Europe’s reliance on Russian gas are expected to create continued demand for exports of U.S. liquefied natural gas to Western Europe. Despite the rising demand and recent increase in prices, the likelihood of sustained increased U.S. production remains unclear due to numerous factors, including shareholder focus on low leverage, free cash flow and return of capital, permitting and regulatory pressures, and tightness in the services markets, as well as availability and costs of debt and equity capital.

Some of the key federal regulatory changes potentially impacting investment in energy infrastructure in the United States include (1) rollbacks of Trump-era rules that narrowed the application of various provisions of the Clean Water Act; (2) the proposed restoration of several provisions of the National Environmental Policy Act (NEPA) that would grant federal agencies greater discretion in developing project alternatives, restore federal agency discretion to adopt NEPA procedures that are more stringent than the Council on Environmental Quality’s regulations, and require agencies to consider direct, indirect, and cumulative effects of major federal actions; and (3) proposed rules that would rescind Trump-era changes to the Migratory Bird Treaty Act and the Endangered Species Act. More broadly, the Biden Administration rejoined the United States into the Paris Climate Accord and pledged to make the federal government carbon-neutral by 2050.

Notable Transactions

M&A

Coterra’s $17 Billion Acquisition of Cimarex Energy Co.

On March 24, 2021, Coterra Energy Inc. (formerly known as Cabot Oil and Gas Corporation) and Cimarex Energy Inc. announced an agreement to combine in an all-stock merger of equals transaction valued at roughly $17 billion. The transaction involved a complementary combination of oil and gas assets across basins and is expected to provide greater stability of free cash flow and return of capital to shareholders. Following closing, Coterra became only the second oil and gas company to announce a variable dividend on top of its regular quarterly dividend, after Pioneer Natural Resources Company did so earlier in 2021. The transaction closed on October 1, 2021.

Conoco Phillips’ $9.5 Billion Acquisition of Royal Dutch Shell PLC’s Permian Assets

On September 20, 2021, Conoco Phillips announced an agreement to acquire Royal Dutch Shell PLC’s Permian assets in a transaction valued at roughly $9.5 billion. The transaction marked a noteworthy withdrawal of Shell from the Permian Basin and Texas overall, as the company focuses its energy on investment in greener assets. Shell announced that it intended to return most of the proceeds from the sale to shareholders in the form of approximately $7 billion in share buybacks. The transaction closed on December 1, 2021.

Pioneer Natural Resources $6.4 Billion Acquisition of DoublePoint Energy

On April 1, 2021, Pioneer Natural Resources Company announced it would acquire all outstanding shares of DoublePoint Energy Inc. in a mixed cash and stock transaction valued at approximately $6.4 billion.

Pioneer issued around 27.2 million of its shares and $1 billion in cash to DoublePoint’s shareholders and assumed roughly $900 million of DoublePoint’s debt and liabilities. The transaction closed on May 4, 2021.

EQT’s $2.9 Billion Acquisition of Alta Upstream and Midstream Assets

On May 6, 2021, EQT announced it would acquire all the membership interests in Alta Resources Development LLC’s upstream and midstream subsidiaries in a mixed cash and stock transaction for $2.9 billion. EQT gained 300,000 acres in the Marcellus currently producing one Bcf/d of dry gas, along with associated pipeline assets. The acquisition closed July 21, 2021.

Southwestern Energy’s $2.7 Billion Acquisition of Indigo Natural Resources

On June 2, 2017, Southwestern Energy Company (SWN) announced it would acquire Indigo Natural Resources LLC for $2.7 billion. The purchase price consisted of cash, stock, and the assumption of $700 million in liabilities. SWN gained more than 1,000 locations from the acquisition, which closed on December 31, 2021.

Chesapeake’s $2.2 Billion Acquisition of Vine Energy

On August 11, 2021, Chesapeake Energy Corporation announced it would acquire Vine Energy Inc. in a mixed stock and cash transaction valued at $2.2 billion. Notably, the acquisition was a zero-premium transaction despite being announced less than six months after Vine became the only oil and gas company to successfully launch an IPO in 2021. The transaction closed on November 1, 2021.

Chevron’s $1.32 Billion Acquisition of Noble Midstream

On March 5, 2021, Chevron Corporation announced it would acquire the remaining publicly held shares of Noble Midstream Partners LP in an all-stock transaction valued at $1.32 billion. The acquisition offered Chevron, which already owned 63% of the outstanding shares of Noble Midstream, access to shale assets in the Permian Basin and natural gas fields in the Mediterranean Sea. The transaction closed on May 11, 2021.

BP’s $723 Million Acquisition of BPMP

On December 20, 2021, BP p.l.c. announced it would acquire all outstanding public common units of BP Midstream Partners LP in an all-stock transaction valued at $723 million. The acquisition complemented BP’s efforts to become an integrated company by deepening BP’s interests in midstream assets that support integration and optimization of its fuels value chain in the United States. The transaction closed on April 5, 2022.

Deal Trends

Capital Markets

The traditional public equity capital markets remained challenging for new issuances and are unlikely to be significant sources of funding in 2022 despite the rise in commodity prices, as investors focus more on environmental, social, and governance (ESG) issues and return of capital. Blackstone-backed Vine Energy Inc. went public in March 2021 but was subsequently acquired by Chesapeake Energy Corporation in a mixed stock and cash transaction only a few months later. There remain pockets of potential investments in renewable-based fuel projects that could provide an avenue for some energy capital investment in 2022, including in collaboration with traditional energy companies.

Green bonds, green bond funds such as the PIMCO Climate Bond Fund, and other debt instruments linked to sustainability initiatives are increasingly becoming popular ways for investors to align their portfolios with internationally recognized sustainability goals. Such debt instruments are devoted to financing new and existing projects or activities directly linked to positive environmental impacts such as renewable energy, clean transportation, green buildings, wastewater management, and climate change adaption. In June 2021, Enbridge Inc. became the first company in the midstream sector to issue green bonds in North America. The bonds, which include a step-up should Enbridge fail to meet its ESG targets, priced at least five basis points below the company’s regular debt.1 While an estimated $859 billion of green bonds were issued in 2021,2 the overall market size could eclipse $1 trillion by the end of 2022 as larger institutions and sovereigns enter the market.

While economic and political uncertainties and increasing ESG concerns are expected to continue to drive market challenges in 2022, opportunities will exist for companies that demonstrate the most sustainable strategies for profitable growth. The drive away from growth-oriented models will continue to enhance investment in service technologies to drive further cost savings. In March 2022, the Securities and Exchange Commission (SEC) proposed a set of rules that would require a wide range of detailed climate-related disclosures for domestic and foreign registrants. For additional information on these proposed rules, see Disclosure Trends below.

Oil prices benefitted from the 2021 rebound, with WTI Crude hitting over $60 per barrel by March of 2021 and a peak of $85.15 per barrel in November, ending the year at $75.21. The price of WTI Crude surged past $100 per barrel in March of 2022 to a high of $119 per barrel following the Russian invasion of Ukraine before moderating slightly in the following weeks. The price of crude oil had remained suppressed since 2014, resulting in capital markets activity for most operators shifting away from traditional IPOs and unsecured debt issuances towards direct investment, hybrid and secured debt offerings, and liability management transactions. Additionally, many operators continue to rely on internally generated cash flows to fund capital expenditures. In lieu of traditional underwritten public or private offerings of equity and unsecured debt, oil and gas issuers have turned to debt exchanges, secured bond deals, private and/or secured convertible note offerings, institutional term loans, and investment by private equity investors to raise capital and manage upcoming maturities.

The high-yield debt markets continue to present difficulties for more speculative energy credits, especially in the new issue market. Depressed interest rates as a result of the Federal Reserve’s policy in 2021 have led to low-yield overall in the debt market, making high-yield in the upstream particularly unattractive to investors given the recent default profiles. Most high-yield transactions are being used to refinance existing debt. However, rising interest rates and increased demand for oil and gas in 2022 may drive some additional appetite for energy-related debt in the near term, but uncertainties caused by geopolitical events and concerns about the overall economy’s strength have presented material uncertainty in the capital markets due to lack of clarity on which direction commodity prices are headed. Fitch issued a neutral sector rating for North American Oil and Gas in December 2021, reflecting the expectation of continued capital discipline, moderate growth, and focus on free cash flow.

In the bank markets, lenders continued to tighten the terms of reserve-based lending facilities and reduced the borrowing base of some companies by double-digit percentages in what amounted to be a contentious year for redeterminations. Several prominent U.S. banks continue to shy away from fossil fuel projects and have publicly announced their opposition to financing new projects as pressure from activists and institutional investors increased.

M&A

M&A in the upstream sector in 2021 was characterized by multibillion- dollar, low-premium consolidations of gas-focused public companies. Many legacy oil and gas companies remain focused on opportunities to lower carbon output through divestment and/or acquisition of lower-emissions assets, and emerging reporting and disclosure standards for ESG continue to be a focus.

As discussed above in Notable Transactions, the majority of 2021’s marquee deals involved further acreage consolidations in the Permian Basin. These large deals were generally characterized by all-stock consideration, moderate premiums, and competitive geographic and structural synergies. The largest deal, Royal Dutch Shell PLC’s sale of its Permian Basin assets to Conoco Phillips, represented nearly double the value of British Petroleum’s sale of its Alaska upstream assets in 2020. The trend of consolidation activity—as upstream companies search for scale to protect against prolonged lower commodity prices and continued demand uncertainty—is expected to continue.

MLPs

Since the 2014 oil price decline, MLPs have not been able to sustain a full recovery and the access to equity capital markets for such issuers has largely dried up. MLPs have also suffered from investors’ move to index funds, most of which cannot hold partnership interests. This has led to an increased cost of capital for MLPs and a shift from external equity capital toward more internal financing for growth capital expenditures. MLPs’ incentive distribution rights, which represent the sponsor’s right to an increasing share of the MLP’s distributions as certain distribution targets to the common unitholders are met, have also weighed on the cost of capital for MLPs, especially for MLPs making distributions at the upper end of such targets (known as being in the high splits).

These factors were exacerbated by tax reform that lowered the corporate tax rate in December 2017, and by a Federal Energy Regulatory Commission (FERC) ruling in March 2018 that raised concerns about the ability of some pipeline MLPs to consider unitholder taxes in determining the rates chargeable to certain customers (discussed further in FERC and Pipeline Tariffs under Legal and Regulatory Trends below). 

These changes have spurred numerous MLPs to complete simplification transactions. These simplification transactions have included, among others, the elimination of the incentive distribution rights in exchange for common units, third-party buyouts, the rollup of the MLP back into the corporate sponsor, and electing to be taxed as a C corporation.

Disclosure Trends

Hydraulic Fracturing and Climate Change

Environmental and regulatory disclosure has become increasingly important for oil and gas companies. For example, with the heightened focus on hydraulic fracturing and increased earthquake activity in certain areas, issuers’ disclosure in the business section and in the risk factors of their securities offering documents and reports filed with the SEC has become more detailed regarding restraints or potential restraints to operations that could be imposed upon such companies by federal and state governmental bodies.

Climate change has also become a hot-button issue and many oil and gas companies have started to pay close attention to how the risks and opportunities associated with climate change may affect their disclosure. In 2010, the SEC issued interpretive guidance on how climate change may impact an issuer’s risk-related disclosures. The SEC’s interpretive guidance focused on four areas where climate change may impact such disclosure:

  • The impact of developments in legislation and regulation concerning climate change, including greenhouse gas emissions laws and cap and trade systems
  • The impact of treaties and national accords relating to climate change
  • The indirect risks associated with climate change regulation and business trends with respect to climate change, including changes in consumer demand away from products that result in significant greenhouse gasses, increased demand for alternative sources of energy, and the reputational effects an issuer may face related to the public’s perception of its greenhouse gas emissions
  • The physical impacts of climate change, including the effects on the severity of weather, the arability of farmland, and the availability and quality of water, and how such effects may affect the issuer’s operations and results

In 2021, the SEC responded to increasing investor demand for climate and other ESG information from public companies with its announcement and implementation of an all-agency approach. SEC’s ultimate objective is to update the 2010 guidance to account for post-2010 developments and put in place a comprehensive climate-related disclosure framework that will result in disclosures that are consistent, comparable, and reliable. A formal rule proposal on climate-related disclosures was released on March 21, 2022.3

The proposed rules mandate a wide range of disclosures, including (1) oversight and governance of climate-related risk; (2) how the company identifies climate-related risks; (3) how those risks have materially impacted or are likely to materially impact its business and financial statements in the short-, medium-, and long-term; (4) how those risks have affected or are likely to affect the company’s strategy, business model, and outlook; (5) the company’s process for identifying, assessing, and managing the climate-related risks and whether (and how) those processes are integrated into overall risk management systems; and (6) if applicable, information regarding the role of carbon offsets or renewable energy certificates and the use of an internal price on carbon and scenario analysis in a company’s climate-related business strategy.

Many companies in the oil and gas sector are affected by climate change legislation, regulation, policies, or impacts and have begun to regularly assess how the foregoing areas impact their business to determine if any climate change-related risk factors or other disclosure are needed. Recently, several major oil and gas companies have begun to follow the recommendations of the Financial Stability Board Task Force on Climate-Related Financial Disclosures (TCFD), with the issuance of more detailed disclosures and reports regarding potential long-term climate change impacts and emissions reduction impacts and analyses. The TCFD recommendations for climate change disclosures focus on governance, strategy, risk management, and metrics and targets used to assess climate-related risks.

Proved Undeveloped Reserves (PUDs)

An item that has received a renewed focus by the SEC in recent years is disclosure of PUDs. The SEC has frequently issued comments with respect to an issuer’s disclosure of PUDs and specifically with respect to how such issuer’s development plan provides for the required development of PUDs within five years of booking, known as the five-year rule. In a low oil and gas price environment, especially with many oil and gas companies facing liquidity constraints, the five-year rule for booking PUDs often results in a reduction in the amount of PUDs disclosed as companies no longer have the necessary liquidity to drill or it is less economic to drill at the same rate as in higher price environments. Prior to the recovery of oil prices in 2021, the sustained lower price environment had forced some issuers to remove disclosure of PUDs altogether due to significant reductions in their capital spending plan. Recently, however, many producers have tapped their PUDs to take advantage of higher prices, leading to a reduction in PUD inventory.

Another emerging issue, especially in the Permian Basin, that may affect the PUD disclosure of shale companies is the so-called parent-child well problem. Shale producers who initially touted the tighter spacing of wells (e.g., drilling wells in closer proximity to each other) as a method of increasing the overall amount extracted from a reservoir are now finding that new wells drilled closer to older wells generally produce less oil and gas than the older wells and often also interfere with their output. Similarly, producers have touted multiple layers of productive formations that are in some cases turning out to be depleted by production from shallower zones. This has led several shale producers to discuss up-spacing, reducing the number of production zones, and reducing the total number of their drilling locations as the best way to maximize a well’s value, even if it means decreasing the overall amount produced. Parent-child well problems have forced some shale producers to write down their PUDs.

Legal and Regulatory Trends

Hydraulic Fracturing

When it comes to regulatory trends in the energy industry, no two areas of interest have drawn more attention in recent years than hydraulic fracturing and climate change. The shift to more unconventional drilling techniques continues to create new regulatory and environmental issues as laws adapt to the new drilling environment.

With respect to hydraulic fracturing, the U.S. government and various states and local governments have moved towards regulating, and in some cases restricting, hydraulic fracturing activity. New York, Maryland, Vermont, and Washington have all banned hydraulic fracturing. In November 2018, Coloradoans voted down a ballot initiative that would have banned new oil and gas drilling within 2,500 feet of homes, businesses, and certain green spaces, a move that would have made much of the state off-limits to drilling. Although the 2018 initiative was defeated, similar ballot initiatives have recently been circulated by interested groups for potential consideration in upcoming elections. In April 2019, the Colorado General Assembly changed the mandate of the Colorado Oil and Gas Conservation Commission from fostering oil and gas development to regulating oil and gas development in a reasonable manner to protect public health and the environment.4 In response, the Colorado Oil and Gas Conservation Commission modified its rules to address the requirements of the legislation, adopting increased setback requirements, provisions for assessing alternative sites for well pads to minimize environmental impacts, and consideration to cumulative impacts, among other provisions. The new law also allows local governments to impose more restrictive requirements on oil and gas operations than those issued by the state.

Another prominent trend at the state regulatory level has been the movement to require oil and gas companies to publicly disclose the chemicals used in hydraulic fracturing fluids. The majority of oil- and gas-producing states (including Wyoming, Colorado, California, Arkansas, Michigan, Texas, West Virginia, Pennsylvania, and Montana) have passed laws requiring disclosure of the chemicals in these fluids. Additionally, there has been recent focus on a possible connection between hydraulic fracturing-related activities, particularly the underground injection of wastewater into disposal wells, and the increased occurrence of seismic activities. When caused by human activity, such events are called induced seismicity. Some states, such as Oklahoma, have begun to regulate and limit disposal activity as well as hydraulic fracturing in certain areas that are seeing increased seismic activity.

Climate Change

On the issue of climate change, the U.S. Environmental Protection Agency (EPA) has focused in the past on regulating methane emissions in the oil and gas sector. In May 2016, EPA issued new emissions standards that aimed to reduce methane and other emissions from new or modified oil and gas sources, whether through capturing emissions from compressors and pneumatic pumps or through requiring periodic surveys to identify any other fugitive emissions sources. In September 2020, EPA reconsidered and amended aspects of the regulations, including the fugitive emissions requirements. However, in January 2021, President Biden issued an executive order directing EPA to suspend, revise, or rescind the amendments by September 2021 and to consider proposing new regulations to establish comprehensive performance standards and emission guidelines for methane emissions from existing operations in the oil and gas sector by the same date. The EPA released a proposed rule on November 2, 2021, to impose additional restrictions on emissions of methane, or natural gas, from new and existing facilities owned by companies in the production, gathering, processing, transmission, and storage segments of the oil and gas sector.

Additionally, although the SEC has not adopted any new ESG disclosure rules or reporting standards since first providing interpretive guidance on the subject in 2010, it is facing pressure from investors and legislators to do so. In October 2018, institutional investors representing over $5 trillion in assets petitioned the SEC to require standardized disclosure by public companies of the ESG factors that impact their businesses. In July 2019, the U.S. House of Representatives’ Financial Services Committee rejected a bill that would have required climate change risk factor disclosures along with other ESG reporting standards found in Europe. In 2021, acting SEC Chair Lee issued a statement directing the Commission’s Division of Corporation Finance to enhance its focus on climate-related disclosure in public company filings, representing the first significant step toward enhanced climate-related disclosure since 2010.

On March 21, 2022, the SEC voted to propose new rules entitled “Enhancement and Standardization of Climate-Related Disclosures for Investors,” which would, for the first time, require registrants to include climate-related disclosures in their registration statements and periodic reports. According to the SEC, the proposed rules are designed to increase transparency and accountability around climate-related risks, and would require public disclosure of climate-related risks and their actual or likely material impacts on business, strategy, and outlook; governance of climate-related risks and relevant risk management processes; direct and indirect greenhouse gas emissions, which, for accelerated and large accelerated filers and with respect to certain emissions, would be subject to assurance; information about climate-related targets, goals, and transition plans, if any; and impacts of climate-related events (e.g., severe weather events and other natural conditions) and transition activities on financial statements. The proposal was subject to a public comment period through May 2022, after which the rule is expected to be finalized before the end of 2022.5

Even without formal disclosure requirements, many issuers are beginning to voluntarily provide ESG information. See Disclosure Trends above for further discussion of the areas that the SEC informed companies they should focus on with respect to climate change.

Pipe Opposition

Over the past several years, there has been a growing opposition towards the use of pipelines. While protests over the Dakota Access Pipeline and the Keystone XL Pipeline gained national attention and have become hot-button political issues, the opposition to pipelines has spread beyond environmental activist groups. Calls from activist investors have led several large banks to announce that they would sell off their stakes in loans funding certain controversial pipelines. In February 2020, the Supreme Court heard oral arguments in Atlantic Coast Pipeline LLC v. Cowpasture River Preservation Association6 concerning the $8 billion pipeline that, if built, would have transported over a billion cubic feet of gas per day from West Virginia to North Carolina. However, due to the protracted legal conflicts, Dominion Energy and Duke Energy announced the abandonment of the $8 billion Atlantic Coast Pipeline project in July 2020. President Biden also issued an executive order revoking the permit granted to TC Energy Corporation for the Keystone XL Pipeline. Most recently, the U.S. Court of Appeals for the Fourth Circuit invalidated a permit issued by the Fish and Wildlife Service for the $6.2 billion Mountain Valley Pipeline, a 300-mile project to link the Marcellus and Utica shale formations to markets in the Mid-Atlantic and Southeast.7

New rules were issued and proposed to address safety and environmental issues concerning the midstream industry. On February 17, 2022, the FERC issued a revised policy statement on the certification of the construction of new interstate natural gas transportation facilities. The policy statement sets forth the factors that the FERC considers in determining whether to issue a certificate for new natural gas pipeline facilities. In the revised policy statement, the FERC placed more emphasis on the consideration of impacts on landowner interests and the exercise of eminent domain, upstream and downstream greenhouse gas impacts, and environmental justice issues, as well as how it should assess project need. On the same date, it also issued an interim greenhouse gas policy statement that sets a threshold for emissions that the FERC will consider to be significant and indicated that it would require mitigation of emissions impacts. However, the FERC withdrew both the revised certificate policy statement and the interim greenhouse gas policy statement on March 22, 2022, returning them to draft status, and established a new public comment period. Further developments are expected on the form and substance of the FERC’s policies on new and expanded natural gas facilities and greenhouse gas emissions. For safety issues, the U.S. Department of Transportation’s Pipeline and Hazardous Materials Safety Administration issued a final rule that subjects all gas gathering lines (even if previously unregulated) to federal oversight and federal minimum safety standards.

FERC and Pipeline Tariffs

In March 2018, the FERC announced it would no longer allow MLPs to include an income tax allowance in the rates charged to customers of certain pipelines through cost-of-service tariffs, which are based on an MLP’s operating costs and a fixed capital charge. This sent shock waves through the midstream industry as MLPs with a cost-of-service model would no longer be allowed to include an income tax allowance in their operating costs, thus reducing the rates charged to customers. This ruling has no effect on rates charged under negotiated or discounted contracts that differ from the cost-of-service-based tariff.

In July 2018, the FERC provided some relief to MLPs when it clarified that (1) pass-through entities that are not directly subject to income taxation that remove the income tax allowance from their cost-of-service calculation also can completely eliminate accumulated deferred income taxes (ADIT) from this calculation and do not have to return the balance of their ADIT to customers, which is an offsetting benefit to the negative impact of the elimination of the income tax allowance; (2) pass-through entities that are not directly subject to income taxation could be eligible to book a tax allowance in their cost-of-service calculation if their income or losses are consolidated on the federal income tax return of their corporate parent; and (3) an MLP will not be precluded in a future proceeding from making a claim that it is entitled to an income tax allowance based on a demonstration that its recovery of an income tax allowance does not result in a double-recovery of investors’ income tax costs.

The 2018 FERC rulings primarily affected MLPs operating interstate natural gas pipelines under a cost-of-service model. Most gas pipelines, including MLP pipelines, were required to submit a filing to the FERC showing the impact of the elimination of the tax allowance or the reduction in the corporate income tax rate. MLP gas pipelines were also given the option to make a onetime rate reduction that reflected the lower corporate income tax rate, but not the immediate elimination of the income tax allowance. The change in the income tax allowance policy and the corporate income tax reduction will continue to be issues in rate proceedings involving interstate natural gas pipelines, particularly for those pipelines that had rate moratorium agreements in place when the changes first occurred and are required to make filings to set new rates when those agreements expire.

For FERC-regulated MLP oil pipelines, the FERC directed the pipelines to reflect the elimination of the income tax allowance in their page 700 of FERC Form No. 6 reporting and stated that it will incorporate the effects of eliminating the allowance on industry-wide oil pipeline costs. For both gas and oil pipelines, the FERC could require pipelines to revise their rates in individual proceedings (including initial rate filing, investigation, or complaint proceedings) or through other action. These proceedings could also address whether other pass-through entities that are not MLPs are entitled to an income tax allowance.

In 2020, the FERC undertook the five-year review of its oil pipeline rate index and issued an initial order on December 17, 2020, adopting a revised formula for calculating the interstate oil pipeline rate index level. The initial order set the rate index for the five years starting July 1, 2021, as the Producer Price Index for Finished Goods (PPI-FG) plus 0.78%. However, the FERC issued an order on rehearing on January 20, 2022, that revised the formula to PPI-FG minus 0.21%. The lower indexing adjustment resulted from the FERC adjusting the data set used to assess pipeline cost changes from the middle 80% to the middle 50%, taking into account the elimination of the income tax allowance and previously accrued accumulated deferred income tax balances from the FERC Form No. 6 page 700 summary costs of service of MLP-owned pipelines, and using updated page 700 cost data for 2014. The rehearing order requires pipelines to recalculate their rate ceiling levels using the PPI-FG minus 0.21% formula for the period July 1, 2021, to June 30, 2022. For any rate that exceeds the recalculated ceiling level, the pipeline is required to file a rate reduction with the FERC to be effective March 1, 2022. This will have an industry-wide impact on the degree to which oil pipelines with indexed rates will be able to annually adjust those rates automatically without making a rate case filing at the FERC. The FERC’s order on rehearing remains subject to judicial review as several parties have filed appeals in the U.S. Court of Appeals for the Fifth Circuit.

Reregulation

The trend of deregulation in the oil and gas industry spurred by the Trump Administration has concluded. In 2021, the Biden Administration undertook a series of regulatory actions to review, reconsider, and reverse certain high-profile Trump-era environmental rollbacks. For pipelines, transmission lines, terminals, and other energy infrastructure projects, these reversals posed the risk of longer project timelines and permitting hurdles. Immediately upon taking office in late January 2021, President Biden issued a number of executive orders covering topics from carbon emissions to environmental justice. Those executive orders include a temporary moratorium on new oil and gas leases on federal lands and in the Arctic and the cancellation of the federal permit required to operate the Keystone XL Pipeline. Additionally, President Biden issued executive orders directing federal agencies to eliminate subsidies for fossil fuels and reversed the Trump Administration’s rollback of methane regulations. President Biden has also reentered the United States into the Paris Climate Accord. Last, President Biden has been carefully selecting his SEC appointments, staffing regulators who have made ESG issues a priority, which set the stage for the SEC’s formal proposal of mandatory ESG disclosures in March 2022.

The EPA released a proposed rule on November 2, 2021, to impose additional restrictions on emissions of methane, or natural gas, from new and existing facilities owned by companies in the production, gathering, processing, transmission, and storage segments of the oil and gas sector. This is the first time such restrictions would be extended to existing facilities.8

Companies across the oil and gas industry should be familiar with the proposed rule and its potential impacts. This proposed rule is not entirely new; the Obama Administration EPA promulgated a New Source Performance Standards (NSPS) rule in 2016 addressing methane emissions from new, modified, and reconstructed facilities in the oil and gas sector, which the Trump Administration EPA rescinded in 2020. This proposed rule reintroduces the 2016 methane NSPS for new facilities and extends it to regulate existing facilities. The EPA held hearings on the proposal in November/December 2021 and sought comments on the proposal, which were due in January 2022. The EPA is currently reviewing those comments.

Market Outlook

The 2022 outlook for the upstream industry is cautiously optimistic given projected demand increases, despite the continued uncertainty surrounding future governmental restrictions, rig and labor availability, demand, and inflation. Natural gas and liquified natural gas (LNG) exports are also expected to benefit, particularly for U.S. operators given the tensions in Europe over Russia’s actions in Ukraine, although it remains to be seen how the LNG export market will be impacted. Nevertheless, obstacles such as local opposition and litigation, particularly in the midstream sector, will hamper the ability of oil and gas companies to timely respond to these market changes.

The trend of consolidation will likely continue to drive M&A activity, and capital markets access will be driven by robust free cash flow models. Vine Energy Inc., despite launching the only successful oil and gas IPO in 2021, was acquired later that year by Chesapeake Energy Corporation. The outlook for public debt activity is more optimistic, given the effects the anticipated interest rates hikes are expected to have on equity prices, along with the potential for higher commodity prices. If prices remain high enough for long enough, investor appetite for leverage from upstream players could return, but the industry is also embracing new technologies that will create opportunities for ESG investment and cross-sector deal activity.

On the regulatory and political front, the Biden Administration and the Democratic-led Congress have signaled support for strengthened regulation throughout the industry as the focus on climate change continues to gain momentum. Production levels in the United States are unlikely to reach the 2020 highs of over 13 million barrels of oil per day under the Biden Administration; however, the pressure to replace Russian energy exports to the United States and Europe could change this trajectory and will likely benefit prices going forward.

This article is part of a series of Market Trend articles available on Practical Guidance. Market Trends articles provide insight into regulatory and disclosure trends, recent deal terms and transactions, and projections for the foreseeable future. Market Trends are exclusively authored by practicing attorneys from leading law firms. For more Capital Markets & Corporate Governance market trends, see Market Trends. 


Justin F. Hoffman is a corporate partner at Baker Botts L.L.P. who focuses on delivering practical and strategic advice in high stakes financing transactions and securities law compliance matters. He regularly advises boards of directors, investment banks, and investors on all aspects of public and private capital raising transactions, as well as out-of-court restructurings, Chapter 11 proceedings, and liability management situations. Known for an ability to focus on both fine details and the bigger picture, clients routinely turn to Justin for practical, business-focused solutions to their most complicated problems. He has extensive experience in advising energy companies in connection with securities offerings and acquisition financings, particularly in the upstream, midstream, and oilfield services sectors, as well as coal mining and renewables.


Thomas Blackwell is an associate at Baker Botts L.L.P. He represents public and private companies in mergers and acquisitions, securities offerings, and general corporate matters. Thomas also advises clients on liability management, acquisition financings, and securities compliance issues, including Exchange Act reporting.


Assistance provided by Kim Tuthill White, Michael Bresson and Emil Barth, Baker Botts L.L.P.


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U.S. SECURITIES LAWS APPLICABLE TO DEBT EXCHANGE OFFERS AND CASH TENDER OFFERS CHART

For guidance on the responsibilities and activities of counsel during the pricing and closing of a municipal bond issue and some of the considerations to be mindful of during this process, see

MUNICIPAL BOND PRICING AND CLOSING

For information on trends in the private investments in public equity (PIPE) market, see

MARKET TRENDS 2020/21: PIPES

For an overview of the applicable securities laws and regulations, securities offering process, disclosure and corporate governance obligations, and stock exchange requirements for a securities practitioner working with a private equity firm, see

PRIVATE EQUITY INDUSTRY GUIDE FOR CAPITAL MARKETS

For an analysis of the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) on private equity funds and managers, see

DODD-FRANK AND PRIVATE EQUITY: THEN AND NOW

1See JWN Media, Enbridge Captures ‘Greenium’ with SLB Debut (June 25, 2021). 2. See Reuters, Global Issuance of Sustainable Bonds Hits Record in 2021 (Dec. 23. 2021). 3. See The Enhancement and Standardization of Climate-Related Disclosures for Investors; Release Nos. 33-11042; 34-94478, 2022 SEC LEXIS 730 (March 21, 2022). 4. 2019 Colo. SB. 181. 5. See The Enhancement and Standardization of Climate-Related Disclosures for Investors; Release Nos. 33-11042; 34-94478, 2022 SEC LEXIS 730 (March 21, 2022).