Although issues in oil and gas chapter 11 cases vary from case to case, there are, nonetheless, certain issues that tend to arise in most oil and gas cases. Among them: treatment of oil and gas leases, the payment of royalties, hedging agreements, and valuation. This webinar addresses such issues.
Part of the webinar series: CHAPTER 11 - INDUSTRY FOCUS 2022
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4. Disclaimer
The material in this webinar is for informational purposes only. It should not be considered
legal, financial or other professional advice. You should consult with an attorney or other
appropriate professional to determine what may be best for your individual needs. While
Financial Poise™ takes reasonable steps to ensure that information it publishes is accurate,
Financial Poise™ makes no guaranty in this regard.
5. Meet the Faculty
Moderator:
Whitney Fogelberg – Kirkland & Ellis LLP
Panelists:
Travis Bayer – Dinsmore & Shohl LLP
David K. Bowsher – Balch & Bingham LLP
Scott Cockerham – AlixPartners
6. About This Webinar
Focus on Oil & Gas
Although issues in oil and gas Chapter 11 cases vary from case to case, there are,
nonetheless, certain issues that tend to arise in most oil and gas cases. Among them:
treatment of oil and gas leases, payment of royalties, hedging agreements, and
valuation. This webinar addresses such issues.
7. About This Series
Chapter 11 – Special Issues
As the economy starts to cool and inflation is on the rise, many experts expect corporate
bankruptcy filing rates to increase after a significant drop in filing rates. Designed for the
corporate attorney, litigator, and anyone else who is not a Chapter 11 bankruptcy expert who
finds herself stepping into bankruptcy for the first time or only on occasion, each episode in
this Financial Poise webinar series takes a deep dive into one aspect of a Chapter 11
bankruptcy case at a level that can be understood by the non-expert.
Each Financial Poise Webinar is delivered in Plain English, understandable to investors, business owners, and
executives without background in these areas, yet also invaluable to seasoned attorneys, accountants, and other
professionals who need to refresh their understanding of this timely topic. Each episode brings you an engaging
conversation designed to entertain as it teaches, and may be viewed independently so that your knowledge will be
enhanced whether you attend one, some, or all episodes.
8. Episodes in this Series
Episode #1: Focus on Retail
Premiere Date: September 8, 2022
Episode #2: Focus on Oil & Gas
Premiere Date: October 6, 2022
Episode #3: Focus on Manufacturing
Premiere Date: November 10, 2022
10. Current State of Oil & Gas Filings
• The U.S. oil and gas industry has had a number of dramatic ups and downs over the last
ten years, including a large wave of Chapter 11 filings of oil and gas debtors from 2015 to
2016 and again in 2019 to 2020.
• Distress in the oil and gas industry is usually tied to a confluence of factors, including:
• Slowing global economic growth
• Excess gas and oil supply
• Declining demand for oil and gas
• The current rate of oil and gas bankruptcy filings is extraordinarily low due to (1) a
recovery in commodity prices, (2) improvements in operating efficiencies, and (3) low
debts levels partially attributable to previous Chapter 11 filings.
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11. Reserve Based Financing
• Most oil and gas companies do not have enough liquidity to finance the exploration,
drilling, and other costs with their own money.
• Many oil and gas companies typically rely on reserve-based credit facilities for their
working capital needs and to fund development projects.
• A reserve-based loan is a type of asset-based loan where the amount the company is
entitled to borrow is based on the value of and is secured by its proved oil and gas
reserves, as determined from time to time.
• Proved oil reserves are quantities of oil that can be estimated by analyzing geological
and engineering data to be recoverable from known reservoirs.
• Unproved reserves are too speculative to form the basis for reserve based lending.
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12. Reserve Based Financing (cont’d)
• In times of steep price declines, oil and gas companies’ availability for additional
borrowings under their reserve-based credit facility are reduced as the value of proven
reserves shrinks.
• There may also be a borrowing-base deficiency that may trigger a requirement that the
borrower:
• Pledge additional collateral, which it may not have.
• Pay down the debt, causing a liquidity crisis.
• The value of oil and gas reserves is far more subjective and variable than the value of
traditional asset-based credit facility inventory, such as consumer goods and raw material.
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13. Oil & Gas Leases: Working Interests and Royalties
• Working interests, such as the exclusive right to drill and produce oil and gas from a
mineral interest, are typically created by an oil and gas lease in which the company
receives the exclusive right to drill from the holder of the mineral interests.
• The holder of the mineral interests frequently retains a landowner royalty interest and
receives a share of the gross production from the mineral interest, free of development
costs.
• The coil and gas company may then carve out various fractional interests from its working
interest, including overriding royalty interests (ORRIs), net profits interests (NPIs), and
production payments (PPs) (see § 101(42A) of the Bankruptcy Code).
• Each of these interests grants the applicable holder the right to receive some portion of
the production from the working interest.
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14. Oil & Gas Leases: Working Interests and Royalties
(cont’d)
• Interests held by fractional interest holders generally are not property of the bankruptcy
estate.
• Specifically, the safe harbor in section 541 of the Bankruptcy Code protects assignees
of PPs or ORRIs from having their oil and gas interests included in the bankruptcy
estate.
• Some oil and gas leases also provide for the automatic termination of the lease if the
royalties remain unpaid.
• It is not necessary to obtain relief from the stay in cases where automatic termination
provisions are enforceable under state law (for example, in Texas).
• Royalty owners in some jurisdictions, like Texas, are protected by state statute as
automatically perfected secured creditors without the filing of a financing statement.
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15. Treatment of Oil and Gas Leases
• Under section 365 of the Bankruptcy Code, a debtor’s executory contracts and unexpired
leases may be either assumed or rejected, subject to court approval.
• If an oil and gas company files for bankruptcy, it may be able to reject certain oil and gas
leases if they are deemed to be executory contracts or unexpired leases.
• Case law is not settled on whether oil and gas leases are real property interests or
executory contracts (or unexpired leases) under the Bankruptcy Code.
• There are important differences between being an owner of a real property interest
and a creditor under an executory contract.
• For example, a real property owner has a present right of possession, while a debtor
may reject an executory contract leaving a nondebtor counterparty with only an
unsecured damages claim.
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16. Treatment of Oil and Gas Leases (cont’d)
• The classification of a specific oil and gas lease as executory generally depends on:
• „
State law property rights.
• A determination of the interests conveyed under the particular agreement as
interpreted under state law.
• The parties’ ongoing obligations under the agreement.
• Some courts applying state law have held that oil and gas leases are unexpired leases or
executory contracts subject to section 365 reasoning that, under state law:
• The lease was a license or similar right to go on to the land to extract minerals from
the ground which constitute personal property, not real property.
• The conveyance was a true leasehold interest.
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17. Gas Gathering Agreements
• Midstream gas gathering agreements — long-term contracts to transport oil and gas from
the wellhead to central facilities by pipeline — are a popular target for oil and gas debtors
when considering contract rejection under section 365.
• Many oil and gas debtors have sought to reject these agreements as uneconomical,
typically over the vigorous opposition of their counterparties.
• Most gas gathering agreements contain a “dedication” clause that designates the
midstream party as the exclusive provider of gathering, transportation and processing
services for hydrocarbons produced from leases and wells in a specified area.
• The contracts typically characterize the provision as a covenant that “runs with the
land.”
• Courts have then had to consider whether dedication clauses actually create enforceable
covenants that run with the land under state law and if so, does the running covenant
preclude rejection or just create an in rem interest that survives it?
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18. Gas Gathering Agreements (cont’d)
• The U.S. Bankruptcy Court for the Southern District of New York analyzed a debtor’s
midstream gas gathering agreements in In re Sabine Oil & Gas Corp. and found that
under Texas law the agreements did not convey an interest in real property.
• The court ruled that the contracts were executory and could be rejected because the
covenants at issue did not “run with the land” under Texas law.
• The court explained that the debtor did not, in the context of the relevant conveyance,
reserve any interest for the contract counterparties, but instead engaged them to
perform certain services related to the hydrocarbon products produced by the
debtor’s property.
• The court also found that the agreements did not explicitly grant the contract
counterparties a real property interest in the debtor’s mineral estate.
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19. Gas Gathering Agreements (cont’d)
• Subsequent to the Sabine decision, courts have reached mixed decisions when
considering the rejection of gas gathering agreements.
• For example, the court in In re Badlands Energy, Inc. found Sabine to be inapplicable
because it involved “a very different” dedication provision.
• In In re Alta Mesa Resources, the court ruled that the gathering agreement at issue
constituted a covenant running with the land under Oklahoma law and was not a contract
subject to rejection under section 365.
• However, in In re Extraction Oil and Gas, the Delaware bankruptcy court found that
several gathering agreements governed by Colorado state law did not create covenants
running with the land and thus were subject to rejection by the debtor.
• While Badlands and Alta Mesa do not outright reject the Sabine decision, they challenge
and potentially limit its applicability under certain circumstances.
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20. Joint Operating Agreements
• An oil and gas company’s joint operating agreement is typically an agreement that splits
the working interests among multiple companies either as operators or non-operators
regarding oil and gas operations in certain specified lands.
• Because exploration, development, production, or a combination of all may be ongoing on
the properties at the time of the bankruptcy filing, unperformed duties remain and the lack
of performance of these duties constitute a material breach.
• Therefore, joint operating agreements likely are treated as executory and are subject to
rejection.
• Even if a particular oil and gas agreement may be rejected or assumed, some operating
agreements may create contractual lien rights and those rights may be preserved despite
the rejection of the operating agreement.
• For joint operating agreements, parties typically must perfect their interests by executing,
acknowledging, and recording a memorandum of the operating agreement in the
appropriate land records of the county or counties where the lands are located. 2
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21. Plugging and Abandonment
• A potentially significant concern in an oil and gas company’s bankruptcy proceeding is the
debtor’s ability or inability to abandon unproductive or unnecessary oilfields and other
facilities.
• Under federal and state laws, oil and gas companies must plug and abandon an oil well
after drilling or production ceases.
• Under federal law, oil and gas companies operating offshore on the Outer Continental
Shelf must plug and remove all structures on a lease within certain time periods after the
end of production.
• Plugging and abandonment (P&A) claims are common in oil and gas bankruptcy cases
and are often brought by state and federal authorities and co-liable parties.
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22. Plugging and Abandonment (cont’d)
• A debtor oil and gas company may try to abandon the well, site, or other facility under
section 554 of the Bankruptcy Code as opposed to undertaking P&A measures.
• Some courts permit abandonment, regardless of non-bankruptcy environmental laws and
regulations, when there is no imminent or immediate identifiable threat posed to public
health or safety, particularly if the debtor lacks sufficient unencumbered funds to do the
remediation itself.
• Bankruptcy courts have authorized a debtor to abandon assets, despite the properties
having to be plugged and decommissioned at significant costs to the debtor.
• To ensure public health and safety, the federal government typically decommissions the
assets and retains an administrative claim in the bankruptcy case for such costs.
• Because it is unlikely the estate has sufficient resources to pay large administrative
claims, the federal government typically pursues other non-bankrupt related parties or
predecessors-in interest for some or all of the decommissioning costs.
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23. Hedging
• The periodic, dramatic declines in the price of oil over the past several years illustrates the
risk that every oil and gas company has to energy commodity price volatility.
• Thus, oil and gas company "hedge" or reduce this price risk and transfer some or all of this
risk to a party that is willing and able to assume and manage this risk.
• Hedging is a crucial component of any oil and gas company’s risk and financial
management program.
• The Bankruptcy Code provides valuable tools that can be used to reduce exposure in the
event of a counterparty bankruptcy.
• The two main types of energy hedging products, physically settled transactions and
financially settled transactions, are treated differently under the Bankruptcy Code.
• In a bankruptcy, physically settled transactions are commonly known as forward contracts,
and financially settled transactions are commonly known as swap agreements.
• The terms "forward contract" and "swap agreement" arise out of the Bankruptcy Code
(11 U.S.C §101(25) (forward contract) and (53B) (swap agreement)).
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24. Hedging (cont’d)
• In the event of a counterparty bankruptcy, forward contracts and swap agreements are
afforded special treatment under the Bankruptcy Code, which enable parties to take
advantage of the safe harbor provisions of the Bankruptcy Code to terminate, liquidate,
and setoff hedge transactions without the need to obtain relief from the automatic stay or
bankruptcy court approval.
• However, despite the importance of these rights, the Bankruptcy Code does not create
new rights to terminate/liquidate forward contracts and swap agreements, or to setoff in
connection with forward contracts and swap agreements.
• Rather, the Bankruptcy Code preserves any pre-existing right the parties may have.
• If a termination or liquidation is not specifically created in the hedging agreement, hedge
parties may not exercise such rights and take full advantage of the Bankruptcy Code's
safe harbor protections.
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25. Valuation Issues
• Valuation is a critical, and often hotly disputed, issue in most bankruptcy cases.
• Valuations drive creditor recoveries and are often outcome determinative for the
success (or failure) of fraudulent transfer and other bankruptcy-related litigation.
• Valuations in the context of oil and gas bankruptcy cases are significantly more
complicated than valuations of operating companies in many other industries.
• Moreover, bankruptcy courts generally rely heavily on experts regarding the geologic
issues, engineering data, and pricing assumptions that drive the valuation exercise.
• Collateral and enterprise valuations are relevant in numerous different contexts within a
bankruptcy case, including, among others:
• plan confirmation
• post-petition financing
• recovery of post-petition interest
• avoidance actions
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26. Valuation Issues (cont’d)
• The primary assets of an oil and gas company are its oil and gas reserves.
• Reserve estimates are uncertain and depend primarily upon the amount of geologic and
engineering data available at the time of the estimate and the interpretation of that data.
• The starting point for the reserve valuation is the reserve report prepared by an
engineer.
• The reserve report estimates the quantity (typically expressed as barrels of oil equivalent
or thousands of cubic feet equivalent for gas) based on the following six categories:
• Proved Developed Producing (“PDP”)
• Proved Developed Non-producing (“PDNP”)
• Proved Undeveloped (“PUD”)
• Probable Reserves
• Possible Reserves
• Undeveloped Reserves
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27. Valuation Issues (cont’d)
• Some key questions have to be addressed in reserve reports submitted in connection
with and oil and gas valuation, including how projected volumes compare with historical
production volumes and what drilling and capital expenditures assumptions were used in
developing the projections.
• Additionally, once the reserves are quantified by an engineer, the next material input
affecting reserve value is the pricing assumption used to determine revenue.
• Pricing assumptions can widely vary due to market uncertainty and volatility.
• Thus, valuation in bankruptcy, especially in oil and gas, is predicated on a host of
subjective assumptions and adjustments that will be ripe for disputes.
• As a result, bankruptcy courts are faced with competing valuations that are materially far
apart in their conclusions.
• Stakeholders in oil and gas bankruptcy cases likely will continue to litigate valuation
issues, or at least use the threat of litigation, to advance their respective positions.
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29. About The Faculty
Whitney Fogelberg - whitney.fogelberg@kirkland.com
Whitney Fogelberg is a restructuring partner in Kirkland’s Chicago office. Whitney represents
both debtor and creditor clients in complex Chapter 11 reorganizations; advises purchasers
and sellers in bankruptcy transactions and acquisitions; counsels boards of directors and
senior officers regarding fiduciary duties and restructuring strategies; and advises financially
troubled companies regarding the structure of various commercial transactions outside of
bankruptcy.
30. About The Faculty
Travis Bayer – Dinsmore & Shohl – Travis.Bayer@dinsmore.com
Travis is a partner in the Cincinnati office of Dinsmore & Shohl LLP and serves as co-chair of Dinsmore’s
Bankruptcy and Restructuring group. He concentrates his practice on all aspects of corporate
restructuring, bankruptcy, liability management, and financial distress. Travis represents clients across a
wide range of matters, including debtor, creditor, and equity holder representations.
He brings broad industry experience spanning the oil and gas, coal, media, manufacturing, automotive,
retail, and equipment rental sectors. He also has experience advising clients with operations in Chapter
11, advising senior management and boards of distressed companies with in- and out-of-court
restructurings and contingency planning, and negotiating and structuring financings and other commercial
transactions.
31. About The Faculty
David K. Bowsher – Balch & Bingham LLP – dbowsher@balch.com
David K. Bowsher is a partner in the Birmingham and Houston offices of Balch & Bingham LLP. His
practice focuses on mergers and acquisitions, including those involving troubled companies, on corporate
restructuring and bankruptcy issues, and on oil and gas matters.
Previously, he served as Acting General Counsel and Deputy General Counsel of the U.S. Department of
Commerce in President George W. Bush’s Administration. During that time, he advised senior U.S.
Government officials on a wide variety of issues, including providing financial assistance to distressed
industries (e.g., the automotive and steel industries), foreign direct investment, Congressional oversight
and investigations, coastal development litigation (particularly oil and gas-related developments), export
control licensing and enforcement, and Internet governance. He also co-led U.S. engagement with the
People’s Republic of China on transparency in government as part of the Strategic Economic Dialogue
and led U.S. participation in the U.S.-China Legal Exchange as part of the Joint Commission on
Commerce and Trade.
32. About The Faculty
Scott Cockerham – AlixPartners – scockerham@alixpartners.com
Scott Cockerham is a Director in the Turnaround and Restructuring practice of Alixpartners, LLP in its
Houston office. Scott works in the Energy & Process Industries community, working with companies in
special situations in the energy, oil and gas, mining, and metals spaces. He also works in the Aerospace
and Defense community with clients in various levels of distress.
Scott began his career as a naval aviator in the US Marine Corps. Following active duty he worked as a
restructuring investment bank CEO, as well as head of corporate development for an onshore oil and gas
company and portfolio of companies in the onshore and offshore oil and gas, oilfield services, mining, and
coking spaces.
33. Questions or Comments?
If you have any questions about this webinar that you did not get to ask during the live
premiere, or if you are watching this webinar On Demand, please do not hesitate to email us
at info@financialpoise.com with any questions or comments you may have. Please include
the name of the webinar in your email and we will do our best to provide a timely response.
IMPORTANT NOTE: The material in this presentation is for general educational purposes
only. It has been prepared primarily for attorneys and accountants for use in the pursuit of
their continuing legal education and continuing professional education.
34. Commercial Bankruptcy Litigation is a must-have
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