Energy Independence vs. Energy Interdependence

Friday, September 21, 2012 - 11:00

 

The Editor interviews Kenneth Culotta, Head of King & Spalding’s Global Transactions Practice Group.

 

Editor: You were recently named head of King & Spalding’s Global Transactions Practice Group. What subject areas does this group comprehend?

Culotta: Global transactions, the name that we gave this practice, is focused on two different, and interestingly convergent, themes. First is the fact that we’re lawyers in the energy, extractive and infrastructure industries and project lawyers, who bring all our different legal specialties together – regulatory, construction, project development, project finance, mergers & acquisitions and a number of others – to focus on skills needed for the entire lifecycle of projects. We try to help developers advance their projects while mitigating development risks, to get them into operation, and to assist the client with needs beyond commercial operations date. We do this by assisting with an orderly series of steps, such as securing needed permits or concessions, rights in the project site, commercial agreements to create the cash flow to support the project, construction financing and so on. Each of these functions is specific to different projects in a way that the market recognizes as a core expertise, particularly in gas, LNG, power and mining projects.

Second, that bundle of skill sets intersects with our interest in being global practitioners. We are global both geographically – in that we’re spread around the world – and professionally, in that we are expert in cross-border work, and by this I mean projects in which the investor parties and their partners or host governments are from different countries. This is a distinct but complementary expertise that complements our industry practice skills. This expertise is also made up of many different parts: expertise in foreign law, especially in our focus industries, foreign language capability, comparative law skills – understanding how a client’s expectations about the shape of its business are changed when it invests in country X, understanding how divergent tax rules affecting international joint venture partners can be reconciled.

This combination of skills has won us some interesting engagements. For instance, we currently represent Anadarko in its LNG project in Mozambique – by far the largest single industrial project in the country’s history. It will require a lot of very diverse stakeholders to satisfy project lenders and customers in places like Tokyo or Seoul over many years. Our job is to try to work with these stakeholders: the government of Mozambique with other stakeholders in our client’s upstream partners, contractors, customers, neighboring concessionaires, LNG transporters, and so on, to get the project contracted, financed and built in a sustainable fashion.

Editor: What do you mean by the entire “lifecycle” of a project?

Culotta: Different projects have different lifecycles and require different legal skills at different points in the cycle.  For example, a land-based LNG project typically requires assurance of a 20-year or 30-year firm LNG off-take agreement (normally with renewal option). But a small-scale floating LNG project may have a shorter one, as short as five to seven years. Contracting and financing have to be geared to the lifecycle. Also, different projects have different entries and exits for different clients. A private equity client will typically want to monetize a project after a defined period of holding it. It may do this, for instance, by selling it or taking it public. And different projects require different financing approaches depending on how they are owned and capitalized. Our firm houses all the critical skills necessary to serve as chief counsel to projects at each stage: concession, siting, commercial, finance, construction, monetization.

Editor: Why have LNG import projects been the scourge of environmentalists?

Culotta: It’s an interesting question, and the answer is that they’re not always. Japan has at least 25 LNG terminals and a constructive attitude about gas. Gas is the cleanest reliable fuel source available on the planet with the exception of Scandinavian hydro. The U.S. is really two countries: the one that hates fossil fuels and the one that produces them. In the last decade LNG import developers had a difficult time in the U.S. largely because of environmental and NIMBY detractors. There was not a lot of public resistance to them in the Texas Gulf Coast, but BHP Billiton’s project off Long Beach, the Fall River project and the Oregon projects are located in places where fossil fuels are viscerally despised. In the western Gulf, fossil fuels are accepted as part of the culture and the economy. As export terminals are now being developed, the Sierra Club is attacking them mostly because it believes their existence will lead to more shale gas development, which it believes is fundamentally bad. Interestingly, the two U.S.’s are converging, as many, many states appear to be joining the U.S. that produces shale gas. This in my view will fundamentally affect this issue over time.

Editor: You have recently discussed the Dodd-Frank sweeping disclosures required of the oil, gas and mining industries. Please acquaint our readers with the far-reaching nature of these disclosures.

Culotta: The U.S. tendency toward what I call moral regulation is inherent in our culture, and it really is the better part of our nature that gave rise to laws like Dodd-Frank. You can clearly see our moralistic side emerging in the Cardin-Lugar amendment, in its requirement that natural resource extraction companies disclose their payments to the U.S. and foreign governments in a manner that is intended to be complementary to the Extractive Industries Transparency Initiative. On one level this is counter to the practice in the industry in that members of the oil, gas, and mining industries negotiate with governments in a competitive environment. A government typically holds title to the mineral resources in the ground, needs the expertise and capital of foreign partners to extract them, and offers a concession to the foreign partner that makes it the best offer. The record of payments made by such investors has typically been confidential. Now that it’s not, foreign competitors (themselves not subject to such requirements) will use that information to gain competitive advantage.

The irony is that the purpose of the legislation is not so much to keep American companies honest – for that we already have moralistic laws like the Foreign Corrupt Practices Act. Rather, it’s to make these foreign governments accountable to their own populations. We Americans think every individual in the world ought to enjoy a level playing field and a representative government. It’s an admirable – if outsized – ambition to think we can cause it to happen by forcing our own companies into competitive disadvantage. One part of me really doesn’t like these requirements for the gratuitous mischief they wreak on smaller businesses. Another part worries about the effect of all the administrative burdens of these laws raising the costs of commodities we need. But look at the FCPA 25 years on -- it is now reflected in the laws of all industrialized countries and has truly set a new norm for our competitors as well as U.S. companies. So part of me wants to be patient.

Editor: There have been many innovations in technology for extraction industries over the most recent years. Which innovations will have the most far-reaching implications for extractive industries?

Culotta: The single most impactful technological development of the last 25 years is the genius of George Mitchell, a Texas oil and gas man, who in the ’90s – in his 70s! – became seriously interested in hydrofracking and horizontal drilling. While K&S was working on U.S. LNG import terminals 10 years ago, everyone in the industry firmly believed the U.S. would become a net gas importer by 2012. It was nearly universally believed that our production capability was irreversibly in decline, and it would be necessary to import gas. Meanwhile, on a lonely stretch of highway, Mitchell was exploring tight gas formations like the Barnett shale, perfecting these techniques. When they combined fracking with horizontal drilling, the shale revolution was born. Suddenly this non-permeable rock layer could be exploited economically.

Why is this so big? Because there are unexploited shale formations everywhere. Because suddenly many more countries can become producers, making gas supplies cheaper and more secure for more people. And it’s changing the dynamic in countries that are traditional producers. In our own domestic gas supply system, it’s changing the economics of long-haul pipelines, pushing gas prices down to historic lows, bringing manufacturing industries back to this country. And the rest of the world is just getting started with it. We’re fortunate to be working in this space in a time of such dynamic change.

Editor: While the developments in removing hydrocarbons from shale formations in the U.S. and Canada are moving apace, why has this technology not been developed on other continents?

Culotta: Well, we’re still in the early going. Things got started in the U.S. because we had a commercial need for innovation – recall we were running out of gas! – and our legal and commercial environments encourage innovation. One of the big differences between U.S. and other countries is that our concept of private property encompasses mineral resources below the ground. Under our law you can own the mineral estate, and you can sever the mineral estate from the surface estate. This means that a landowner can exploit his own minerals or rent the mineral estate to another while continuing to own and use the surface. The potential for profit encourages commercial activity – it makes willing participants. In other countries the government owns the mineral estate. To develop those minerals a contract must be made with the government. This alone adds layers of obstacles. Then consider that the landowner who will get to enjoy all the noise and dust of an oil and gas operation may get little or no direct return. Whereas our system exerts a commercial pull on oil and gas activity, in other countries a push is required. In countries without a common law tradition, legal innovation comes slower, slowing down commercial trends. So we build innovative momentum more quickly. The Canadians share many of these traits, including the common law – though not private mineral ownership. But don’t worry, the rest of the world is catching on.

Editor: How can the OGM industries better solidify their presence in partnership with governments of third world countries? How do they protect themselves against expropriation?

Culotta: You try to be a good citizen there, just as you are at home. If you want to solidify your relationship with governments, you have to take them on their own merits, recognize they’re usually trying to do the best they can – no matter their standing with the moralists in our government – and you are a guest in the country. You have to exert effort to understand what’s important to them and how to be constructive within constraints placed on both of you. To protect against expropriation, see all the above. But should events go beyond the ability of people of goodwill to manage, you need good agreements. Where treaties are available to help support your agreements, you structure to take advantage of those. Take bilateral investment treaties. For projects on the scale of a major pipeline or LNG project, you may need to participate in crafting enabling legislation for the host country that provides the project a solid footing. And of course, good arbitration and stabilization clauses!

Editor: Do you consider that the U.S. will ever become energy independent?

Culotta: I doubt it, in my lifetime at least. But I think rational energy interdependence is a far wiser goal, and today we have so many possibilities for rational interdependence. For instance, a number of our clients are developing LNG exports. Gas in South Texas now is so distant from the premium markets that the methane has little value. It’s much more valuable to extract ethane, a product used in petrochemical plants. We all love to see the petrochemical industry coming home, but you can’t get the ethane without producing the methane, so low gas prices may actually be placing a limit on growth. However, in Japan the methane is priced at $12-$15 per MCF as compared with $2.75 in the U.S. There are opportunities for us to create strong relationships with good trading partners such as Japan while strengthening our own economy at home – an excellent example of interdependence. Another example is collaboration with our neighbors in Mexico, who have for the past 70 odd years been very reluctant to have us involved in their oil and gas industry. They are way behind – they currently import close to 25 percent of the gas they use, much of it from the U.S. – because their experiment in trying to control that industry strictly as a government enterprise has stopped working. We’re filling the gap. But Mexico has as much oil and gas as almost any country in the world, and if we can get the suspicions of the past behind us there is room for a rational interdependence here. NAFTA has fostered an environment in which we are interdependent in so many ways that benefit each of us. We may be ready in the near future for a bridge to a more rational energy relationship, one where American companies can bring their innovations and capital to bear for the mutual benefit of our countries. A rational interdependence should be encouraged rather than energy independence.

 

Please email the interviewee at kculotta@kslaw.com with questions about this interview.