Current Issues Involving Latin American Upstream M&A

First published in Bloomberg Law Reports, March 19, 2012

Introduction

Latin America is seeing an upsurge in transactions in the oil and gas industry, including asset purchases, joint ventures and equity acquisitions. Much of this is due to significant discoveries of new oil and gas reserves. The pre-salt discoveries in Brazil are some of the most well-known, with some experts estimating that the Brazilian pre-salt may ultimately be discovered to contain up to 120 billion barrels of recoverable reserves. But other Latin American countries have also realized new successes. Argentina, for example, has been the site of two recent large discoveries by Repsol YPF: an estimated 927 million barrels equivalent of shale oil at the Loma La Lata field in northern Patagonia announced in November 2011, and an estimated 4.5 trillion cubic feet of shale gas in Neuquen province in December 2010. Uruguay is also a country where recent and potentially large discoveries of gas, both offshore and onshore, could lead to the emergence of another hub of upstream activity.

Another factor driving the momentum in upstream M&A activity in Latin America is the privatization or partial privatization of state-owned oil and gas companies that began with Petrobras in Brazil in 1997 and followed with Ecopetrol in Colombia in 2003, when their respective legal monopolies over the hydrocarbon sector were abrogated and some of their shares were sold to the public. In a similar fashion, Repsol acquired Argentina's YPF in 1999. The privatization trend has reversed in recent years, but this has only fueled further M&A activity.

These former state-owned companies are now attracting capital and knowledge for exploration and production activities through joint activities with major independent and other state-owned oil companies. Examples of this trend include Petrobras' joint ventures in the Brazilian pre-salt concessions, and Ecopetrol recently joining with Statoil to announce its first find in the Gulf of Mexico. These examples also illustrate the companies' willingness to expand internationally.

In the medium – to long-term, there is the potential for more partnerships and transactions in countries where state-sanctioned monopolies remain, such as PEMEX in Mexico and PDVSA in Venezuela, if those countries modify their hydrocarbon frameworks similarly to Brazil, Colombia and Argentina. To this end, Mexico and the United States reached an accord on the Transboundary Hydrocarbons Agreement, which will allow U.S. companies to partner with PEMEX to develop transboundary reservoirs such as the Western Gap in the Gulf of Mexico.1

Although former state-owned companies are major players in their domestic markets, it is not necessarily the case that one must partner with them to do a deal. For example, recent deals in Brazil did not involve Petrobras, including HRT's sale of a 45 percent stake in 21 Amazon blocks to TNK-BP in October 2011 for $1 billion, and Sinopec's acquisition of a 30 percent stake of Galp Energia's deep sea blocks in November 2011 for $5.2 billion.2

The size, complexities and nuances of these deals bring to the surface old and new business and legal issues. Interested parties must be careful to address them, or risk encountering difficulties down the road. For example, according to statements issued by BP, the proposed sale of its 60 percent stake in Argentine crude oil producer Pan American Energy to a joint venture comprised of Argentina's Bridas Energy Holdings Ltd. and China's CNOOC recently collapsed after the parties failed to obtain Argentine anti-trust approval and Chinese government approval.3

This article will discuss a number of issues involved in upstream oil and gas M&A activity in Latin America with a focus on valuation and operational issues, considerations in selecting the form of the transaction, and problems encountered in structuring cross-border transactions. Attention to these matters with the assistance of experienced counsel will help ensure that any proposed transaction progresses smoothly.

Valuation and Operational Issues

Due to the dynamic and changing nature of Latin America's oil and gas industry, both strategic and financial investors must fully understand and address relevant valuation and operational issues in target countries. Careful examination of these issues may significantly affect valuation models.

Unitization

Although governments typically grant exploration and production rights in square or rectangular geographic blocks, the deposits themselves are not laid out in the same way. In other words, while a grantee may have the right to explore a certain block, the deposit under that block may extend into other blocks. If this is the case, grantees will sometimes be forced to stop all exploration and production activities until a unitization agreement is reached with the holders of the adjacent blocks under which the whole deposit extends.

Problems can also arise when countries change their granting regimes, thus resulting in adjacent concessions governed by both the former and new regimes. Unitization...