Navigating joint ventures in the oil and gas industry Introduction Transaction trends in the oil and gas industry вЂ” the JV Oil and gas merger and acquisition activity was strong in 2010 and has continued in 2011, with credit markets opening and big oil flexing its financial strength. Total global industry transaction value topped US$266 billion in 2010, up 33% from 2009. The number of deals went up 13% and deal value rose strongly in each of the four industry segments, with total upstream transaction value reaching a record high. Transaction activity is expected to be similarly brisk in 2011. Furthermore, independent players in the capital-intensive oil and gas industry began partnering more vigorously with major oil companies. The past 18 months have seen a significant ramp-up in oil companiesвЂ™ planned investments in unconventional oil plays, with a marked increase in joint ventures. The past year saw a dramatic uptick in Asian companies investing in North American energy projects. In 2010, public and national players from countries such as China, India and South Korea invested a total of US$17 billion in energy ventures вЂ” the majority of them joint ventures вЂ” in the United States and Canada. It is expected that joint ventures will continue to be extremely active for the remainder of 2011. Notably, 37% of oil and gas companies in the April 2011 Ernst & Young Capital Confidence Barometer indicated that they are seriously considering a JV in the next 12 months. TodayвЂ™s joint venture transactions, however, come in so many shapes and sizes that it can be difficult to decide on the optimal arrangement. For example, private equity partners have come into play вЂ” several funds are dedicated to the oil and gas industry вЂ” small independent oil companies are partnering with one or many major oil companies, and public and national oil companies from all over the world are entering the US oil and gas market. All offer exciting combinations of resources, assets, capital, expertise and labor. The right joint venture can optimize these to shape a dynamic growth strategy. In this paper, we explore the rationale behind utilizing a joint venture (JV). We look at the JV lifecycle and, in particular, what JV partners need to do to ensure that the JV process is a successful one for the partners and for the JV itself. Also highlighted are new and proposed US federal income tax laws that will dramatically affect the US oil and gas sector, including negating some of the benefits of entering into a JV transaction. Why consider a JV? JVs are a well-established feature of the oil and gas industry. They are typically less risky and are easier to unbundle than full organizational mergers. With the scale of organizations within the oil and gas industry, antitrust concerns and the importance of national energy security, JVs are a useful way of gaining the benefits of collaboration without the economic and political risk associated with a merger or other business combination. There are a number of drivers behind why JVs are used so extensively within the US oil and gas sector: вЂў Capital intensive: upstream projects can be too big for a single company (even a super-major) to finance on its own. Many of the larger liquid natural gas (LNG) and deepwater projects fall into this category. вЂў Supply chain optimization: downstream supply chains may be optimized across disparate geographies by pooling assets. Many of the refining JVs are based upon supply chain and market supply optimization for the various participants. вЂў Market positioning and portfolio optimization: pooling assets may allow the JV to develop a market-leading position in a particular geography (downstream) or product (chemicals) and enable a portfolio to be optimized across both asset pools, generating a value uplift from prioritizing larger assets. In an increasingly cost-focused climate, economies of scale are critical to success and partnering may help achieve this. вЂў Regulatory requirement: some countries require foreign companies to partner with local entities if they are to enter that market. вЂў Political sensitivity or energy security: this means that JVs вЂ” as opposed to acquisitions and takeovers вЂ” may be more appropriate. вЂў Risk concentration: the risk profile attached to large-scale exploration and production (E&P) projects is such that no single company may wish to take full exposure. вЂў Access to technology: complex or frontier developments may require proprietary technology that requires the owner to have a stake. вЂў Access to resources: the legal owner of resources may not have the capital or technological ability to develop them to their maximum potential. Entering into a JV may also allow access to complementary assets or reserves. Navigating joint ventures in the oil and gas industry 1 Past, current and future trends The past few years have seen high numbers of oil and gas JVs being entered into, particularly in the upstream segment, where the cost, risk and technology issues clearly favor a collaborative approach on the largest projects. Oil and gas JVs 2008вЂ‰вЂ“вЂ‰2011 Number of JVs 70 60 50 40 30 20 10 0 2008 Upstream JVs Downstream JVs 2009 Midstream JVs Oilfield services 2010 2011 through 15 May 2011 Source: IHS Herold The increase in the number of JVs in the last 18вЂ‰вЂ“вЂ‰24 months could be attributed to a number of different factors, including, in part, the recovery in oil prices, increased access to the credit markets, advances in technology and an increased global emphasis on exploration and development. Management of JVs is both risky and time-consuming. Significant research has been carried out on the subject of JVs and their performance. The results are mixed, with many studies suggesting that they have high failure and inefficiency rates: e.g., 30вЂ‰вЂ“вЂ‰70% of JVs have problems of inefficiency and bad performance, and about 50% of the JVs fail due to high cost (Kogut, 1988; Bleeke and Ernst, 1993). Other studies, however, show a failure rate of 30вЂ‰вЂ“вЂ‰61%, and show that 60% failed to start or faded away within five years (Osborn, 2003). Properly structured, however, JVs offer exciting combinations of resources, assets, capital, expertise and labor, and the right JV can optimize these to shape a dynamic growth strategy. 2 Oil and gas companies can be positioned somewhere along each of the following four continuums: Asset/reserve seekers Asset/reserve holders Low access to capital High access to capital Lagging technologists Leading technologists Low appetite for risk High appetite for risk If an oil and gas company is on the right-hand side of all four continuums, then it may have no need to partner and may wish to proceed with a project as a sole venturer. If, however, it is positioned toward the left-hand side of any of these continuums, then it may well be appropriate or even necessary for it to partner. In general, during a downturn and/or a flight from risk in the capital markets, companies may move significantly to the left on the capital access continuum, and may also have a low appetite for risk on the continuum. Conversely, as has been the case during the last 18вЂ‰вЂ“вЂ‰24 months, companies have moved significantly to the right on both the capital access continuum and the appetite for risk continuum. The recovery in the oil price to around US$100 per barrel has generally meant that there are now a broader range of potential projects that have become economically viable. These projects are in locations remote from the markets that they will supply, and, consequently, large-scale capital investment is generally required to develop and commercialize them. Again, these types of projects favor a collaborative approach. These factors likely have provided the necessary stimulus for JVs to return to the levels that we have seen in previous years. In the April 2011 Ernst & Young Capital Confidence Barometer, it was revealed that 37 % of oil and gas companies are seriously considering a JV in the next 12 months. Navigating joint ventures in the oil and gas industry The oil and gas sector is no stranger to joint ventures. TodayвЂ™s JVs, however, come in so many shapes and sizes that it can be difficult to decide on the optimal arrangement. 3 JV types JVs typically utilized within the oil and gas industry broadly fall into one of three categories: вЂў The full asset JV вЂў The full business JV вЂў The marketing alliance Full asset JV Full business JV Marketing alliance A JV entered into with regard to a specific set of existing asset(s) or to develop asset(s). These have tended to occur around upstream JVs, pipelines, refineries and increasingly now with LNG projects. The upstream/ full asset JV is the most commonly occurring type. A JV entered into to combine the resources of entire businesses to create marketing, supply chain, production and scale synergies. These have historically tended to occur with: A JV entered into with the intent of jointly marketing product(s), e.g., motor fuels retailers and convenience stores joining forces to combine their consumer offerings. Exploration Refining Development вЂў Downstream, chemicals and midstream businesses вЂў Oil field services companies within the upstream sector Exploration Exploration Development Upstream Upstream Production oil/gas Production oil/gas Production oil/gas LNG liq./re-gas Pipelines LNG liq./re-gas Pipelines LNG liq./re-gas Midstream Midstream Midstream Transportation Transportation Transportation Distribution Retail/ wholesale Refining Downstream Petrochemicals Development Upstream Pipelines 4 These types of JVs tend to occur in specific areas within the oil and gas sector. The lined boxes within each JV category highlight the areas that are more prevalent within the three main subsectors, upstream, midstream and downstream. This can be summarized in the graphic below: Distribution Distribution Retail/ wholesale Downstream Retail/ speciality Petrochemicals Distribution Refining Distribution Retail/ wholesale Downstream Retail/ speciality Navigating joint ventures in the oil and gas industry Petrochemicals Distribution Retail/ speciality JV phases and issues If JVs go wrong, then JV partners may lose money, credibility, proprietary technology, assets and management focus. In the following sections, we look at some of the key areas to focus on at each stage of the JV lifecycle to ensure that the major pitfalls are avoided. The four key phases in the JV lifecycle can be summarized as follows: JV planning Define the commercial rationale and identify partner(s) JV formation Build the legal and commercial structure JV operation Operate and manage the JV on an ongoing basis JV dissolution Wind up the JV 37% of the oil and gas executives surveyed believed that they would be making an increased number of strategic alliances over the next 12 months. Navigating joint ventures in the oil and gas industry 5 JV planning Once a decision has been made that a JV is the appropriate vehicle for a particular project or asset, there are a number of stages and processes that should be gone through. Commercial analysis of the JV Commercial analysis and modeling of the JV is a key step and should contain a number of scenarios with sensitivity analyses around key variables. These variables can be, in part: вЂў Financial (i.e., oil price, interest rates, inflation) Defining the scope of the JV вЂў Production/recovery-related (i.e., bpd, throughput) The first step is to clearly define the scope of the assets that will be the subject of the JV. Where the asset is upstream acreage or a particular oil/gas field, this step may be relatively straightforward. However, if the assets are a collection of existing businesses that form part of a broader business or supply chain, defining the scope may be more complex. It is, however, critical that the boundaries of the JV arrangement are clearly articulated and are understood by all of the JV partners and contained within the JV agreement. This process should include not only the definition of the physical assets but also the definition of the markets and potential customers that the JV is aiming to serve. This is especially important where a JV could potentially be in competition with the venturing partnersвЂ™ other business interests. вЂў Geopolitical (i.e., implications of a change in government, tax regimes) By thorough modeling of the financial implications of a range of scenarios, JV partners will understand the possible implications for the JV in terms of net present value and internal rate of return. This will help ensure that all partners are aware of and have considered a range of potential scenarios for the JV and are realistic about their expectations. By considering and discussing upside and downside scenarios in an open and honest manner, partners can anticipate potential difficulties and discuss how they would respond if that scenario should occur. These scenarios and anticipated outcomes can even be built into the legal agreement and can provide protection against future litigation, which may be costly for all sides and damaging to the business. Defining the legal, tax and financial structure Consideration needs to be given to the appropriate legal, tax and financial structure that the JV will assume. Prospective JV locations, jurisdictions, legal and tax-efficient operating structures should be evaluated to discover, at an early stage, operational restrictions imposed by applicable laws and regulations. If multiple options are being considered, such due diligence can be utilized to assess the pros and cons of each of the proposed locations and jurisdictions to produce a tabular comparison, with risk rating scores and weightings. Part of this process should involve a consideration of the tax implications for both the JV and the venturing partners, where the JV will be domiciled for tax purposes and where its main centers of operation and management will be located. This analysis should also include an assessment of the tax implications of the potential legal structures under consideration. 6 Navigating joint ventures in the oil and gas industry Defining the business strategy and plan A business strategy and development plan should be prepared for early discussion with potential JV partners. The plan may change over time as a result of discussion and negotiation with JV partners, but it is important that there is a clear, early view of the assets, geographies, markets, outstanding commitments, investment case/timings and growth targets on which to base discussions with JV partners and potential partners. This plan should also cover areas such as the proposed JV governance model and decision-making process. It is critical to get the balance right between allowing JV management enough autonomy to effectively manage the business while allowing the JV partners to maintain control over the operations and effectively determine the longerterm strategy and commitments of the JV. Partner identification and selection JVs are often complex, long-term arrangements. Trust, therefore, is critical to the success of the relationship. The early signs of whether your company and its partners are compatible will be evident during the negotiation process. A business strategy and development plan should be prepared for early discussion with potential JV partners. DonвЂ™t overlook the cultural aspects of a JV. Culture isnвЂ™t restricted to countries. Partner selection is a critical step and one that will determine the success of the JV. When JVs fail, it is often because of a breakdown in the relationship between the JV partners. This can be caused by a lack of trust, differing strategic objectives, and unrealistic or nonaligned expectations of what partners can expect from each other. Clarity and thoroughness of planning at this and the JV formation stage can mitigate the risk of disagreement in the JV operation stage. This is especially true when international oil companies are partnering with National Oil Companies (NOCs). Each needs to be aware of the othersвЂ™ aims and limitations. Shareholders and governments may have very different strategic aims and views on an investment, i.e., NOCs may well have social welfare obligations that may seem alien to an international oil company. The number of partners in a JV can be a critical determinant of the success. Smaller numbers of partners make it easier to manage the decision-making process and to align objectives and the strategic direction of the JV. It is important for JV partners to carry out due diligence on each other across a range of areas, including key financials, credit status, technical capabilities, management strength, existing commitments, outstanding litigation and prior JV performance. When a number of partners are being considered, it may be appropriate to have a scoring process covering all of the required partner criteria to assist in the selection process. Navigating joint ventures in the oil and gas industry 7 JV formation The JV formation process will see the development, negotiation and finalization of many of the outputs of the JV planning phase. Detailed location planning Planning and implementation reports on the chosen, or short-listed, tax and legal environment(s) that will host the JV will need to be completed. Reports should cover aspects such as: вЂў Required licenses вЂў Necessary regulatory approvals вЂў Environmental impact assessment requirements вЂў Governing law вЂў Corporate law and compliance requirements of any JV company and any shareholders or stakeholders in a JV вЂў Local employment law analysis вЂў Local asset, property and land ownership rights and requirements вЂў Applicable company law stipulations (such as nationality of general manager, board voting and shareholder voting and retaining of profits in-country) Financing of the JV Details of the JV financing will need to be discussed, agreed upon and finalized. This will include: вЂў Exact definition of contributions from each partner вЂў Value of contributions from each partner вЂў Capital structuring of JV (e.g., use of debt) The implications of the proposed financing will need to be assessed: вЂў Does the proposed jurisdiction allow the contemplated form of financing? вЂў Can security be enforced in theory? In practice? вЂў Is there, in fact, a working, transparent, local banking system that a foreign investor can keep working capital in without fearing for it? вЂў What are expropriation laws, protections and remedies? All of these questions will need to be considered and addressed. Financial reporting for the JV The integration of the JV financial reporting with the partnersвЂ™ statutory reporting requirements will need to be considered. There may be a need for the JV to provide local accounts for statutory reporting purposes, International Financial Reporting Standards (IFRS) and US or other Generally Accepted Accounting Principles (GAAP) accounts to meet the reporting requirements of the JV partners. The proportion of the JV investment and operator responsibilities of each of the venturing partners will determine whether the JV will need to be treated as an equity investment or consolidated within the partnersвЂ™ accounts. Clearly the need for consistency with the JV partnersвЂ™ accounting requirements will be greatest where the accounts need to be consolidated. Critical reporting issues, such as oil and gas reserves recognition by the various partners, will need to be discussed and clarified and the principles, if not the quantities, agreed. There may be critical areas of the JV that are of particular interest to the partners that may require additional due diligence to be carried out on behalf of some/all of the partners. One such example is the production management processes and output of a production sharing agreement. Where such issues exist it may be necessary for partners to consider putting in place additional assurance processes and mechanisms, such as a Statement of Standards for Attestation Engagements No. 16 (SSAE 16), to provide all JV partners with a high level of comfort regarding the robustness of the process and output. вЂў What is the tax treatment of debt financing? вЂў Does a limited resource project financing model work under the legal system? вЂў Is leveraged financing possible? вЂў Does the applicable law allow the free and easy taking of security in certain properties? 8 Navigating joint ventures in the oil and gas industry Management of legacy risk issues Dissolution options Where the JV is formed from existing assets, there will need to be a clear mechanism for ring fencing liability, risk issues, and tax contingencies that pre-date the formation. These items may include ongoing litigation, environmental cleanup liabilities and outstanding human resources (HR) liabilities (pension funding, redundancy costs, etc.). These legacy items will need to be attributed to the appropriate JV partner who вЂњownsвЂќ the potential liability and detailed within the JVs legal agreement. The JV partners need to be clear about what the JV dissolution strategy and options should be. There is a range of mechanisms that exist to enable partners to buy each other out should the need arise вЂ” e.g., вЂњRussian rouletteвЂќ or вЂњTexas shoot-outвЂќ clauses (see page 13). However, other scenarios should be considered and included within the legal framework of the JV. These scenarios could include, in part, the following: Use of proprietary technology Where the JV will use proprietary technology owned by one of the partners or the JV itself, the legal agreement between the partners should cover the usage of this technology. In addition to any patents or trademarks that exist, the agreement should identify the licensed users and the geographies where this technology can be deployed. Suspicions over perceived or real intellectual property theft are a common cause of friction between partners, but by dealing with these issues in a pre-emptive, thorough manner, the risks in this area can be largely mitigated. Dispute settling mechanism It is important that there is a clear dispute escalation and resolution process understood and agreed to by all of the partners. This may include defining escalation mechanisms in the JV itself, involving the partners as stakeholders and also referencing local and international laws. вЂў The inability of one or more of the partners to meet a cash call or unanticipated liabilities вЂў A number, but not all, of the partners wanting to sell the JV in its entirety вЂў Putting the JV into liquidation should the need arise Implementation of a partner review process As part of the ongoing JV review process, partners should consider the implementation of a regular review process where the performance of the partners is discussed and appraised in the context of the management of the JV. This will enable issues to be discussed, raised and resolved on a timely basis вЂ” as opposed to going unsaid and potentially escalating into larger issues that lead to a breakdown in the working relationship. The JV partners need to be clear about what the JV dissolution strategy and options should be. Navigating joint ventures in the oil and gas industry 9 JV operation Ensuring that the JV is structured and set up correctly is critical to the success. However, it is equally important that the JV performs in line with the partnersвЂ™ plans and expectations. Many of the problems that occur with JVs stem from performance issues that undermine the initial rationale for creating the JV. Organization design Creating the new JV management structure, policies, procedures and culture will be critical to success. Where the JV involves the combination of existing assets and organizations, this will involve decisions regarding whether to harmonize around the partnersвЂ™ existing policies, procedures and cultures or instead create a completely new set. The organization design needs to be sympathetic to the employees and ensure that they all feel part of the new organization. Change should be managed and communicated proactively. This will be more difficult where there are overlapping or duplicated roles and a need to simplify and reduce the structure and number of employees engaged in the business. Positioning senior and middle management from all the partners within the new organization is a critical activity. If one organization is seen to dominate the new management structure with little senior representation from the other partner, this may demotivate and destabilize staff from that partner. It is important to recognize and understand corporate culture differences within the partnersвЂ™ organizations. This will help the new leadership team to effectively manage and communicate with the new organization. It is important to bring the new leadership team together, create a shared identity, vision and purpose, and then focus on communicating and sharing this with all levels of the new organization. Where the JV is a new organization, starting with a blank piece of paper can potentially avoid legacy issues and inefficiencies. However, designing and populating the organization will consequently be more time consuming, and there may well be protracted partner discussions as to the appropriate operating structure and candidates for the key leadership roles. Where part or all of the JVвЂ™s management is provided by the venturing partner, due consideration needs to be given to either the duration and type of secondment or the transfer of employment contracts and employer obligations. Where management secondments to the JV are in place, succession planning for key roles needs to be an integral part of the HR management processes. 10 Design/harmonize business processes, technology and infrastructure Where the JV is a combination of existing assets, decisions will need to be made regarding whether there are overlapping assets in terms of office locations, information technology (IT) applications/ infrastructure and business processes. Where the JV businesses will operate relatively discretely from each other, this may be less of an issue вЂ” i.e., the combination of a sales and a production organization into a new JV may simply require that interface processes are put in place but the core processes, systems and office locations may remain unchanged. Where there is a need to integrate two vertically integrated businesses to realize synergies, certain issues will need to be addressed early in the JV operation phase. The combination of two vertically integrated organizations will result in a potential overlap in a number of areas: functional support (e.g., HR, finance, IT, legal, real estate management, procurement), IT applications/ infrastructure, office space, supply chain, suppliers and contractors. Such overlaps will need to be identified and plans put in place to rationalize the new organization and consolidate the overlaps. Where the JV is a new organization, however, all of these areas will need to be either developed or provided by the partners. Where the partners will be providing services to the new JV, contracts for the provision of these services and remuneration/consideration will need to be agreed upon, put in place and monitored. Creating the new JV management structure, policies, procedures and culture will be critical to the JVвЂ™s success. Coal seam gas: broadening the energy mix Meeting partnersвЂ™ financial and tax reporting requirements Appropriate involvement of partners in decision-making process The JV partners are likely to have different reporting requirements and time frames for fiscal and tax reporting. The JV partners may also have Sarbanes-Oxley, IFRS or other regulatory reporting requirements that, even though they may not be specifically relevant or necessary for the JV itself, need to be taken into consideration. All of these requirements will need to be communicated to both the other JV partners and the JV itself. JV partners will need to establish clear rules for maintaining control over the strategic direction of the JV and over key operational decisions that will significantly impact the JV. However, they must allow the JV management enough freedom to manage the organization on a day-to-day basis and not be weighed down by an overly bureaucratic and cumbersome decision-making process. This can be a difficult balance, and there will need to be a clear and well-understood delegation of authority between the JV partners and JV management. As previously mentioned, there may be key areas of the JVвЂ™s operation that may need to be subjected to additional assurance. This may take the form of a SSAE 16, JV partner right of audit or annual rolling audits with each of the JV partners taking turns to assure a specific process/output. A clear program of audit and reporting requirements, formats and timings will need to be agreed to and established. The timings of cash calls and distributions will also need to be carefully considered and agreed to in relation to the partners and the JVвЂ™s reporting timetable. The JV partners need to establish a regular series of governance oversight meetings with both the JV management team and with each other to monitor progress, track performance against strategic goals and review and update the agreed upon strategy. Partner capital management Where the JV receives capital funding from the partners in terms of either capital injection or assets, there needs to be a clear plan for the proposed timings and values of the partner capital investment in the JV and proposed timings for capital repayments. The capital repayment obligations need to be carefully evaluated against the cash flow projections for the JV to ensure that they are realistic and achievable. Navigating joint ventures in the oil and gas industry 11 New US federal income tax laws may affect the US oil and gas sector Proposed US federal income tax legislation may have a negative impact on the industry (including JV transactions within the US oil and gas industry) The US GovernmentвЂ™s proposed budget for fiscal year 2012 (Proposed Budget) includes the proposed repeal of certain federal income tax incentives currently available to certain oil and gas companies. On February 14, 2011, the Obama Administration released its Proposed Budget, which incorporated a number of provisions that, if enacted, would significantly affect the US oil and gas industry, and could dramatically affect JV transactions within the US oil and gas industry. In part, these provisions would: вЂў Repeal expensing of intangible drilling and development costs вЂў Repeal percentage depletion for oil and natural gas wells вЂў Repeal the domestic manufacturing deduction for oil and natural gas companies вЂў Increase the geological and geophysical amortization period for independent producers to seven years вЂў Repeal the exception to passive loss limitations for working interests in oil and natural gas properties In addition to provisions that would directly affect the US oil and gas industry, the Proposed Budget includes certain provisions that, if enacted or eliminated, may have a negative impact on the financial condition and results of operations of certain oil and gas companies, including, in part, the reinstatement of the Superfund taxes, repeal of the last-in/first-out method of accounting for inventories, modification of the rules for dual-capacity taxpayers and certain other international reform measures. 12 As many of the aforementioned incentives currently available to investments in US oil and gas plays play an integral role in a projectвЂ™s overall return, the repeal of all or a portion of the incentives could dramatically impact JV transactions within the US oil and gas industry. The US oil and gas industry was on the defensive for the better part of the 111th Congress, fighting numerous congressional attempts to eliminate tax provisions that benefit the industry in order to offset the cost of other provisions. Although the repeal of such measures has not been provided for in recent legislation, the situation requires continued monitoring to determine whether such proposals may be included in future legislation. New bonus depreciation provisions aim to spur growth by encouraging capital investment On December 17, 2010, President Obama signed into law H.R.В 4853, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the Act). Although it affects all industries, the Act generally extends and modifies the bonus depreciation provision under Section 168(k) of the Internal Revenue Code of 1986, as amended (the Code), and provides for the temporary 100% expensing of certain qualifying capital expenditures. These provisions have вЂ” and will continue to have вЂ” a significant effect on the capitalвЂ“intensive US oil and gas industry. The Act adds Section 168(k)(5) to the Code, under which certain taxpayers may qualify for a first-year, bonus depreciation percentage of 100% вЂ” effectively allowing immediate expensingВ вЂ” with respect to qualified property if certain requirements are met. The Act also extended the application of the 50% bonus depreciation allowance for certain properties. It is expected that cost recovery incentives relating to bonus depreciation should accelerate plan and equipment purchases in 2011 to take advantage of the 100% first-year bonus depreciation allowance. The changes should also provide some assurance to companies and act as a catalyst to spur growth by encouraging capital investment. Navigating joint ventures in the oil and gas industry JV dissolution JV dissolution may be a planned milestone event when a certain JV goal has been achieved or it may be a response to circumstances. Either way, it should be an event that has been foreseen, the options considered and provision for it contained within the JVвЂ™s legal framework. There are a number of scenarios or options that the JV partners may have to consider. Sale to a third party This is perhaps the most straightforward of the options: the JV partners agree to sell the JV in its entirety to a third party. Where the JV is a stand-alone entity, the impact on the partners will be minimal. Where the JV has significant linkages into one or more of the JV partnersвЂ™ businesses, it will be more complex. These linkages could involve the provision of certain services (e.g., technical support, research and development, IT) to the JV, or the JV could be integrated into the supply chains of one or more of the partners. The nature of the business relationships between the JV and the JV partners will need to be carefully assessed and planned for in the sale process to ensure that the sale does not damage either the JV partnersвЂ™ businesses or the JV itself. Legal assistance will be needed in the sales process, as there will be a suite of documents to provide for the share sale and purchase, the transfer of obligations, possible renegotiation of the joint operating agreement, possible amendments to the finance agreements and an assignment of guarantees, support documentation, direct agreements and rights and obligations. Separation of the JV with a return of assets and business to the JV partners is potentially the most complex JV dissolution mechanism. Sale to one of the partners Sale to one of the partners is a common outcome with many JVs. Often the sale process is governed by a вЂњRussian rouletteвЂќ or a вЂњTexas shoot-outвЂќ clause. A Russian roulette clause allows one JV partner to make an offer for another partnerвЂ™s share of the business, but the partner that has received the offer may then purchase the other partnerвЂ™s share under the same terms as those that were offered for the purchase of its share. A Texas shoot-out clause initiates a process where JV partners submit written sealed bids for the purchase of the JV and the highest bidder wins. Once again, consideration will need to be given to how integrated the JV is with the JV partnersвЂ™ businesses and how ongoing relationships between them should be governed. Separation of organization with sharing of assets to partners Separation of the JV with a return of assets and business to the JV partners is potentially the most complex dissolution. The longer the JV has been operating, the more likely it is that there will have been a вЂњblurringвЂќ of the JV partnersвЂ™ original inputs. There will need to be discussions and subsequent agreement around which assets (people, technology, licenses and property) go to which partners, valuation of those assets, and the appropriate settlement mechanism. These are likely to be complex and time-consuming negotiations. Again, where the businesses are integrated within the partnersвЂ™ businesses, the process will be more complex, and partners will need to consider the potential impact on their core businesses of reintegrating the JVвЂ™s assets back within their organizations. Consideration of this option should be part of the partner discussions, and provisions for how it would be managed should be contained within the JV agreement if there is more than a remote likelihood that this is a potential dissolution scenario. Navigating joint ventures in the oil and gas industry 13 Summary JVs are an inherent part of the oil and gas industry and are likely to remain so for the foreseeable future. When managed well, they can deliver real value to all stakeholders. However, when things go wrong, they have the potential to destroy shareholder value, with arbitration and legal proceedings being a costly, time-consuming distraction for the management of both the JV and the partners. There are a number of critical success factors for JVs: вЂў Transparency, openness and honesty between the partners вЂў Thorough financial and tax planning вЂў Consideration of all potential dissolution scenarios вЂў A robust legal agreement that contains provision for all of the above 14 Navigating joint ventures in the oil and gas industry Ernst & YoungвЂ™s JV services Ernst & Young has significant experience supporting JVs throughout the JV lifecycle. An overview of the services we provide in each of the phases is contained below: JV planning Ernst & Young services JV planning Ernst & Young services Defining the scope of the JV Financial, operational, commercial and tax due diligence Detailed location planning Market risk and quantitative advisory services Commercial analysis of the JV Valuation Financing of the JV Debt advisory Financial and business modeling Capital markets advisory Financial, commercial and tax due diligence Defining the legal and financial structure Defining the business strategy and plan Tax structuring Supply chain optimization Financial reporting and IT advisory Statutory audit and reporting Organization and governance Tax compliance and advisory Financial and business modeling SOX/J-SOX*/internal controls advisory Transaction integration Dispute advisory expertise with regard to clarity of business plan Partner identification and selection International tax structuring Financial reporting for the JV Coordination of the partner selection process Management of legacy risk issues Environmental, financial, tax and human resources due diligence and advisory Dispute settling mechanism Dispute advisory Dissolution options Transaction carve-out services Transaction integration services Environmental, financial, tax and human resources due diligence and advisory Implementation of a partner review process Internal audit Risk advisory *JapanвЂ™s Sarbanes-Oxley Navigating joint ventures in the oil and gas industry 15 Ernst & YoungвЂ™s JV services (continued) JV planning Ernst & Young services JV planning Ernst & Young services Organization design Organization design advisory Sale to third party Valuation Design/harmonize business processes, technology and infrastructure Governance advisory Investigations and dispute monitoring Risk advisory Environmental, financial, tax, operational and human resources due diligence and advisory Post-deal integration Supply chain and tax efficiency Shared services planning Finance transformation and consolidation Performance management Transaction carve-out service Sale to one of the partners Cost reduction Financial reporting advisory Transaction integration Tax advisory Transaction carve-out services IT design Separation of organization with sharing of assets to partners Risk advisory SOX/J-SOX* advisory Appropriate involvement of partners in decisionmaking process Risk advisory Partner capital management Debt advisory Governance advisory Internal audit outsourcing Capital markets advisory *JapanвЂ™s Sarbanes-Oxley 16 Investigations and dispute monitoring Environmental, financial, tax, operational and human resources due diligence and advisory IT effectiveness Meeting partnersвЂ™ financial and tax reporting requirements Valuation Navigating joint ventures in the oil and gas industry Valuation Investigations and dispute monitoring Environmental, financial, tax, operational and human resources due diligence and advisory Transaction integration Transaction carve-out services Navigating joint ventures in the oil and gas industry 17 Ernst & YoungвЂ™s Global Oil & Gas Center contacts: For more information about our service lines and our principal oil and gas-focused service offerings, please contact the below-referenced individuals, or your local Ernst & Young office. Dale Nijoka Global Oil & Gas Leader +1 713 750 1551 [email protected] Sanjeev Gupta Asia-Pacific +65 6309 8688 [email protected] Marcela Donadio Americas +1 713 750 1276 [email protected] John Avaldsnes Europe, Middle East, India and Africa (EMEIA) +47 51 70 67 40 [email protected] Enrique Grotz Argentina +54 11 4515 2655 [email protected] David Barringer Middle East +973 3961 7303 [email protected] Russell Curtin Australia +61 8 9429 2424 [email protected] Jeff Sluijter Netherlands +31 88 407 8710 [email protected] Carlos Assis Brazil +55 21 2109 1606 [email protected] Alexey Loza Russia/CIS +7 495 641 2945 [email protected] Barry Munro Canada +1 403 206 5017 [email protected] James Newlands South Africa +27 21 443 0489 [email protected] Raymond Ng China +86 10 5815 3332 [email protected] Andy Brogan United Kingdom +44 20 7951 7009 [email protected] ErnstВ &В Young Assurance | Tax | Transactions | Advisory About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 141,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of ErnstВ &В Young Global Limited, each of which is a separate legal entity. ErnstВ &В Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com How Ernst & YoungвЂ™s Global Oil & Gas Center can help your business The oil and gas industry is constantly changing. Increasingly uncertain energy policies, geopolitical complexities, cost management and climate change all present significant challenges. ErnstВ &В YoungвЂ™s Global Oil & Gas Center supports a global practice of over 8,000 oil and gas professionals with technical experience in providing assurance, tax, transaction and advisory services across the upstream, midstream, downstream and oilfield service sub-sectors. The Center works to anticipate market trends, execute the mobility of our global resources and articulate points of view on relevant key industry issues. With our deep industry focus, we can help your organization drive down costs and compete more effectively to achieve its potential. В© 2011 EYGM Limited. All Rights Reserved. EYG no. DW0101 1106-1264588 This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global ErnstВ &В Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor. www.ey.com/oilandgas