Philip Dunlap (partner), David Bowsher (partner) and Derek Anchondo (partner) are part of Balch & Bingham's Houston-based mergers and acquisitions team. They help their clients by providing insight into the current state of M&As in the oil and gas industry. Texas Lawyer spoke to them recently about the types of deals likely to occur in the coming months as well as what to anticipate in the future.

Can you tell me about the current state of mergers and acquisitions in the oil and gas industry?

Philip Dunlap: It's a surprise to no one that deal volume is down in 2020 and particularly in the oil and gas industry. However, depending on the sector of this industry, there will be opportunities for deals as everyone starts to reengage in the market. In the upstream and oilfield services sectors, the deals that will be pushed through this year are those where buyers think they are getting a discount or sellers are extremely motivated to sell (either out of necessity or desire to "hang it up"). I expect that lack of available debt will mean more strategic buyers closing deals than financial buyers. Although not traditional "oil and gas," I've seen a couple of deals in the retail gasoline market close this year. Those businesses are not tied to the price of WTI crude like the upstream and midstream sectors, so buyers and sellers are still working through traditional deal scenarios.

What does this mean for attorneys in the M&A practice area?

Dunlap: Because buyers will have less access to debt in their capital stack, M&A lawyers need to be prepared to think through different structures that allow buyers to retain some cash in the purchase. I expect more earnouts or contingent payments in deals, especially those that may be distressed or seen as risky businesses. Lawyers also need to be prepared to ask different questions in the due diligence process. Understanding how a target company has handled employees during the various stay-at-home orders (have they laid off or furloughed any employees?) and whether the target company received a PPP loan are new issues that need to be discussed in due diligence and negotiation.

What do they need to do in order to survive in this market or to position themselves to capitalize when they come through the other end?

David Bowsher: Deal lawyers need to be versatile and ready to handle deals with some hair on them. Many of the deals that get done in the coming months will likely involve a distressed seller, so M&A lawyers need to brush up on their bankruptcy skills. Even if the seller hasn't actually filed for bankruptcy, a bankruptcy filing may soon follow, and both buyer's counsel and seller's counsel need to anticipate that and structure the transaction accordingly.

What types of deals are likely to occur in the coming months?

Bowsher: There will likely be two principal kinds of deals getting done: big sales by large companies making a strategic exit from a region or an industry, and distressed acquisitions from vulnerable companies—either in or out of bankruptcy.

An example of the first kind of deal is Shell's recent divestiture of its Appalachia assets for $541 million to National Fuel Gas Co.—10 years after coming to Appalachia through its $4.7 billion acquisition of East Resources.

We're all too familiar with what the second kind of deal looks like.

What should we anticipate in the future?

Bowsher: In a word, consolidation—and not in a good way. Do not expect Exxon Mobil-type mergers. Instead, expect wounded or dying sellers to put their assets up for sale. Strategic buyers with lots of liquidity (there aren't lots of those) will certainly be interested in picking up assets on the cheap, and financial buyers with dry powder and a lot of intestinal fortitude (or those) will also be buyers.

The one bright spot may be natural gas producers. With the dramatic reduction in oil production, there's been a corresponding reduction in byproduct natural gas production by oil-focused producers. As the economy reopens, and as we get closer to cold weather, that reduction in supply should result in higher prices for natural gas and put natural gas-focused producers in good shape.

How do you see the energy industry in Texas playing out?

Derek J. Anchondo: The energy sector in Texas is as diverse as the different geographic regions across the state. We are fortunate to have, among others, oil and natural gas exploration and production, renewables, electrical and power generation, coal, crude oil refining, and liquefied natural gas plants. Texas uses more energy than any other state and accounts for almost one-seventh of the U.S. total consumption, according to the U.S. Energy Information Administration. While the hydrocarbon extractive sector is struggling at the moment, the broader energy sector in Texas remains active.

What does this market do for renewables?

Anchondo: The renewables sector in Texas has been strong for many years, even before the current decline in prices for crude oil and natural gas. According to statistics from the U.S. Energy Information Administration, Texas leads the country in wind-generated electrical power, producing almost three-tenths of the U.S. total. In 2011, Texas was the first state to reach 10,000 megawatts of installed wind generating capacity, and by the end of 2019 installed capacity was about 28,800 megawatts. Wind power accounts for nearly all of the electricity generated from renewable resources in Texas.

Texas also has some of the greatest solar power potential in the nation because of the high levels of direct solar radiation in the western part of the state. Texas was the country's sixth-largest producer of solar power in 2019.

It will be interesting to see, however, if the renewables market can maintain its growth as federal subsidies for wind and solar projects phase out.

Do you see the feds signing a big stimulus check for the oil and gas industry? If not, what do you think the Trump administration will do to bolster the industry?

Anchondo: There has been talk about signing some form of stimulus for the oil and gas sector, but nothing concrete has been drafted. Additionally, there is discord in Washington, D.C., and also the oil and gas sector itself as to whether a stimulus is the best option for the struggling industry.

One alternative has been to reduce royalty charges for drilling on federal lands. Since May 1, the Bureau of Land Management just approved 76 petitions to cut royalty payments for oil and natural gas produced on public lands in Utah. These approvals temporarily lower the royalty rates from the usual 12.5% to as little as 2.5%.

Philip Dunlap represents clients in mergers and acquisitions transactions across all industries. He counsels private companies, private equity funds and their portfolio companies in connection with strategic investments, joint ventures, mergers, acquisitions and divestitures, as well as on general corporate matters. Dunlap also serves as outside general counsel in matters including finance transactions, employee compensation, commercial contracts and employment agreements. He has represented clients in raising capital through private offerings and debt transactions, including real estate funds, private equity funds and early-stage, startup companies.

David Bowsher advises on oil and gas acquisitions and financing, mergers and acquisitions, and bankruptcy matters. His oil and gas practice centers around exploration and production companies with operations in Texas and elsewhere. The focus of his mergers and acquisitions practice is middle market deals, in which he has represented both buyers and sellers. Bowsher has deep background in all aspects of corporate restructuring, with particular experience in §363 asset sales in bankruptcy cases. Additionally, Bowsher's corporate and transactional experience includes securities offerings, financing transactions and capital raising efforts.

Derek Anchondo focuses his practice on domestic and international oil and gas transactions, energy transactions, and corporate transactions. He has experience in offshore and onshore upstream exploration and production activities, including conventional and unconventional resources, offshore and onshore drilling, the purchase or supply of crude oil or natural gas, joint operating agreements, production sharing agreements, host-country work contracts, the procurement of equipment or services, and engineering, procurement and construction.