CHAPTER 13 BUYING OR SELLING A MIDSTREAM ASSET

• Jurisdiction: United States

Oil & Gas Agreements: Purchase & Sale Agreements
(May 2016)
CHAPTER 13
BUYING OR SELLING A MIDSTREAM ASSET
Patrick J. Beaton
Partner
Locke Lord LLP
600 Travis Street, Suite 2800
Houston, Texas 77002
(713) 226-1602
Thomas E. Knight
Partner
Locke Lord LLP
701 8th Street, N.W., Suite 700
Washington, B.C. 20001
(202) 220-6922

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PATRICK J. BEATON is a Partner with Locke Lord LLP in Houston, Texas. He practices in the areas of oil, gas, and energy, with an emphasis on upstream and midstream oil and gas transactions. He has extensive experience in business and commercial transactions on behalf of both privately held and publicly traded energy companies. Patrick has represented and assisted in the representation of numerous oil and gas exploration and production companies in both the acquisition and divestiture of producing properties or equity interests. He has represented midstream companies in the negotiation of various contracts. He has assisted in the representation of several companies in various oil and gas litigation matters and the resolution of oil and gas disputes. He has also helped represent various parties in complex transactions involving the monetization of interests in producing properties and reserves, including the review of associated exchange, balancing, and transportation agreements.

THOMAS E. KNIGHT is a partner in Locke Lord LLP's Energy practice group. Tom represents several of the leading natural gas, crude oil, and products pipeline companies, natural gas storage companies, and producer interests on regulatory matters before various agencies, including the Federal Energy Regulatory Commission, Department of Energy and Department of Transportation. He also advises such clients on general contract, tariff, rate, permitting, project development, and project financing matters. Recently, Tom represented NET Mexico Pipeline Partners in its successful construction of a large diameter intrastate pipeline for the export of natural gas to Mexico. Tom also is regulatory counsel for Lake Charles LNG and the Alaska LNG Project, two of the most important liquefied natural gas export projects in the United States. Within the last year, Tom served as lead counsel for Florida Gas Transmission, Transwestern Pipeline, and Sea Robin Pipeline in their respective Natural Gas Act Section 4 general rate cases at the Federal Energy Regulatory Commission. As a member of the Firm's Corporate and Securities practice group, Tom represents a wide range of clients on transactional and general corporate matters, including as the long-time lead transaction counsel for Cable One, Inc., a publicly traded top-10 cable company.

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TABLE OF CONTENTS

I. Overview

II. Defining Midstream Assets

A. The Midstream Sector

B. Midstream Assets

III. Drivers of Midstream Acquisition and Divestiture Transactions

A. Monetization of Assets

B. Core Business of Exploration and Production

C. Private Equity and Traditional Midstream Opportunities

IV. Midstream Transaction Structures

A. "Company Peals" vs. "Asset Deals"

B. Joint Ventures.

V. Main Transaction Agreements

A. Preliminary Agreements: Confidentiality Agreements and Letters of Intent

B. Midstream Asset Purchase and Sale Agreements

C. Stock/Membership Interest Purchase Agreements

D. Gathering and Processing Agreements

E. Construction, Management and Operating (CM&O) Agreements

VI. Diligence Concerns

A. Identification of the Assets

B. Material Contracts

C. Land and Right-of-Way Review

D. Environmental Review

VII. Representations and Warranties

A. Capital Commitments

B. Material Contracts

C. Imbalances

D. Inventories

E. Compliance with Law. Regulatory

F. Real Property Representations

G. No Undisclosed Liabilities

I. Overview.

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This paper is intended to provide a very broad overview of some of the common issues in the acquisition and divestiture of midstream assets, and emphasize some of the similarities and differences between midstream and upstream oil and gas purchase and sale transactions. After briefly describing the midstream sector and midstream assets, this paper will look at some of the drivers of midstream transactions, and some of the common structures and types of agreements used in such transactions. It examines a few of the diligence issues involved in midstream transactions, certain representations and warranties that may be used in part to address such issues, and discusses some of the governmental approvals involved in the acquisition or divestiture process.¹ While what is entailed in any particular midstream transaction can vary dramatically (from a small disposition of a discrete asset such as a private pipeline up to the acquisition of a large midstream company) thus making it difficult to categorize a "typical" midstream transaction, this paper looks at some of the issues common to many midstream transactions.

II. Defining Midstream Assets.

A. The Midstream Sector.

1. The oil and gas industry is generally considered to be made up of three sectors: "upstream," "midstream" and "downstream." Although the boundaries of the three sectors may not always be clear or consistent, the midstream sector is generally considered to be made up of the activities bridging the gap between the upstream exploration and production (E&P) activities and downstream activities such as refining, processing,

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marketing and delivery of natural gas or refined petroleum products to the end user.²

2. Natural gas midstream activities tend to be more complex than crude oil midstream activities in part because, in many cases, when natural gas is produced at the wellhead, it contains contaminants (such as water vapor, hydrogen sulfide, carbon dioxide and other non-hydrocarbon gases) and natural gas liquids (such as ethane, propane, butane, and pentanes), and often must be treated and/or processed to some extent to meet the specifications required for transport on high-pressure long distance interstate pipelines. ³ Different reservoirs or producing areas produce gas of different qualities, so not all gas will necessarily need to be treated and processed in the same manner. For example, natural gas produced from coal seams usually consists of mostly methane and carbon dioxide, with almost no natural gas liquids, meaning it can meet pipeline specifications with treating for carbon dioxide but would not need processing to remove liquids. Additionally, certain activities may be performed in close proximity to the wellhead by a producer, such as oil-gas separation, condensate separation and dehydration, and may be thought of as "upstream" processes depending upon where and by whom they are performed. For example, in some cases, the use of field facilities known as "skid-mounted" plants can be used to dehydrate and decontaminate produced gas to pipeline specifications rather than sending gas to a central processing plant. ⁴ Such field facilities tend to change hands as part of an upstream transaction, rather than a midstream acquisition or divestiture. Generally, natural gas midstream activities are considered to include the following:

a) gathering, or the physical movement of gas from the well or central delivery point to a treating facility, processing plant, or pipeline for transportation, often involving compression in the field or in processing plants;

b) treating, or the removal of contaminants such as hydrogen sulfide, nitrogen or carbon dioxide;

c) processing, or the removal of the combined stream of natural gas liquids (often referred to as "raw make" or "Y-Grade") from the natural

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gas stream in a natural gas processing plant by use of cryogenic processing or other means, with the resultant pipeline-quality "residue" gas being available for delivery to a pipeline transporter or marketer;

d) fractionation, or the process of separating the individual natural gas liquids components from the raw make or Y-Grade such as ethane, propane, butane, and pentanes and heavier components, for further transport, marketing and/or sale; and

e) transportation of the residue gas to market via intrastate or interstate pipelines, possibly including storage, marketing and related services.

3. Because crude oil can usually be transported by truck, rail or pipeline from the lease (e.g. from a Lease Automatic Custody Transfer or LACT unit) or central delivery point directly to a refinery without the need for extensive intermediate processing and treatment, the crude oil side of the midstream sector tends to be more straightforward than the natural gas side. Traditionally, while the major oil companies either sold production at the well or used their own crude oil transportation to move production from the lease to refineries or other major hubs, the independent producers used a network of brokers, pipelines and trucking companies to move their production. ⁵ However, as crude production increased in shale areas, this side of the midstream business grew in size and complexity as both established midstream companies expanded their facilities and services offered in crude oil and condensate gathering and transportation, and new, smaller private-equity backed portfolio companies and producer-midstream company joint ventures developed facilities in crude production areas. ⁶ Crude oil and condensate storage and marketing services are often considered to be within the suite of midstream services in addition to gathering and transportation services.

4. A necessary step in any midstream transaction is reviewing which governmental authorities have jurisdiction over the facilities. For instance the regulatory analysis for natural gas midstream facilities under the jurisdiction of the Federal Energy Regulatory Commission (FERC) are vastly different from the analysis for FERC-jurisdictional crude pipelines.

a) Natural Gas. With respect to natural gas, FERC's governing statute is

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