One pumped hydrocarbons out of the ground; the other had a way of moving them to market.
Fate—or more likely, shale—brought these companies together and soon enough they were both standing in the same oil (or gas) field, ready to declare their project intentions to a judge, er, team of lawyers and make their joint venture (JV) official.
But funny things can happen in a relationship, even a sustainably profitable one.
“I worked years ago on an extremely successful joint venture in the energy space between two parties and it was incredibly profitable but their core philosophies at the corporate level diverged,” Cliff Vrielink, co-managing partner of Sidley Austin’s Houston office and co-leader of the law firm’s global energy practice, told Hart Energy. “One party wanted to grow the business; the other wanted to grow other parts of the business. It just came to the point where they sold it and they each took their 50% of the capital and pursued different strategies.”
And they were a perfect couple!
“Right now, the volatility in the marketplace is a huge challenge for any investor in the North American energy patch, be they housed within a JV structure or not,” Greg Haas, director of integrated energy services for Stratas Advisors, told Hart Energy. “If prices, margins and differentials erode, production and flows could be curtailed and the JV may see its fortunes wither.”
For want of a better term, the JV partners should have a prenup—a clear set of goals for the venture’s end game:
- Will one partner buy out the other?
- Will both seek to monetize via a sale to the public or a third party entity?
“Conditions change and partners will need to remain flexible,” Haas said, “so these questions may bedevil even the closest of partners in good times, bad times or in-between.”
A Good Fit
Companies that pursue JVs usually fall into one of two categories, Vrielink said. Either they are industry players with different strengths or complementary strengths, or strategic pieces that fit together well; or a financial investor with capital that joins with an industry player possessing assets.
“A joint venture from a legal perspective is an unclear term because it can have so many different variations to it,” Vrielink said. “What you’ve started seeing since more recently is that the producers will recognize that, from a capital deployment perspective, it’s advantageous to have somebody else build and own the midstream but they also realize that their production is a key part of the value of that midstream asset.”
For example, he said, a producer is working some shale acreage and a midstream player shows up with an offer to build out the infrastructure and bring production to market. So far, everything’s cool; they just work together, right?
But then the midstream player decides to move on (“it’s not you, it’s the Eagle Ford”) and sell the midstream assets for a large multiple on investment. The producer sees the increased value of the midstream assets and realizes that it was largely dependent on the oil and gas produced.
“In cases like that, we started to see some producers say, ‘we would like to participate in the midstream as well,’” Vrielink said. “‘We would like to own some portion of it or we would like to invest some capital in it or we’d like to figure out some way so we could really align both of us.’”
Matters Of Trust
While the marriage analogy might seem a bit simplistic in the arena of corporate negotiations, it is relevant because companies are run by people.
“I think it takes a level of trust between the two parties and a certain level of commercial alignment,” Vrielink said. “People will make rational decisions that make sense for both parties. The reason it’s so difficult, of course, is that people’s priorities and expectations can change over time and the same, of course, is true for companies.”
Then again, the market changes, too, he said, which makes it difficult for a 50:50 venture to work in the long run. When there are three or more parties involved, most JVs work out a strategy in which one party makes operational decisions and the others occupy the roles of investors.
That would be part of the agreement establishing the JV, but other stressors develop over time and require different mechanisms. One that affects lots of relationships: money.
“If the venture requires some major capital investment, either to remain viable or to take it to another level of profitability or scope, and some partners want to do it and others don’t—maybe everybody wants to and some can’t afford it or just can’t,” Vrielink said. Typically, a dilution mechanism is proposed so that ownership is ratcheted down for partners that don’t invest more.
“The real stressors are, what provisions do you have in the agreement that give a party an absolute blocking or veto right?” he said. “For instance, if they are deciding whether or not to expand, the decision maybe gets put on hold, but in the meantime, everybody can still operate the project and still function.”
That can be a fairly critical provision. Without it, a game of chicken can theoretically ensue in which one partner can virtually hold the system hostage to force agreement from another. That doesn’t happen much, he said, because the availability of capital right now makes it easy to drop out of a venture and compels many to be reasonable to keep a good thing going.
For those considering a JV, the abundance of capital makes now a good time.
“I think you’re seeing joint ventures a bit more just because there is a lot of capital in the marketplace now and there are lots of people looking for opportunities,” Vrielink said. “I think that’s leading people to be even more creative than they have been in the past because to find the better opportunities you have to be creative. I think that’s also leading people to be willing to put together some ventures and do some things that historically they might never have pursued.”