Snapshot 2016: Upshots, Quick Tips, and What to Look for Next

Chris Hanslik, Lauren McLaughlin

April 20, 2016

HOUSTON, TEXAS. If you are doing business in Texas, you are inundated with daily news regarding the state of the energy industry. There are competing market forecasts, projected prices per barrel, anticipated reductions-in-workforce, and dueling supply-side analyses. The proliferation of information only adds to the uncertainty facing the sector and those reliant on it.

As with the City of Houston at large, there is not much that BoyarMiller touches that is not directly affected by the current energy climate, and its anticipated impacts going forward. While we are lawyers by trade, what makes us unique is our ability to deliver legal advice with a view towards practical business solutions. That requires an understanding of the current energy climate, and how to apply the law to that context in a way that gets our clients out ahead of the curve.

To that end, and informed by the fantastic speakers at our March 2016 Energy Breakfast Forum, the following are five observations—and related tips—we have gleaned from our legal practice, which at all times is carried out with a view towards the energy sector and the businesses affected by it.

Number 1 – The Force Is With The Supply Side

The data tells us that, throughout the energy downturn, there has been a strong demand for oil globally. Accordingly, analysts are focused on excess supply as the cause for the low price-per-barrel, and the driver of price (and growth) moving forward.

In general, the consensus wild card on global supply is foreign production, with countries like Iran threatening to increase production despite the low prices and correspondingly low returns. U.S. production, on the other hand, has shown a rational reaction to the recent prices-per-barrel—we have seen a staggering decrease in domestic production since its peak in March 2015. This domestic reduction leaves many optimistic about supply adjusting and price rebounding in the next 2-3 years.

In the meantime, we are observing the many effects of domestic E&P companies hitting the “pause” on production, where possible. Deep water drilling projects have continued due to the significant capital commitments—and potential production gains—involved. On land, however, we are seeing an increasing backlog of Drilled but UnComplete wells (DUCS or “ducks,” as referred to in the industry). These wells enable production companies to hold their drilling stakes until price recovers. They also eventuate a growing number of disputes between royalty owners and mineral lessees regarding, among other things, the lessees’ obligations of continuous development on the mineral lease. Whether and to what extent a production company is obligated to drill when it is not profitable—for the benefit of its joint venturers and/or mineral owners—is a hot button issue that we will continue to monitor.

Number 2 – Collections

When the going gets tough, the collection efforts get going. As in other times of economic downturn, we have seen the expected increase in disputes over payments for goods and services. While collection difficulties are no surprise in economic hard times, here are a few quick tips on how to anticipate—and sidestep—protracted collection efforts in the future:

  • Paper up a demand quickly. Soft negotiations are invaluable, but if you have an aging account receivable past the 90-day mark, we recommend putting together a written demand for the payment. These sorts of letters are commonplace in the industry, not a snub to your clients. Also, and in addition to formalizing pressure to settle the account, demand letters serve important legal purposes, like perfecting your right to potential attorneys’ fees if the dispute escalates down the road.
  • Take an hour or two to get familiar with the lien process. If you are in the business of providing or purchasing goods or services for mineral activities and/or real property improvements—whether such are for drilling an oil or gas well, the construction of a chemical refinery, or otherwise—it is worth sitting down with an attorney to gain an understanding of how and when to use or get rid of a lien. Liens are not appropriate in every context, but they are an important last resort for unpaid subcontractors, materialmen, and mechanics. They also present a significant encumbrance on the property owner, and expose a general contractor to collateral liability. Whatever side you are on, understanding how to quickly leverage—or invalidate—a lien is a powerful tool to have.
  • Flexibility works. We have seen—and encouraged—a number of flexible and creative payment arrangements to facilitate the specific realities confronting suppliers and purchasers alike. Papering up an alternative payment arrangement that works for both sides allows all parties to avoid costly disputes and cultivate a lasting business relationship going forward.

Number 3 – Labor Issues On The Up

Another thing on the rise in times of market downturn are labor and employment issues. Layoffs, M&A activity, and other cost-cutting initiatives spike a more frequent ingress and egress of employees. One collateral effect of this is that our clients are having to pay increased attention to issues surrounding employee confidentiality, non-compete, and non-solicitation obligations. If you are an employer concerned about departing employees, some steps to ease your mind could be (i) reviewing your employment agreements to ensure the enforceability of the confidentiality, non-competition, and/or non-solicitation provisions contained therein; and (ii) making it a practice to have each departing employee sign a statement that they have returned all confidential information, including client contacts. If you are a departing employee concerned about a former employer, be aware of the obligations in your employment agreement and the ways to minimize their impact on your activities going forward.

Number 4 – The Effect On Houston Real Estate

Houston real estate is feeling the ripples of the energy downswing as well. We are seeing an increase in vacancies in commercial office space and, particularly on the West side of town around the Energy Corridor and in the Woodlands, a dip in residential housing prices. However, the situation is far from bleak. Mixed-use commercial projects continue to roll out, quite successfully. We are also seeing a decline in industrial vacancies, as industries such as petrochemical and steel pipe manufacturing continue to thrive in Houston. The Medical Center and Houston’s bio-technology scene also do their part in sustaining occupancy of commercial real estate spaces. Globally, the biggest upshot we see at the intersection of the energy downturn and real estate is the rise of the flexible leasing arrangement. Owners should be on the look-out for increasing subleasing arrangements and shorter lease terms, as lessees feel the crunch and anticipate it going forward.

Number 5 – The Resilients

Perhaps just as interesting as the market downtrends are the numerous companies managing to successfully weather the storm. Much of this is the result of a learning curve. While the 2008 downturn was a global credit crisis rather than industry-specific, we are seeing fewer bankruptcy filings in the energy sector now than in 2008 because of the lessons gleaned in that period.

In addition, although there has been a decrease in energy M&A activity lately, we are seeing larger consolidations with a view towards providing fully integrated services. The Houston Business Journal’s Suzanne Edwards recently gave the example of the Schlumberger-Cameron deal, which enabled Schlumberger, now in possession of Cameron’s equipment fleet, to become a “one stop shop for customers” and minimize the use of various independent contractors. While the majors may continue to move towards life-of-field services offerings, small to medium firms providing specific technology, environmental, and other services are intact and will continue to rebound as the market does.

In general, we view the resiliency demonstrated by the energy market—and the Houston labor and real estate markets so affected thereby—as a positive sign for the coming years. In the meantime, our focus remains on gathering information, minimizing uncertainty, and navigating this climate to our clients’ best advantage.