INDUSTRY AFFAIRS REPORT
July 18, 2011
This is the 71st report from the Industry Affairs Committee of OCAPL. The opinions expressed herein are those of the writers and not those of OCAPL, AAPL, former clients, or our current employers. The objective of this exercise is to alert OCAPLmembers to (a) the activities of organizations and governments that affect the way we do business, (b) public opinion that shapes legislation, and (c) judicial decisions relating to energy issues. Hopefully, this knowledge will provoke each of us to recognize the critical role we, as LANDMEN, play in sustaining America’s standard of living and thereby feel compelled to respond to the challenges before us. Your comments regarding this effort are always welcome.
The Committee at Work: Current members in the OCAPL Industry Affairs committee include Phil Jones, Brandt Vawter, Brett Hudson, John Raines, and Jack Rayburn. If you would like to participate in the committee’s effort, we would be pleased to hear from you.
Local OCAPL member produces video in hopes of advancing CNG vehicle transportation.
Ron Mercer and Bob Hammack teamed-up to make “Pump Fiction”, a video available on YouTube. Copy and paste the following address in your browser to view Pump Fiction: http://youtu.be/cJOZ--5d_68
Pollution from drilling in Fort Worth isn’t harming health, study says
By Elizabeth Souder
Dallas Morning News
Natural gas drilling and production in Fort Worth doesn’t generate enough air pollution to cause adverse health effects, although some facilities don’t comply with environmental rules.
Those are the findings of an air quality report commissioned by the city of Fort Worthand released Thursday. The city, with its 2,000 natural gas wells, is in the heart of the Barnett Shale natural gas field, where residents, drillers and politicians have argued about making sure operations are safe.
“The measured and estimated air pollution levels did not reach levels that have been observed to cause adverse health effects,” the report states, and “the measured benzene and formaldehyde levels in Fort Worth were not unusually elevated when compared to levels currently measured by TCEQ [Texas Commission on Environmental Quality] elsewhere in Texas.”
Further, 98 percent of the emissions came from pollutants with low toxicities, such as methane, ethane, propane and butane, the report states.
Five sites reviewed by the study — a processing facility, three compressor stations and a well pad — emitted more pollution than allowed. Most natural gas sites do not emit enough pollution to require a permit, but those five sites “had overall emission rates that exceed regulatory thresholds that are supposed to trigger certain permitting requirements,” the report states.
The study is the most comprehensive publicly available information about pollution caused by new drilling techniques. It could help other cities in shale plays around the world understand pollution in their own areas.
The study could be of particular interest to members of a task force that will recommend new drilling ordinances for Dallas.
“This will be a significant contribution to the understanding of how much emissions are being released from natural gas operations,” said Ramon Alvarez, a senior scientist with the Texas office of the Environmental Defense Fund and a member of the Dallas task force.
The report “shows us some things that are working,” said Bruce Bullock, another member of the task force and director of Southern Methodist University’s Maguire Energy Institute.
“At the same time, it shows us — albeit some relatively minor things — some things we need to make sure are done from a housekeeping standpoint,” he said.
According to the report, Fort Worth’s rule that wells must be at least 600 feet from homes and businesses is adequate. Still, the report urged city leaders not to be complacent.
Eastern Research Group Inc., which conducted the study, said it “fully supports implementing all reasonable precautions to reduce emissions from the well pads and compressor stations,” and it recommended equipment the operators could use to cut emissions.
The most common sources of emissions were pneumatic valve controllers at well pads and compressor stations, the report states. And at a few sites, equipment had malfunctioned or corroded, or hatches on top of tanks were left open, allowing pollutants to escape.
“I was actually rather pleasantly surprised by reading the report,” said Bill Godsey, founder of GeoLogic Environmental Services, which helps companies comply with environmental regulations. “I was really expecting something a little different than what came out.”
Clashing Views on the Future of Natural Gas
By ARTHUR S. BRISBANE, Editor- The New York Times, 7/17/2011
A NEW YORK TIMES article last month, “Insiders Sound an Alarm Amid a Natural Gas Rush,”warned across two columns at the top of the front page that high expectations for companies drilling shale gas might be headed for a fall. It was the kind of story you wish The Times had written about Enron before it collapsed. Or about Bernard Madoff.
The June 26 article, written by Ian Urbina, was clearly intended to offer that kind of signal and specifically invoked “Enron,” “Ponzi schemes” and “dot-coms” in the early paragraphs.
Raising the prospect of a fall, though, is a journalistic gamble. Adding to the risk, the story painted its subject with an overly broad brush and didn’t include dissenting views from experts who aren’t entrenched on one side or another of the subject. After publication, critics jumped in with both feet.
A UBS investment analyst, William A. Featherston, and colleagues issued a reportsaying that the article, part of The Times’s continuing “Drilling Down” series on shale gas, was “unduly harsh,” failed to recognize the “enormous” growth of shale gas in recent years and offered no “credible source and context.”
An M.I.T. natural gas study group released a statement taking issue with The Times’s analysis of shale gas economics, well productivity and other matters. Other commentators assailed the sourcing used to support the article’s premise: only two people named in the text, plus a large trove of e-mail from people whose names were redacted by The Times.
A countervailing surge of support for the article, meanwhile, has come from environment-minded readers. And four Democrats in Congress have called on public agenciesto examine some of the issues that Mr. Urbina raised in that story and one the next day.
The reaction underscored the stakes involved in shale gas. Hailed as a cleaner replacement for coal, it is extracted using a relatively new, water-intensive drilling technique commonly called fracking. As The Times documented in an earlier installment of “Drilling Down,” there is concern that fracking could wreak environmental havoc in shale basins across the country.
I asked Mr. Urbina and his editors to address complaints about the article, starting with the broad objection that it cast doubt on shale gas without mentioning that it had grown rapidly as an energy source — rising from 2 percent of all natural gas production in 2000 to 23 percent 10 years later, which the M.I.T. group called a “paradigm shift.” The journalists said The Times had already cited the big picture of a gas boom in the “Drilling Down” series opener back in February and had thoroughly covered it elsewhere.
I also asked why The Times didn’t include input from the energy giants, like Exxon Mobil, that have invested billions in natural gas recently. If shale gas is a Ponzi scheme, I wondered, why would the nation’s energy leader jump in?
Mr. Urbina and Adam Bryant, a deputy national editor, said the focus was not on the major companies but on the “independents” that focus on shale gas, because these firms have been the most vocal boosters of shale gas, have benefited most from federal rules changes regarding reserves and are most vulnerable to sharp financial swings. The independents, in industry parlance, are a diverse group that are smaller than major companies like Exxon Mobil and don’t operate major-brand gas stations.
This was lost on many readers, including me. Michael Levi, a senior fellow for energy and the environment at the Council on Foreign Relations, wrote that the article “repeatedly confuses the fortunes of various risk-hungry independents with the fortunes of the industry as a whole.”
He told me he hadn’t realized that the report was focused on independents and read it more broadly, adding, “If I didn’t know they were talking about certain independents, then Times readers — who don’t know what an independent is — they aren’t going to know what they are talking about either.”
This confusion stems from the language in the article, which near the top referred to “natural gas companies” and “energy companies.” The term “independent” appeared only once, inside a quoted e-mail.
The article’s sourcing has also been questioned. The Times presented a large array of e-mails — some recent, some three and four years old — from geologists, analysts, energy executives and others who expressed the belief that companies were exaggerating their prospects. The Times excised the names but not the company affiliations from the e-mails. It was from this trove, which became part of a 487-page online document collection for readers to peruse, that the hot-button references to dot-coms, Ponzi schemes and Enron were pulled for the text of the article.
The two named sources in the story, Art Berman, a geologist from Houston, and Deborah Rogers, a farm owner from Fort Worth, say they provided some of these e-mail conversations.
Mr. Berman, who was described appropriately as “one of the most vocal skeptics of shale gas economics,” told me he had traveled the country giving presentations questioning some companies’ claims for shale gas prospects. It’s clear that some of the e-mails in The Times article came from people who had heard him speak.
Ms. Rogers, a former stockbroker, was described as serving on an advisory group of the Federal Reserve Bank of Dallas. What was not mentioned was that her primary business was a small agricultural operation and that she had clashed with Chesapeake Energy, a leading shale gas producer, over its drilling on land next to hers. Mr. Bryant told me it wasn’t necessary to mention this because the issue had not resulted in litigation and Ms. Rogers was clearly presented as an industry critic.
My view is that such a pointed article needed more convincing substantiation, more space for a reasoned explanation of the other side and more clarity about its focus. The Times journalists countered that their reporting consisted of more than three dozen interviews with industry experts, and analysis of S.E.C. filings from two dozen companies and data from more than 9,000 wells. The Times also published several dozen e-mails from industry officials and federal regulators voicing concerns.
“The article challenges conventional wisdom and a powerful industry, so we expected criticism,” said Richard L. Berke, the national editor. “But it is deeply sourced, meticulously reported and measured, and we would not change a word.”
No question, the article challenged conventional thinking, and perhaps some of the shale gas independents will eventually founder. But the article went out on a limb, lacked an in-depth dissenting view in the text and should have made clear that shale gas had boomed.
SEC probe of US-listed Chinese firms hits Great Wall
U.S. investors had risked billions of dollars on hundreds of companies based in China – under a belief they were subject to U.S. rules when they sell and list shares in the United States – but a lot of that money has gone up in smoke, according to a July 10 Reuters report.
According to the news agency, the accounting blowups have humbled some prominent American investors such as top hedge fund manager John Paulson and former AIG CEO Maurice “Hank” Greenberg, spawned lawsuits and prompted a broad investigation by U.S. regulators.
Since March alone, more than two dozen U.S.-listed Chinese companies have announced auditor resignations or accounting problems, and there have been similar blowups in Canada.
Regulators and exchanges also have appeared flat-footed in the face of the growing scandal.
U.S. laws, including the sweeping 2002 Sarbanes-Oxley reform act meant to root out accounting fraud, lose some of their power with Chinese-based entities. The U.S. has no extradition treaty with China and the evidence gathering process in China is impeded by state secrets laws.
“The Chinese accounting problem has been festering for a long time,” said Duke University law professor Jim Cox, who serves on a standing advisory group of the Public Company Accounting Oversight Board, which was set up under Sarbanes-Oxley to oversee accounting firms, including doing thorough inspections of their work.
Thwarted by state laws?
“It's going to get worse before it gets better,” said Cox, who faults the U.S. Securities and Exchange Commission for not taking quicker action.
In particular, he said, the SEC has been slow to tighten oversight of U.S. shell companies acquired by Chinese firms through so-called “reverse mergers” to gain access to U.S. capital markets without having to go through an initial public offering.
SEC officials acknowledged problems with inspecting the accounting records of China-based companies well over a year ago at a meeting of the PCAOB advisory group, he said.
Meredith Cross, head of corporation finance for the SEC, said the agency has stepped up its reviews of Chinese reverse merger firms over the past year.
“We’re currently thinking through whether there is more that we can do,” Cross said.
A year ago, it launched a cross-border working group to review issues with Chinese reverse mergers and other companies with substantial foreign operations.
Officials from the SEC and PCAOB are holding talks with counterparts in Beijing this week in an attempt to get inspection access to Chinese auditors for U.S.-listed companies as one way to get on top of the problem.
But regulators said there is a core problem with tackling the reverse merger question head on because mergers come under state rather than federal law.
“We don’t have a way to say, ‘you can’t do reverse mergers,’ ” said the SEC’s Cross. “Because the issue of whether someone can merge is not an SEC question, but a matter of state law, it's not something where we could just wave a magic wand and say, 'we're not going to let reverse mergers happen anymore.’ ”
She did, though, note that such firms were bound by reporting requirements once they were listed.
The SEC also has resource constraints, she said, with about 350 people in its corporation finance division reviewing financial reports of more than 10,000 public companies. It has, though, been devoting more resources to the reverse mergers problem, she noted.
Further complicating matters, the SEC’s Chinese counterpart, the China Securities Regulatory Commission, has no enforcement authority over many of the companies accused of fraud because they only sell shares in the United States.
Like other securities regulators, the CSRC has limited resources, said former SEC chairman Christopher Cox. “When triage is the name of the game, it's natural that the home country’s priority is protecting its own citizens.”
The SEC has brought several actions against China-based issuers in recent years. In most cases, action consisted of suspending trading or revoking companies’ registration, though more severe penalties were also pursued.
China Energy Savings Technology Inc and its managers were ordered by a federal court in 2009 to pay a US$34 million judgment after being charged with a stock manipulation scheme by the SEC.
Chinese courts typically do not enforce U.S. judgments, though at least US$4 million will be recovered in that case because the SEC froze assets in the United States.
Accessing work papers difficult
Accounting misconduct fell dramatically in the United States after authorities cracked down on corporate crime in the wake of the Enron and WorldCom frauds. A section of Sarbanes-Oxley that made it a felony for executives to certify false financial statements was one big deterrent.
That provision applies to companies that sell securities in U.S. markets, whether they are based in the United States or another country, but few Chinese executives fear being led away in handcuffs because of the lack of an extradition treaty, lawyers said.
“If you’re a CEO of a company based in China and sign a false Sarbanes-Oxley certification, it’s very difficult for the U.S. government or Justice Department to charge you with that crime, indict you and bring you to justice,” said Phillip Kim, attorney at the Rosen Law Firm. “There are no treaties that provide for that.”
Some Chinese executives resist answering to U.S. authorities at all, auditors said.
“They believe they should not have to respond if they feel any request is too intrusive and believe that they can tell the SEC no,” Mimi Justice, head of Deloitte's forensic and dispute practice in Orange County, California said at a recent conference in Los Angeles.
Getting auditors’ work papers – crucial evidence in many accounting frauds – has been especially difficult. Many accounting firms would like to hand over records but fear violating China's state secrets law, attorneys said.
“They have a real dilemma on their hands as to how to respond to the U.S. regulators when to do so might expose them to criminal sanctions in China,” said Alan Linning, a partner at Sidley Austin in Hong Kong.
Crashing share prices and the publicity surrounding them do, of course, have their own Darwinian way of making investors more vigilant. There is, for example, much less appetite for new Chinese listings now, and many of the earlier listings are little more than penny-stock wreckage.
But to some that just begs the question – is the action from the regulators too little, too late?
“I think the public is looking for an SEC that is proactive and in front of these issues, and they have yet to do that in this instance,” said Lynn Turner, a former chief accountant at the SEC.
BHP to Acquire Petrohawk For $12.1 Billion, Betting Natural Gas Will Climb
BHP Billiton Ltd. (BHP), the world’s largest mining company, agreed to buy Petrohawk Energy Corp. (HK) for about $12.1 billion in cash in its biggest acquisition, betting natural gas demand will gain in the U.S.
BHP will pay $38.75 a share using cash and debt, the companies said in a statement today. That’s 61 percent more than Houston-based Petrohawk’s average price over the past 20 trading days and compares with the 25 percent average premium in 17 deals worth at least $5 billion for oil and gas producers in the past five years, according to data compiled by Bloomberg.
The deal marks Chief Executive Officer Marius Kloppers’s second foray in shale gas, forecast to make up half of U.S. gas output by 2030, after the $4.75 billion purchase ofChesapeake Energy Corp. (CHK) assets in March. BHP, based in Melbourne, sees total spending on developing Petrohawk assets of as much as $65 billion by 2020, Morgan Stanley analysts said in a note today.
“BHP wants to increase the scale of its oil and gas business given that most of its existing energy assets are mature,” said Jason Teh, who helps manage about $3 billion, including BHP stock, at Investors Mutual Ltd. in Sydney. “This acquisition nearly doubles BHP’s resource base.”
BHP fell 1.9 percent to 2,340 pence at the 4:30 p.m. close in London, the lowest price since June 27. It dropped 1.6 percent to A$42.89 in Sydney. Petrohawk had its biggest gain, increasing $14.68, or 62 percent, to $38.17 at 4:15 p.m. in New York Stock Exchange composite trading. The shares have more than doubled this year.
The premium is “probably a little bit more than expected,” Cameron Peacock, a market analyst at IG Markets Ltd. in Melbourne, said by phone. Paying in advance for future growth “is something the analysts often don’t like to see,” he said.
The cost of protecting BHP’s debt against default rose 3 basis points to 80.5 basis points as of 2:28 p.m. in Sydney, according to Deutsche Bank AG. Standard & Poor’s Ratings Services said it’s A+ credit rating on BHP remains unchanged because the company’s cash flow can support the acquisition. The takeover also includes $3 billion in Petrohawk debt, BHP said.
The deal adds three fields across about 1 million net acres in Texas and Louisiana and takes BHP into the top 10 of oil and gas companies. The offer values Petrohawk CEO Floyd C. Wilson’s 0.99 percent stake in the company at about $117 million.
Kloppers, 48, has had three deals totaling more than $100 billion aborted or rejected in the past four years, including hostile bids for Rio Tinto Group and Potash Corp. of Saskatchewan Inc. BHP is committed “to be in every aisle of the energy supermarket,” he said today on a conference call.
“There has been growing pressure on Marius Kloppers, or a feeling among the board at least anyhow, that they have to do some sort of deal,” Gavin Wendt, director at Sydney-based Mine Life Pty Ltd., said by telephone. “They’ve spent a significant amount of time, money and energy coming up with nothing.”
Still, “shareholders may well have some concerns, considering BHP is planning on spending a total of about $20 billion on an entirely new business that they don’t know that much about,” he said.
Formed in 2003, Petrohawk expanded by acquiring companies including Missions Resources Corp. in 2005 and KCS Energy Inc. in 2006 before “aggressively” buying shale acreages in 2007, the developer’s website shows. It has about 650 employees. BHP expects to complete the acquisition in the third quarter.
Petrohawk held 3.4 trillion cubic feet of reserves at the end of 2010. It produced 825 million cubic feet of gas as of March this year, of which 10 percent was in the form of liquids such as oil. The company expects to produce 950 million cubic feet of gas a day this year, with liquids accounting for 15 percent of output, according to its website.
The Chesapeake purchase gave BHP 487,000 net acres of properties in centralArkansas with 2.4 trillion cubic feet of proven reserves. Petrohawk’s million acres triple BHP’s acreage in U.S. oil and gas fields.
BHP will become the seventh-largest independent upstream oil and gas company based on total resources, BHP said in an investor presentation, citing Wood MacKenzie Consultants Ltd. The U.S. gas market is the world’s largest, BHP said.
“Petrohawk are extremely well regarded as innovative but aggressive operators,” Prasad Patkar, who helps manage the equivalent of $1.7 billion, including BHP shares, at Sydney- based Platypus Asset Management Ltd. said by phone. “You might find that they have made a very smart acquisition.”
The proposed deal would be the biggest all-cash takeover by any Australian company, according to Bloomberg data. BHP is being advised by Barclays Capital and Scotia Waterous. Barclays will act as dealer manager for the offer, the statement said.Goldman Sachs Group Inc. (GS) is advising Petrohawk.
BHP is paying 18.4 times earnings before interest, tax, depreciation and amortization, versus a median of 13.5 times for seven purchases by producers over the past five years, the data show. It’s paying $2.54 a barrel of oil equivalent for Petrohawk, compared with $2.79 a barrel for the Chesapeake assets, Morgan Stanley Melbourne-based analyst Cameron Judd said today in a note to clients.
“BHP has valued this asset for growth,” Deutsche Bank AG analysts Grant Sporre, Rob Clifford and Gaetan De Buyer, said in an e-mailed note. “BHP is increasingly confident on the future of gas and shale in particular as they continue their broadened push into the shale gas sector.”
The company, which forecasts the acquisition will boost earnings in its first full year, asked Barclays Capital to coordinate a $7.5 billion credit facility to help finance the purchase. BHP expects to have net cash of $7.4 billion in fiscal 2012, according to a May report by Royal Bank of Scotland Group Plc.
BHP, which this year committed to spend $80 billion on mines and oilfields by 2015, joins Exxon Mobil Corp. and Chevron Corp. in ramping up acquisitions in gas prospects previously considered too costly and difficult to exploit. Shale-rock formations require injection of water, sand and chemicals to release gas. Environmental groups have opposed using the process called hydraulic fracturing, or fracking.
Transactions for shale gas properties in the Eagle Ford area of Texas, where some of the Petrohawk assets are located, accounted for 20 percent of energy deals in the second-quarter, according to data compiled by Bloomberg. The purchase would be the largest acquisition of a U.S. exploration and production company since Exxon announced its $34.9 billion purchase of XTO Energy in 2009, according to Bloomberg data.
Mergers and acquisitions in the industry will continue as “various majors and others consolidate their positions to get scale, synergy, and so on,” Kloppers said on a conference call. “It’s very highly likely that you’re going to continue to see us participate in that as well.”