IADC Tax Conference M&A Update for Oil and Gas Sectorsingle source of global oil supply growth over...

IADC Tax Conference M&A Update for Oil and Gas Sector Deborah Byers 5 June 2014

Introduction

Global oil and gas: the macro themes

►Economic uncertainty

►Geopolitical volatility

►Technology-enabled “unconventional” revolution

►Industrial Darwinism – survival of the fittest (and generally the largest) – competition and consolidation

►Resource nationalism – the era of the NOC – resource keepers and resource seekers; customers, partners and competitors for IOCs

Global GDP growth hits a soft spot

Source: International Monetary Fund

Growth still driven by developing economies

Source: International Monetary Fund

Global oil

Global oil markets: the new normal ►Balanced-to-slightly-loose global crude markets

►Endemic geopolitical risks = sustained volatility

►Modest expectations for non-OPEC supply growth outside US; OPEC growth potential primarily in Iraq

►Marginal non-OPEC supply cost ~$70-90/bbl (Bakken/Canadian oil sands)

►Saudi fiscal needs also dictate ~$80-100/bbl

►N American logistical constraints causing price disconnects Source: US Department of Energy

The “other” unconventional ►US oil production back from “terminal decline” – US as the largest

single source of global oil supply growth over next 3-5 years

►Applying shale gas technology to “light tight oil” formations

►Bakken and Eagle Ford booms just getting started

►Big contributor to logistical constraints in US Midcontinent

►With increasing Canadian supply, defining the new North American crude oil dynamics

Source: US Department of Energy

Oil balances expected to shift

Source: EY analysis of data from the International Energy Agency (IEA), World Energy Outlook 2013

And a big regional shift in the making

►US tight oil, Canadian oil sands, and deepwater Brazil to lead supply growth in the face of only modest demand growth

►Major economic and geopolitical implications

►Trade flow implications as Russian, Middle East, and African supplies have to shift from West to East

►Americas region (North plus South America) to shift from net importer of oil to a net exporter after 2025

Source: EY analysis of data from the Energy Information Administration (EIA)

Risks and issues

► Strong US production gains counterbalanced by moderately strong global oil demand growth and in particular, OPEC production problems ► Significant continuing problems in Libya and Iraq, minor but

seemingly endemic problems in Nigeria and Venezuela ► But OPEC to be severely challenged by full return of Iranian

production to the market ► US crude markets trending toward surplus, but global

markets remain reasonably tight ► Saudi/Kuwait sales to the US stay high, amplifying the downward

US pressures and keeping global prices high ► Declining US oil imports shifting global crude flows ► Despite lots of noise, US crude export ban unlikely to be

lifted in short-term

Oil and gas transaction activity

Transactions: developments, prospects and perils ► Annual transaction activity off sharply in 2013 – both in

terms of reported value and deal numbers ► Total reported deal value down 21% from 2012; number of deals off 23% ► Upstream value down 17% and deals down 21%

► 1Q14 activity neither particularly strong or weak; total reported transaction value of $60 billion, with ~300 deals

► Notable deals in 1Q14: ► Russia’s Alfa Group buying RWE’s upstream assets for $7.1 billion ► AMEC acquiring OFS/E&C firm Foster Wheeler for $3.5 billion ► CNQ acquiring Canadian upstream assets from Devon for $2.8 billion ► Trader Vitol buying Shell’s Geelong (Australia) refinery for $2.5 billion

► Russian and Asian NOCs dominating the landscape last few years ► Big Rosneft deals for TNK-BP, big Arctic JVs in 2012, and crude supply deal

with trading giants in 2013 ► Big Russian/Chinese oil and gas supply agreements signed in 2013 ► NOCs do 7% of all deals in 2013, but account for 35% of total global value

Global industry M&A activity: down in 2013

Source: IHS Herold, Inc.

Recent industry M&A activity disappoints


Industry upstream M&A has been volatile


North American M&A activity has been slowing


As has the deal activity trend


North American upstream with some signs of life


But the non-upstream totals have drifted lower


Latest Capital Confidence Barometer findings

► Our April CCB reports a more conservative price outlook and relentless pressure on capital efficiency driving a greater strategic emphasis on optimization as opposed to growth

► Cautious optimism characterizes the global economic outlook and confidence is growing across most key financial indicators

31%

25%

29% 35% 31%

31% 28%

27%

39%

30%

0%

10%

20%

30%

40%

50%

Apr-12 Oct-12 Apr-13 Oct-13 Apr-14

Global Oil and gas

► The appetite for M&A activity is moving back to its medium-term average

► But 59% expect deal volumes to increase and 56% are confident in the number of acquisition opportunities in the next 12 months

► Bolt-on acquisitions will continue to be favored over transformative deals

Does your company expect to pursue an acquisition in the next 12 months?

But OFS activity picking up


OFS revenues by segment – top 20 segments

Source: Spears & Associates, Oilfield Market Report , April 2014

Revenue Rev growth Rev growth2014 2009-2013 2013-2014

(US$ billion) (% CAGR) (%)Offshore Contract Drilling $61.3 1.5% 10.0%Offshore Construction Services $40.6 4.3% 5.0%Hydraulic Fracturing $34.9 13.8% 5.0%Land Contract Drilling $30.5 2.2% 3.0%Oil Country Tubular Goods $21.7 -0.3% 2.2%Subsea Equipment $21.3 8.8% 20.0%Rig Equipment $20.2 6.1% 8.0%Geophysical Equipment & Services $16.7 0.6% 3.0%Directional Drilling Services $16.0 7.5% 10.0%Wireline Logging $14.9 3.2% 8.0%Artificial Lift $15.2 11.7% 15.0%Completion Equipment & Services $14.1 10.2% 11.0%Drilling & Completion Fluids $13.7 6.1% 10.0%Cementing $10.6 7.0% 5.0%Supply Vessels $9.0 3.2% 12.0%Specialty Chemicals $8.3 7.1% 6.0%Rental & Fishing Services $8.5 5.8% 3.0%Well Servicing $6.0 1.5% 5.0%Surface Equipment $6.6 6.7% 5.0%Production Testing $5.9 5.7% 10.0%

Other segments (subtotal) $44.4

TOTAL $420.4 4.9% 7.3%

What does the Future Hold?

What’s the M&A/Capital Picture for Drilling? ► Landscape dominated by organic growth and

specialization ► Deepwater ► Shallow water ► Onshore conventional ► Onshore unconventional pressure pumpers ► Regional plays

► New entrants add rig count and competition ► NOCs eyeing drilling companies ► Spin-offs create new shallow water plays ► PE continue to show interest in smaller players ► Capital strategies such as MLPs and non US IPOs continue to be

of great interest as way to fund new asset growth

► New Geographic plays ► Mexico, Arctic, Middle East, Africa

Crystal Ball…..probably wrong but…..

► Mega Merger on the horizon? ► Not likely…..Big barriers

► Obvious combinations already completed ► Stock valuations at high levels ► Executive Management relatively young with succession planning well

managed ► Prior combinations continue digestion, divestment and specialization

► Note recent spin/divestments by Rowen, Noble, Transocean ► Ongoing marketing of older fleet ► New entrants on shallow water fleet with higher horsepower, lower costs

make old fleet tough to divest ► Significant pressure by customers on margin and safety has

companies focused on operational efficiencies ► Money is cheap—equity and debt readily available for strong players

so build v. buy decision is skewed toward build.

► A Billion Dollars doesn’t buy what it used to…..

► Potential lower cost of capital ► Valuation uplift ► Set value/price for retained assets (sponsor assets) ► Strategic growth – alternative acquisition capital ► Monetization – partial immediate liquidity ► Capital raise alternative ► Access to different potential investor base

Overview Why form an MLP?

Overview Benefits and considerations Benefits ► Tax advantages provide improved cash flow and

potential for a lower cost of capital

► Opportunity for monetization at premium valuation and valuation uplift on ownership retained

► Potential to defer taxable gain

► Ability to retain control of strategic assets through GP

► Creates a vehicle for growth through drop downs and acquisitions; lower cost of capital may give the MLP a competitive advantage in the acquisition markets

► Access to capital markets / acquisition currency

► Issuers have incentive to grow distributions through subordination / Incentive Distribution Rights

Considerations ► Creates a true independent entity with independent

directors and independent board committees, and potential for conflicts of interest

► Requires significant time spent on investor relations, reporting and disclosure

► Investors expect distribution growth; MLP will need to continue to seek opportunities to grow

► Consider how to account for shared services, allocation of expenses and push-down of debt

► Consider accounting ramifications of the MLP on the parent company‘s financial statements

► Yield driven security / distribution of available cash flow

► Smaller institutional investor universe than C-Corps

Sponsors may form MLPs for several reasons, including: (1) a need for capital, (2) desire for a valuation uplift, or (3) to create a vehicle to execute a growth strategy through acquisitions

Overview MLPs – investor profile ► Flow-through treatment to common unitholders ► Retail (primarily domestic) investors (minimal tax-exempt investors)

► Tax exempts generally subject to unrelated business taxable income ► Effectively connected income and withholding issues for non-U.S.

investors ► Cash distributions (and tax shield) driven by market

demand/expectations ► Income Stream

► MLP yield compares favorably to alternative investments ► Growth Potential

► Particularly for publicly traded general partner interests ► Administrative Complexities (and related costs)

► K-1 vs. 1099 ► State tax compliance

Foreign MLPs

Foreign MLPs General overview

► Foreign entities with foreign assets offer a unique structuring opportunity ► By using a foreign limited liability company checked to be classified as an

association taxable as a corporation for U.S. federal income tax purposes, the use of a non-US “MLP” may be incredibly beneficial

► Foreign MLPs (although registered on a U.S. exchange) are typically formed in low or no-tax jurisdictions (e.g., Marshall Islands), providing effective flow-through treatment.

► e.g., Golar LNG Partners, LP, Seadrill Partners LLC, and Teekay Offshore Partners LP

► Market multiples for Foreign MLPs are comparable to traditional MLPS ► Tax analysis and considerations differ substantially depending on the

jurisdictional location and tax classification of the entity ► For instance, to the extent that a traditional MLP is contemplated, numerous

additional considerations and strategies would apply

Foreign MLPs General overview (cont.)

► Certain similarities to domestic MLPs ► Classes of interests

► Common units (LP units) ► GP interests ► Subordinated units ► IDRs

► Structural similarities

Foreign MLPs U.S. federal income tax considerations to investor ► Foreign MLP is treated as a corporation for U.S. federal income tax purposes. As

a result and subject to the PFIC rules (see next slide), income and losses do not flow through to unitholders. ► 1099 vs. K-1

► Foreign investors and institutional investors can invest in the Foreign MLP without limitation (from a U.S. perspective). ► No U.S. federal income or withholding tax on distributions to non-U.S.

unitholders not engaged in a U.S. trade or business. ► Certain considerations for U.S. investors

► Distributions to U.S. unitholders would generally be treated as dividends to the extent of current and accumulated earnings and profits. Distributions in excess of E&P are treated first as a tax-free return of capital to the extent of such unitholder’s adjusted tax basis in the units, then as capital gain.

► Individual unitholders - so long as certain requirements are met, dividends may be eligible for reduced ‘qualified dividend income’ rates.

► Corporate unitholders - generally be taxed at the ordinary rates applicable to such unitholders / not eligible for a dividends received deduction.

Foreign MLPs U.S. federal income tax considerations to investor (cont.) ► Certain considerations for U.S. investors (cont.)

► No ‘qualifying income’ requirements for a Foreign MLP – however, must test for Passive Foreign Investment Company (“PFIC”) or controlled foreign corporation (“CFC”) status.

► Certain negative U.S. tax implications to the extent that MLP constitutes a PFIC or CFC.

► Should closely monitor status ► Service vs. rental income ► ‘U.S. Shareholders’ (>10%)

Foreign MLPs U.S. federal income taxation of MLP’s income ► The Foreign MLP is subject to U.S. federal income taxation on any income it

receives that is effectively connected with the conduct of a trade or business in the U.S.

► U.S. source gross transportation income, if any, generally is subject to a 4% U.S. federal income tax (without allowance for deduction of expenses), unless an exemption from tax applies under a tax treaty or Section 883 of the Code. ► Under Section 883 of the Code, U.S. source gross transportation income

consists of 50% of the gross shipping income that is attributable to the transportation that begins or ends, but that does not both begin and end, in the U.S.

Foreign MLPs Other tax considerations ► Other tax concerns:

► Is the MLP subject to taxation in any other jurisdiction (e.g., its jurisdiction of organization or operation)? ► Although ‘Foreign MLPs’ are generally organized in jurisdictions that do

not impose taxes on their income, if the MLP operates in another jurisdiction, the tax laws of that jurisdiction must also be considered to ensure that the MLP will not be subject to tax in that jurisdiction.

► Withholding tax considerations ► Tax analysis and considerations differ substantially depending on the

jurisdictional location and tax classification of the entity ► For instance, to the extent that a traditional MLP is contemplated, numerous

additional considerations and strategies would apply (see prior slides)

Potential structure for Non-US Assets Illustration of Foreign MLP structure

MLP (NASDAQ /

NYSE)

Sponsor

GP units / IDRs

LP Interest

GP GP Public

LP Interest

OpCo

Non-US Assets

Non-US Assets

Non-US Assets

Comparison Matrix Domestic MLPs vs. Foreign

Domestic Foreign Tax characterization Partnership Corporation Qualifying Income Yes No Jurisdiction of formation Commonly Delaware Marshall Islands ECI / UBTI Investor limits Yes No Market requirement for growth

Yes; market requires certain tax shield %

? Maybe not

Distributions Generally tax-free Treated as taxable dividends to the extent of

E&P Disposition (nature of gain/loss)

Capital (except to the extent of recapture)

Capital

Investor reporting K-1s 1099’s PFIC Analysis No Yes

IADC Tax Conference M&A Update for Oil and Gas Sectorsingle source of global oil supply growth over...

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