with David Sheach, Managing Partner, Stronachs
Stronachs has been around Aberdeen since the early 1800s, over which time its focus has clearly shifted; what is the current importance of oil and gas to the firm?
It’s extremely important. Although Stronachs is a very broad-based firm, doing private client, court, property, and corporate work, because of our location in Aberdeen, the majority of corporate clients are involved in the energy sector, either upstream companies, supply chain companies,, private equity groups investing into those companies, or banks lending to those companies. It’s a fair estimate that 75-80% of the firm’s commercial activity is linked in some way to the oil and gas sector.
What are some of the biggest legal issues in the UKCS at present?
There are major issues around the complexity of title transfer in the UK. Unfortunately, it’s not a nice, neat, registered title system, but layer upon layer of contract, and therefore the legal process involved in transferring ownership of assets can be quite complicated and time consuming. The fractional ownership of many fields can be quite a challenge as well, which is more a commercial than legal point, but obviously it impacts on the speed of the legal process. Unlike regions with onshore licenses, where the capital costs are much less and therefore there may be a single company or two who buy, in the UK it’s not unusual to have four or more field owners, and the dynamics of getting all of them to go in the same direction at the same time can be interesting. Therefore, there’s a tendency in more mature assets to consolidate ownership, with more appetite to take 100% or share 50/50 with another partner. There are more financial partners, as opposed to pure oil companies, entering the market, and therefore that partner group dynamic is changing. Whereas the legal process was quite messy with a large number of oil companies trying to manage one field, if that turns into one oil company and its equity funder or bank, then it becomes much simpler. The speed of transactions should increase as the ownership profile changes over the years, but at the moment there are process challenges in moving the asset base from ownership by lots of big companies to smaller and fewer companies.
Decommissioning, although still a few years away yet, is becoming a real concern, with real decommissioning projects happening and liabilities crystallizing. As smaller companies come into the North Sea, their balance sheets aren’t as strong as the old companies, and with all partners and sometimes former partners having joint and several liability for decommissioning there is a need to ensure that even if a company is not going to be around in five years’ time, their money for decommissioning is. A lot of work has been done on decommissioning, security agreements and financing arrangements. Various insurance companies and banks have looked at various models to provide security, and it is a constantly evolving and interesting area to watch. The approach to banking for these projects has evolved over the last five years, and given the current state of the credit market will likely evolve some more. Five or six years ago, it was difficult to raise anything other than limited term loan bank finance for producing assets. Banks then became more sophisticated, changed their borrowing base calculations, and looked at NPV/borrowing base calculations to give more credit against an asset. Towards the height of the credit boom, banks had an appetite even for predevelopment funding. Now that the banking world has changed, it will be interesting to see where the capital comes from for these fields in the future. Asset prices will moderate, and seller expectations will come down. There will be less money from banks, some more from equity investors, and returns will lower. Now, everyone is generally waiting for the credit markets to shake down and it’s not just in the corporate world generally, but also in the oil and gas markets. Profitable projects will always attract finance – there is no lack of money for such projects, but we are in a more cautious lending environment, so the financing models will be different.
Some people think there is an unsustainable level of independents in the UKCS, which could signal near term consolidation. What is your assessment of the current financial climate on deals occurring in the North Sea?
The world is divided into two camps. Outside the oil and gas world, it’s very difficult to get funding at all. The oil and gas side is, curiously enough, even with the decline in the oil price seen as still an area of relatively good news. There’s a general and increasing shortage of energy in the world, and companies who have access to energy, whether oil and gas, coal, or anything else, are attractive places to put money in the medium and long term, and oil and gas is just one subset of that. In the UK, there’s probably less political risk, and any fiscal risk is probably less than most competing opportunities, and it is therefore an attractive place to invest. More private equity houses entered Aberdeen in the last six months, probably because they don’t have much to do elsewhere! Clients already with money are in the fortunate position of looking for bargains to pick up. For those clients who don’t yet have money, the ones trying to raise money to buy a single asset are finding it almost impossible. It was getting increasingly hard even in 2007, but in 2008, single asset companies aren’t going anywhere terribly fast until the credit markets loosen up. That said, there is certainly still money for some new entrants, but we’re seeing bigger, better capitalized startups. Eight or nine years ago, startups were $2-3 million in size, but now, they’re $200-300 million, with a serious intent to buy assets with near term or existing production.
There will still be new entrants, but they’re likely to be bigger and fewer. Consolidation occurs in every marketplace, and what shakes it all out is a credit crunch like this, where there are players who run out of steam and money, and have no option other than be taken over. There are many with proven, undeveloped discoveries, who have built up portfolios over the last two or three years expecting the credit markets to continue as well as they did, and now the money is not there. The only thing they can do is farmout to partners with money, sell the asset or be taken over or if that fails put out the lights and hand it back to the government,. The credit crunch, in some respects, will stop activity from happening that would’ve otherwise, but also creates activity and opportunity for other things to happen. 2009 should be a busy year for M&A work.
You mention decommissioning, and some believe this is the biggest roadblock in the way of deals going to the next level in the North Sea. What’s your assessment of the situation?
It is undoubtedly a hot topic, but it’s perfectly manageable. We haven’t heard of any deals founder over a decommissioning issue. It’ll affect asset value, but if that’s factored into the economics and the project still has a positive NPV, then there’s still meat on the bones, as it were, and there’s still reason to do a deal. The danger is, because of the slow sales process of some of the majors, they may end up hanging on to assets just a little too late, and they find that when they come to sell it, they haven’t left enough time or life in the asset for anyone to make money off it, which may accelerate the decommissioning process on some assets. In terms of structuring the deals, if anything, some real life experience of the actual costs of decommissioning might be helpful because at the moment too many sellers are risk-managing to an extreme degree, and perhaps looking for too much security by way of letters of credit, which are expensive and eat up working capital. As and when more decommissioning projects are done and the industry develops its expertise at decommissioning, and can predict costs with more certainty, this will help. There is still always the risk of vessel day rates fluctuating, which hugely impacts decommissioning costs, but hopefully the scope for getting the calculations as wrong as some have been in the past will diminish as experience and clever new technology builds. There was a time when large platforms had to be decommissioned in situ, whereas now large lift vehicles are being developed that essentially allow for sailing up to a platform, cutting the legs, and bringing it back to land, which significantly reduces decommissioning costs. It may be found that companies, having bought assets while putting up large letters of credit, if they can push out the life of the asset by investment, and find a smarter way of decommissioning, may find there’s a gain to be had because the cost of decommissioning and security for it is less than expected.
It took until 2004 for Stronachs to do Ј1 billion in oil and gas deals, and then just a few more years to reach the second billion. What has the evolution meant for the firm over the last few years?
We actually did more than $1bn of deals in 2007 and currently have around $500M of deals in progress. The evolution of a new generation of E&P companies has been extremely important for Stronachs. The firm has been able to take an oil and gas team of essentially two lawyers in 2000 doing upstream oil and gas work, to 17 now, a reasonably-sized energy team by any standards. This size has allowed us to hire senior lawyers, appoint new partners, and improve our training program so junior lawyers are better educated. Size also gives us the clout to take on bigger and bigger transactions. Whereas the firm might have been occupied on deals involving the purchase of a single asset back in 2000, now we are able to do things like the Dunlin platform acquisition for Fairfield, which involved large amounts of kit, a lengthy and complicated negotiation, aspects of decommissioning, financing, employment law, etc. That larger, experienced team allowed us last year to publish ‘The Technical and Legal Guide to the UK Oil & Gas Industry’ through our publishing company Aberlour Press. The book brings together chapters on commercial, taxation, geological and technical aspects of the UK offshore industry, written by industry experts, with a legal commentary by Stronachs.
Further, Stronachs has taken on more general corporate and employment law specialists and they have adapted their skills to the oil industry, which has the same kind of general legal issues but in a particular industry environment. Other changes in this time include moving to bigger offices and occupying twice as much space. Although absolute headcount has only grown by around 50% since 2000, Stronachs has changed the mix of lawyers reflecting the opportunity to grow in higher margin areas of work. For example, when I joined the firm in 1997, there were 25 people doing residential conveyancing. Now, there are 6 people making as much profit as those 25 ever did, and those other lawyers have been replaced with ones doing more commercial property work, corporate work, or banking, private equity, and upstream oil and gas. We still provide private client services but to a more select, high net worth client base. In 1832, Stronachs acted for farmers, fishermen, local businesses and builders, and we still have that ‘traditional industry’ mix in the client base, but the firm is now also positioning itself as a niche, international energy practice, but still with a core private and commercial client business in Aberdeen. The expectation going forward is to use those skills and opportunities to internationalize our business, which is what we’re already seeing.
You mention the internationalization aspect; what is the advantage of using a firm like Stronachs that does not have offices based around the world?
Cost. Stronachs is one third to half the price of larger more international competitors, for the same job. We can do that because we’re as good as they are, but with lower overheads. Higher fees for our competitors go to subsidize expensive London offices, or partner compensation expectations of Ј1-2 million per year. Their associates need to be paid Ј150-175,000 per year to get them to do the hours they need to work. In Aberdeen, buildings are significantly cheaper yet still fit for purpose. Partner expectations are much lower, therefore the charge-out rates are much less. Therefore, a client can get twice or three times as many man-hours out of Stronachs for the same price they would pay a City firm – or, more accurately, the same job for half or a third of the price. The absolute advantage of going to London to get something done and paying twice the price is pretty minimal. Most of our clients are smaller oil companies, and in the same way they look to their supply chain for value in buying bits of kit for an oilfield, so too do they look for value for money from their professional advisers.
As the firm continues to move internationally, do you think maintaining this edge will be more difficult?
I don’t think our edge over large firms will disappear, because Stronachs will never be an enormous factory competing ‘head to head’ with the big firms. At the moment, the firm has 16 partners, and in the next 10 year time scale I don’t envisage there being more than 20-25 partners – we don’t need to exceed these numbers in order to realize the individual business plans of the partners. Stronachs is a completely different business from the large corporate legal entities. They have business plans that require them to be top 15, top 10 then top 5, always growing and thinking about taking turnover from Ј1 billion to Ј2 billion per year and so on. Our business plan is more flexible and personal to us – in effect, it is the sum total of what 16 individuals in Aberdeen want to do at any one point in time. The world is full of large, expensive law firms, targeting clients who are prepared to pay their charge out rates. Our market is the smaller E&P companies, owner-managed businesses and high net worth individuals looking for better value for their money than a large law firm can deliver. Relatively small E&P companies are usually run by two or three individuals, who want an individual lawyer they know and trust sitting next to them, doing the deal for them. Value for money, pragmatic, personal legal advice, delivered by a small but high quality team is our USP.. We don’t need to be five times the size to deliver that and our clients certainly don’t want or need to pay for the overheads a large legal firm carries. That’s how Stronachs will continue to compete.
What direction do you see the international expansion going?
It’s difficult to predict; wherever our clients take us! It’s not as if Stronachs sits down with the atlas and says ‘we’ll seek business in Dubai this year, and Stavanger next year’. We look at what our clients are doing, where the opportunities come to us from the network of people who have worked with us over the years. If they happen to want a lawyer to go to Geneva to negotiate a gas deal in Poland, then we will get on a plane, go to Geneva, and do it. It’s not because we’ve targeted specifically the Polish gas market as an interesting prospect; it’s simply because our clients saw the opportunity and we followed them. Our job is to respond to whatever our clients want us to do. What we have found is that, as we look after some clients and do a good job for them and protect their interests, either individuals there recommend us, or move to other companies and bring us along with them – we act for people, not companies. Additionally, because of the international buyout work I and Ewan Neilson, one of my partners, have done in London, we already know which firms to go to in just about every country around the world, and are thus able to match our clients up with capable, similarly sized and priced firms in a local jurisdiction.
In spreading the word about Stronachs in these other regions, what would you like your clients to say about the firm?
It’s not about price, although that’s always in the mix. Stronachs is seen as pragmatic, in that we have a desire to get the job done, and the process shouldn’t drive the whole deal. The firm also has an ability not to risk-manage things to death. There’s nothing more soul-destroying and expensive for a client than seeing lawyers scoring points off each other or arguing about how many angels can dance on the head of a pin. We step back from every debate and ask, ‘Is there any money attached to this, and does it matter?’
This approach comes from the culture Stronachs’ partners have. We’ve done typically private equity and banking work in the past, and the small oil companies we act for are mainly private equity-backed, so we and they both know that whatever it is they’re trying to do commercially, there’s a meter running at 30% IRR in the background and time is of the essence. The companies Stronachs works for are usually prepared to take on additional risk in order to get the deal done faster and get the bigger rewards. Stronachs is not a risk eliminator, but a good risk manager and deal processor – if that’s how our clients introduce and recommend the firm, we’re happy to hear it.
In the 10 year time horizon, where do you want to bring the firm?
Stronachs will be a slightly bigger and better version of what we are currently. Culturally, we’ve got a lot of good things going for us as a firm, with 16 partners who all know each other very well, 100 staff with all of whom I am on a first name basis, and it’s overall a very comfortable business to manage and run. If you try to double or triple that, the firm would lose a lot of what makes it successful. However, Stronachs still aims to serve a bigger and broader client base, do a variety of challenging projects, make a reasonable living, and have fun in the process. All 16 partners are in that frame of mind, and that’s where we want to be. It’s not about a grand plan calling for world domination and being #1.
What is your final message to OGFJ readers and what they can expect to see from Stronachs internationally?
To our existing client base we are helping to internationalize, it will just be more of the same: helping them raise money and acquire assets in the UK is exactly the same process overseas. With the network of lawyers to ensure compliance overseas, they get the same Stronachs experience of pragmatism and commercial dynamism that gets the job done, and someone managing the complexity of the local legal process.
For other potential clients, they should come and have a chat about what Stronachs can do for them. The firm has bought and sold close to 100 assets in the UKCS in the last few years, and there’s hardly a bit of the North Sea map we haven’t had a look at. Stronachs has a tremendous amount of know-how about how the transportation systems work, who owns what, the dynamics of particular partnerships, and what the parameters are in the UK with regard to what’s a reasonable deal to do and what’s simply beyond the pale or unachievable. Every market is just a bit different, and while Stronachs has expertise in the UK market, and whilst we may not be experts in the West African oil and gas market, we don’t need to be to advise our clients – we are experts in moving money around, liaising with local lawyers, contract drafting, and the practicalities of getting deals done. That’s what Stronachs is about.