Selling midstream assets? Here’s what you should be asking.
Oil and gas companies have been challenged over the past year, to say the least. Now, as they’ve already cut costs at almost every level of their organizations, some are looking at selling midstream assets to specialist infrastructure companies or other investors in order to free up cash. But before starting that process, companies would be wise to develop a comprehensive plan. EY’s oil and gas team weighs in on some of the questions companies should be asking when considering midstream transactions:
- How do you get relevant stakeholders on board?
You need a full understanding of the underlying economics of the assets and the inherent risks. A robust, transparent, reliable model with scenario and sensitivity analysis, synergies, accounting allocation and tax structure will not only give confidence to the stakeholders involved, it may also help you land on the right decision. Something that may seem immaterial, like a re-allocation of dollars as part of the purchase price allocation, could have an impact on your cash taxes.
- How will you recognize the full value of the transaction?
It’s important to facilitate early planning (pre-deal) for integration on the basis of a detailed assessment of synergies, value drivers, priorities and risks during the due diligence phases. Through the integration, a process should be developed for monitoring and measuring the success, which will ultimately contribute to a strong overall return on investment. Without a proper integration process and structure, it will be a challenge to facilitate knowledge transfer throughout the entire transaction lifecycle. More collaboration across all departments increases the chances of a successful transaction and recognition of the full value of the deal.
- Will your arrangement contain a lease?
A number of considerations will have a big impact on a lease assessment — and often, those considerations aren’t black and white. Buyers and sellers alike need to consider whether there will be third party users of the sold assets, how the capacity contracted back to the seller will be priced and who will direct the operation of the assets after their sale. These decisions often evolve and change throughout the deal structuring and negotiation process so it’s important to identify their accounting impact before they become an issue, rather than after the deal structure has been finalized.
- What type of control will you maintain over the sold assets?
Today’s accounting standards can make control assessment a complex exercise. Such assessments require significant judgment and a thorough understanding of how the decisions that will have the most impact on the economic returns from the assets after their sale will be made and, more important, who will have the rights to make them. Sellers who retain significant decision-making rights may not be able to recognize a gain on sale or get the sold assets off their balance sheet. Additionally, determining which decision-making rights they need to retain versus the rights the buyer expects to obtain can be an area of significant friction during the negotiation process. Bottom line — both buyer and seller need to reach a mutual understanding without creating unintended accounting consequences.
- Have you used the target operating model to identify deal killers in your transaction?
Evaluating the historical earnings against the target operating model can help you make a good deal better, or avoid making a bad deal. It will also identify issues that could impact the final transaction value. You must define the degree of integration and anticipated end-state in order to better understand expected future performance. It’s important to anchor the baseline financial data to source date to understand and assess the suitability of the financial information presented to assess performance. This assessment is often referred to as diligence.
- How will you account for resulting assets and liabilities?
Midstream deals can be complex, with a co-mingling of assets being acquired. It’s rare that a strategic mid-streamer will invest significantly in a plant without a contract with committed level of revenue. The accounting will be scrutinized by analysts, shareholders, debtholders, rating agencies, and auditors. They will want to understand a multitude of issues whether the cash flows from the contract are returning to the asset owner, whether there are other volumes that could be tied into the plant, what capacity of the plant is contracted and more. The results can impact how these stakeholders view the health of your balance sheet, and ultimately their decision to buy, loan or rate.
- What will the tax implications of the deal be?
Structuring a transaction as an asset or share deal will have material implications to both buyers and sellers. Considering alternative structures such as a partnership can help both parties achieve their commercial and tax objectives. Funding the chosen structure on an efficient basis for tax purposes could enhance the after-tax cash flows from the project. Meanwhile, it’s important to consider value drivers such as like indirect taxes and the potential to be subject to British Columbia's Liquefied natural gas (LNG) tax consequences, where applicable, as they may impact current and future cash flows from a project.
Finding the right balance between the desired level of operational control and economic control requires extensive involvement, communication and cooperation between operations, finance, legal and tax experts. It is important to bring in those experts before it’s too late in the process.
To explore these questions in more detail, contact a member of EY’s oil and gas team.