Chapter 11 Procuring a Place Along the Stream: Considerations When Buying or Selling Midstream Infrastructure

Chapter 11 Procuring a Place Along the Stream: Considerations When Buying or Selling Midstream Infrastructure

Seth Belzley advises financial and strategic clients on a wide range of corporate matters with a focus on mergers and acquisitions ("M&A"), joint ventures, financing, project development, and commercial transactions. Mr. Belzley has significant experience in the energy industry that includes representing clients in the oil and gas, midstream, refining and downstream, renewable fuels, and renewable energy industries, including on wind and solar projects. He has served as lead counsel on the development of several significant energy infrastructure projects in the most important energy hubs in the country. He also regularly advises buyers and sellers of energy infrastructure assets on the sale of those assets or the formation of joint ventures to develop and operate those assets.

Josh Downer is an energy attorney in Holland & Knight's Houston office. Mr. Downer focuses his practice on oil and gas transactions, with a particular emphasis on midstream projects. His transactional experience includes the representation of clients in the drafting and negotiation of oil and gas gathering, gas processing, purchase and sale, storage and similar midstream agreements as well as transactions concerning the acquisition and divestiture of midstream assets and facilities. Mr. Downer also regularly advises clients in the preparation of master service agreements, production sharing agreements and similar contracts related to the construction and operation of midstream facilities.

Nneka Obiokoye is a corporate attorney in Holland & Knight's Denver office, where she focuses her practice on domestic and international commercial transactions in the renewable energy and oil and gas industries. In each of these industries, Ms. Obiokoye helps businesses navigate complex commercial issues at every stage of a project's life cycle, from development to day-to-day to operations. Ms. Obiokoye has in-house experience through her secondment with a midstream energy company. Her responsibilities included negotiating oil and gas gathering and storage agreements, gas processing agreements, hydrocarbon marketing agreements, and

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produced water agreements. Ms. Obiokoye routinely assists renewable energy developers in negotiating power purchase agreements, construction contracts, storage agreements, and other supply chain and development contracts. In addition, Ms. Obiokoye counsels clients engaged in, or seeking to engage in, clean energy projects, including projects involving renewable fuels (renewable natural gas, biodiesel and other digester fuels) and hydrogen.

The authors would also like to specifically thank Anna Boyer¹ and Kitty Xie² for their contributions to this paper.

I. INTRODUCTION

II. WHAT IS MIDSTREAM?

A. Defining "Midstream."
B. Midstream Operations Examples
C. Midstream Assets (Traditional Examples)
D. Midstream Assets (Emerging Examples)

III. STRUCTURING THE DEAL

A. Types of Transactions

1. Asset Transactions
2. Membership Interest or Stock Purchase Agreements
3. Mergers

B. Selecting the Correct Structure

1. Scope of the Assets to Be Acquired
2. Consent Considerations
3. Closing Logistics and Due Diligence

C. Other Considerations

1. Change of Control
2. Joint Ownership Complications

IV. BASIC OVERVIEW OF TRANSACTION DOCUMENTS

A. Preliminary Agreements

1. Confidentiality Agreements
2. Term Sheets and LOIs

B. APAs and MIPAs

V. DILIGENCE CONSIDERATIONS

A. Generally
B. Identifying the Assets
C. Real Property Diligence

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1. Overview
2. Gap Analysis

D. Contracts

1. Overview
2. Key Issues

E. Permits and Authorizations
F. Other Diligence Concerns

1. Cybersecurity Risks
2. General Corporate Considerations
3. Volume Commitments and Acreage Dedications

VI. REPRESENTATIONS & WARRANTIES

A. Generally
B. Areas of Heightened Focus for Midstream Transactions

1. Environmental
2. Real Estate
3. Regulatory Status and Compliance
4. Indebtedness

C. Product Volumes and Quality

VII. ALLOCATION OF POST-CLOSING RISK: INDEMNITIES, ESCROWS, HOLD BACKS, AND REPRESENTATION AND WARRANTY INSURANCE

A. Indemnities Generally
B. Limitations on Recovery.
C. Sources of Recovery for Indemnification Obligations
D. Representations and Warranties Insurance

VIII. VALUATION CONSIDERATIONS

I. INTRODUCTION

The midstream infrastructure of the United States consists of a complex network of facilities, equipment, and pipelines, separate and unique from, but intrinsically connected to, the hydrocarbon production-related infrastructure made the subject of the vast majority of this conference. As such, it poses unique considerations for the M&A practitioner and requires further expertise and knowledge concerning the complexity of these facilities, designed not only to move hydrocarbons from point A to point B, but also to compress, treat, process, fractionate, and otherwise convert those hydrocarbons into distinct products usable for a variety of purposes.

The United States midstream industry is also currently undergoing not one, but several different transformations, each happening simultaneously, making this an exciting, but challenging time to be in the field.

One transition is the marked consolidation of midstream providers. Major midstream providers have gotten even larger as they attempt to acquire and consolidate assets to provide greater connectivity to customers and gain access to more diverse markets. Recent examples at

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the time of writing include Targa Resources' acquisition of private equity backed Lucid Energy³ and Southcross Energy,⁴ Williams' acquisition of NorTex Midstream,⁵ and Delek's acquisition of 3Bear's assets in the Delaware Basin.⁶

Another transition relates to the changing dynamics of supply and demand in the United States and around the world. Since the Obama Administration's decision to end the longtime ban on the export of U.S. crude oil in 2015, overall exports of crude oil and petroleum products from the U.S. tripled through 2020,⁷ adding nearly 6,000,000 barrels per day of demand for new energy infrastructure to handle these volumes in a little over 5 years. Similarly, since 2014, the volume of natural gas exported from the U.S. has increased four-fold, from around 1.5 trillion cubic feet to more than 6.5 trillion cubic feet in 2021.⁸ More recently, the war in Ukraine and other geopolitical shifts have added to the demand for the U.S. to supply hydrocarbons to the rest of the world. These increasing demands for export infrastructure have required massive investments by midstream companies in pipelines, storage, and export facilities.

Finally, the midstream industry stands poised to take tremendous advantage of the ubiquitous enhanced focus on Environmental, Social, and Governance ("ESG"), expanding the industry into new products (such as hydrogen and renewable fuels), as well as new product applications (such as the mining of cryptocurrency). A greater focus on ESG presents challenges as well. As banks, funds, and other debt and equity investors become increasingly interested in environmental and sustainability issues, many are choosing to avoid investments related to the oil and gas industry in general. This has two implications. First, it may be more difficult than in past years for midstream companies to obtain financing for new projects. Second, financing may be tied to the disclosure of ESG-related items or it may require the company to meet certain sustainability-related benchmarks. While potentially less directly impacted than traditional exploration and production companies, midstream companies will have to continue to adapt to this increased focus.

This paper addresses some of the issues that purchasers and sellers of assets may face when attempting to acquire or divest midstream infrastructure in this complex and rapidly changing environment.

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II. WHAT IS MIDSTREAM?

A. Defining "Midstream."

Before diving into the peculiarities of a transaction concerning a "midstream infrastructure," it will likely be helpful to define the term "midstream" for the purposes of this paper. If the reader will indulge to envision a literal stream (i.e., of water) flowing from the mountains down to a coast, for example, then, upstream would refer to the sources of this water. Downstream, on the other hand, would refer to the various outlets at the end of the river or stream. Midstream would refer to the intricate series of brooks, creeks, and rivers that move water from place to place, as well as the ponds and lakes that store water as it moves between the brooks, creeks, and rivers.

Not unlike a stream of water, midstream in the oil and gas industry often refers to the various facilities, processes, and movements required to take oil or gas from its production sources and to gather it, refine it, and transport it to end users. As such, there is no one set definition or clear demarcation between the "upstream," "midstream," and "downstream" phases, much as there would be no clear demarcation between the terms "upriver," "downriver," etc. The authors tend to think of "midstream" as including everything that occurs from the point that the applicable hydrocarbons leave a well pad until the creation of refined products suitable for retail, and even the system of storage facilities and pipelines that move refined products from place to place until they are handed over to a transporter for delivery to an end user. However, these lines can (and often do) get blurred, particularly as greater access to equipment has allowed producers to adopt activities that traditionally would have necessitated the involvement of a midstream provider, such as treating...