How to be a smart non-operating partner

The issue

Many oil and gas companies are non-operating partners in Joint Ventures with other companies[1]. This is generally (although not always) combined with the fact that as a non-operating partner you are a minority shareholder.

We have found that companies often struggle with their role in these kinds of situations. How many staff should we deploy to “look over the shoulders” of the operator? What should our staff focus on? What are the main risks for us? How do we best contribute to the success of the Joint Venture?

In this article we share our insights and propose a simple model to help companies make quality decisions in this area. But first let’s look at some data.

What makes Joint Ventures successful?

External research (see section on Resources at the end of the article) combined with our own experience highlight the key requirements to make Joint Ventures work:

·     First, it is important that partners are aligned on the strategic objectives of the Joint Venture. Of all the Joint Ventures that fail, 50% or more do so because there is misalignment in this area.

·     The second key issue is working relationships. If key people get along well and particularly understand and respect differences in working cultures that may exist between partners, this has a tremendous impact on the success of the Joint Venture.

·     As a third point it is important that the governance is clearly defined. How are decisions being made? How does the Joint Venture respond to requests of individual partners? In what level of detail does the Joint Venture report business performance to the partners?

Knowing these critical success factors, how do you as a non-operating partner determine how you are going to interact with the other partners and particularly the operator?

Alternative roles a non-operator can adopt

For a start, it helps to think about the two extreme ends of the spectrum in playing your role as a non-operator in a Joint Venture. The first one is that of a “Dormant Investor”. In this case you supply the required funds, attend the shareholder meetings, collect your dividends, and verify that your investment is paying off as expected. Often the dormant investor has a portfolio of investments in different assets and the focus is on managing the overall portfolio.

On the other side of the spectrum, as a non-operator you seek to be actively involved in operational decisions. To do so, you may replicate some of the work done by the operator. For example, you may independently build reservoir simulation models and generate field development plans, you could make your own cost estimates and possibly do part of the engineering design work. Apart from the real “hands-on” operator work like running the plant or letting contracts, you could in theory duplicate almost everything.

These two extremes are hardly ever followed exactly. As we show in Exhibit A, there are other models which we call “Strategy and Oversight” and “Active Management”. You can also choose different models for different parts of the Joint Venture’s business. However, a well-informed choice about which model to adopt is important as there are huge manpower and cost implications depending on exactly which alternative you pick.

Exhibit A: Non-operating strategies

How should you position yourself as a non-operator?

How do you decide where on the spectrum you will be? This depends on five main considerations:

·     What are the main risks for you as non-operator?

·     How competent is the operator?

·     Can you add value to the Joint Venture that the operator cannot do?

·     How much real influence do you have over operational decisions?

·     What can you learn from the operator?

Let’s first focus on risks. The most obvious one is losing economic value. Many people assume that this risk correlates primarily with the absolute value (e.g. in terms of Net Present Value) of the Joint Venture (see https://hbr.org/2014/11/a-refresher-on-net-present-value for an excellent refresher). In our view this is not the entire story. It is more important to look at potential misalignment in what drives value for you and what drives value for the operator. As discussed earlier, this is one of key reasons that Joint Ventures fail. For example, if your driver is to maximize Net Present Value over the lifecycle whilst the operator wants to maximize cash flow in the first three years, that could lead to very different development and operating decisions. You need to be on top of this to ensure your own objectives are not unnecessarily compromised.

Another key risk is reputation or even liabilities because of preventable mistakes made by the operator. It is key that the operator has a well-functioning risk management system in place. If this is not the case, you need to do your own risk identification and assessment for the Joint Venture and influence the operator to take the results into account.

With regards to competence, it is your task as a non-operating partner to assess where the operator is fully competent and where you have concerns. You can do this in a number of ways. You can for example ask to see the standards the operator is working to and verify – either in-house or by experts – that these meet your requirements. You can look at their performance on similar assets elsewhere in their portfolio. Do they meet their production targets, are their operating costs competitive and do their projects deliver the predicted returns? Finally, by participating in technical reviews and audits, you can form an opinion about the skills and experience of the operator staff.

You may be able to add value in areas where this is much more difficult or even impossible for the operator. For example, you may have advantages in terms of financing costs (costs of capital), vertical integration (e.g. own a sizeable downstream and trading department in addition to your upstream business), or in the case you are a National Oil Company in crude balancing or lifting rights. Careful identification and consideration of these differences can add further value to the Joint Venture and your own returns.

Your degree of influence is important. If the shareholder agreements stipulate that your share is too small to have an actual say in decision making, it is probably not going to be good business to dedicate huge resources to shadowing the operator.

Finally, you may be able to learn from the operator. You can learn about their processes, their technology and how they make decisions. Secondments into the operator’s organization can be a great way to increase your knowledge and develop your staff. The more you believe you can learn, the more involved you should get.

An easy formula

In summary, the amount of effort you should put into shadowing the operator and hence where you position yourself on the spectrum shown in Exhibit A can be expressed in a simple formula:

 The variables in this equation cannot be expressed in a precise numerical manner. Yet going through the thought process above and using the logic of the equation can assist companies in deciding whether and where they should get involved and where they can choose to remain “dormant”.

This method works for a single Joint Venture where you hold a minority interest but is equally effective when a company holds a portfolio of these type of assets. You can compare the elements of the equation for each of these assets and then decide how you best deploy your resources.

Other considerations

Finally, a few other important considerations that can help you in determining how you engage with the Joint Venture operator.

People are a key success factor to make Joint Ventures work. As a non-operator choose people in key roles who understand and respect the working culture of the operator. Chemistry between the most senior people can make a big difference. Partners in Joint Ventures are often competitors in other areas; make sure that this “competitor mindset” is not there in your interactions with the operator.

Joint Ventures often struggle with excessive requests for data or general information from non-operating partners to satisfy the internal corporate processes of these partners. Particularly when there are many shareholders, this can drain the energy of the Joint Venture staff. Therefore, as a non-operator resist the temptation to inundate the Joint Venture with ad-hoc requests for all kinds of different things. Be selective in what you ask for and agree requirements with Joint Venture management up-front. Where possible, include these and other governance issues in the Joint Venture agreements, this will prevent lack of clarity and potentially conflict at a later stage.

Conclusion

Rightsizing your efforts for companies in which you are non-operator is important. These days, the value of an oil company is often very significantly (> 50%) represented by their holdings in these type of assets.

At ValVestris, we have decades of experience in managing Joint Ventures and non-operated assets in many different parts of the world (https://valvestris.com/our-team/). Our capabilities are shown in detail in Exhibit B. If you would like to find out more, please get in touch via LinkedIn or via [email protected].

Exhibit B: ValVestris capabilities in the areas of Non-Operated Venture management.

Resources

Article “The Science of Alliances: Success factors in Joint Ventures and Strategic Alliances” by PWC

https://www.pwc.com.au/pdf/science-of-alliances-2014.pdf

Article “Why Joint Ventures Fail — And How to Prevent It” by Josh Kwicinsk, David Ernst, and James Bamford

https://www.waterstreetpartners.net/blog/why-joint-ventures-fail-and-how-to-prevent-it

Article “Why do international joint ventures fail?

A strategic mismatch explanation” by Bo Bernhard Nielsen

https://www.researchgate.net/publication/5092998_WHY_DO_INTERNATIONAL_JOINT_VENTURES_FAIL_A_STRATEGIC_MISMATCH_EXPLANATION

[1] There are many types of Joint Ventures with different kinds of governance mechanisms, operating agreements, and financing arrangements. In this article, we use the term broadly; a Joint Venture is any kind of business entity in which two or more companies agree to co-operate and share ownership, financial returns and risks. Companies can be listed international companies but also wholly state-owned or even private companies.