Anatomy lessons: important considerations for a successful PSA

Dec. 1, 2007
Many companies in the oil patch see M&A activity as a better route to adding scale than organic growth.

Many companies in the oil patch see M&A activity as a better route to adding scale than organic growth. Richard Burleson offers some general guidelines that can be drawn and made applicable to most oil and gas purchase and sale agreements.

Richard L. Burleson Burleson Cooke LLP Houston

Merger and acquisition activity in the oil and gas industry is booming, as players snap up reserves to remain competitive. Trying to complete the transactions quickly, however, should not compromise the need for careful and prudent deal-making. This launches a series of articles on this topic, and it includes special attention to analyzing the oil and gas purchase and sale agreement, i.e. the anatomy of a PSA.

Current state of the market

According to recent analyses by PricewaterhouseCoopers and, 485 oil and gas deals, an approximate one-third of all M&A activity worth a record $82 billion, were completed in 2006. The average value of deals in the energy sector rose 18% that year, and 2007 could set another record.

Some obvious deal drivers are the torrential cash flow resulting from oil sales that have topped $80 a barrel and the emergence of MLPs in the upstream oil and gas sector.

“The pressure to replace reserves and the structural rationale for consolidation will remain,” writes PWC’s Rick Roberge. “It is clear that consolidation has a long way to run in the independent and mid-size sector of the market, particularly in North America. At the same time, the [national oil companies] and private equity players will be key drivers of deal activity both in the mid-tier and at the top end of the market.”

Many companies in the oil patch see M&A activity as a better route to adding scale rather than organic growth. Political instability abroad is driving potential acquirers to look closer to home for such M&A opportunities. Small, large, independent, regional, specialized, and even alternative energy companies are thus aggressively seeking out transactions.

Even advisory firms that specialize in oil and gas mergers are consolidating, like Standard Chartered, which just announced its takeover of Harrison Lovegrove, following similar moves such as Merrill Lynch’s takeover of Petrie Parkman.

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Despite all of the exuberance, the fundamentals of a successful oil and gas deal remain constant. Although the objectives, the parties, and the nature of the assets vary in each transaction, some general guidelines can be drawn and made applicable to most oil and gas purchase and sale agreements, which highlight important considerations that can help make a deal successful. They are:

Elements of an agreement ­ definitions

After identifying the parties involved in the purchase and sale, most agreements go on to a detailed section of definitions because of the document’s technical nature and subsequent language. Precise utilization of defined terms is important to reduce the length of the document and facilitate negotiations.

So, mutual understanding of defined terms is especially important in oil and gas deals, facilitating communication and minimizing confusion due to terms that can be highly technical, arcane, or sometimes varied by region. Other terms may have specific meanings set forth by regulations, such as the federal Comprehensive Environmental Response, Compensation, and Liability Act or “CERCLA.”

Some parties insert the defined terms in an exhibit or annex to the document so that the primary commercial terms of the agreement are the first section to appear. This strategy is often utilized and gives a document better “optics” by making it appear shorter. A good source for definitions is the Dictionary for the Oil and Gas Industry, 1st Ed. (PETEX, 2005).

Assets to be conveyed

The purchases almost always constitute a broad description of the assets being conveyed, coupled with exhibits or schedules that list the leases, wells and units and a disclosure of the working interest and net revenue interest the seller claims to own in each respective property. In addition, descriptions of the various assets such as contracts, equipment, records, rights of way, easements, intellectual property, and other assets that are to be sold should be stipulated in a detailed itemization.

A catch-all description of the assets assures that property falling within the broad description but left off the exhibit will be included in the sale. It is worth mentioning however, that utilizing a broad description could result in a buyer inadvertently picking up properties that are environmentally impaired or have plugging and abandonment liabilities that were unanticipated. Due diligence coupled with carefully prepared representations and warranties about the property can mitigate the risk of acquiring unintended assets and liabilities.

Excluded items

A separate section with a comprehensive schedule of assets that are not being transferred is an effective defensive mechanism against unwanted or unintended conveyances. This section can also ensure that oil and gas produced prior to the effective date of the agreement remains on the seller’s side of the post-closing adjustment ledger. In addition, excluded items often include any leased equipment, legal causes of action pertaining to the property arising before the effective date, environmentally contaminated property, furniture, software, claims for tax refunds, the company name and phone number, and even the office lease.

“Despite all of the exuberance, the fundamentals of a successful oil and gas deal remain constant.&rquo;
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Seismic data
Since seismic data can be extremely valuable, some purchase and sale agreements break out a section solely to deal with this issue. The seller may want to convey none or some of its seismic data. Often the license agreement for the seismic data prohibits transfer of the data, requires a new licensing fee to be paid upon a transfer or change of control of the ownership of the company. This section can also contain a defensive provision excluding from the conveyance any data which, if disclosed, would cause the seller to breach any contract or agreement.

Effective date and closing date

Parties to an oil and gas deal involving producing oil and gas wells typically establish the effective date as of the date information about the subject properties was provided by the seller to the buyer in their initial negotiations. Since information about producing wells is never available in real time, and due to the time necessary to prepare the purchase and sale agreement and conduct due diligence, the closing date is typically several months after the effective date of the agreement. For this reason, it is necessary to account for the oil and gas produced and other matters that occur between the effective date and the closing date.

Typically, a purchaser is entitled to receive all production and income from the property after the effective date and is responsible for all liabilities attributable to the properties after the effective date. However, since the seller is still controlling and operating the properties during this interim period, there is often significant negotiation of the liabilities to be allocated between the parties for certain matters such as capital expenditures, litigation, environmental liabilities and even operating costs. The PSA will typically address these issues and set forth detailed protocols for adjusting the accounting for interim operations after the signing of the PSA leading up to the closing and conveyance of the assets.


The purchase price set forth in most purchase and sale agreements is only the starting point for determining the actual consideration that will be paid at closing. Purchase price adjustments calculated as of the closing date will reflect numerous accounting matters based on a calculation determined as of the effective date. For example, the purchase price will increase based on capital expenditures made by the seller after the effective date but prior to the closing date. Conversely, the purchase price will be reduced to reflect the sale of oil, gas or other products received by the seller after the effective date.

One of the most significant ways the purchase price may vary is in connection with title defects. The seller typically represents that it owns good title to the subject properties and that, except as otherwise disclosed, there are no environmental issues existing on the properties. A prudent buyer will conduct due diligence to confirm independently the status of title and environmental concerns. Defects and concerns that are brought to the attention of the seller within the time allocated in the agreement, and that are above a threshold established by the parties, operate to reduce, or sometimes increase, the purchase price if the due diligence discloses that the seller owns a different interest in one or more assets than initially represented.

Negotiations surrounding purchase price adjustments form the basis of the most active negotiations leading up to the closing. Therefore, it is critical to set up appropriate mechanics in the PSA to assure that from a buyer’s perspective, there is sufficient time and opportunity to conduct due diligence and impose adjustments to the purchase price to reflect the actual value for the subject properties contemplated in the stated purchase price.

Next installment

The next installment of this series of articles will begin with a discussion of the representations and warranties made by the parties to a purchase and sale agreement. This is important because the topic encompasses the critical starting point for due diligence including matters of title, environmental compliance, and the condition and operation of properties. These matters go to the very heart of a purchase and sale agreement.

About the author

Richard L. Burleson [[email protected]] is managing partner at Burleson Cooke LLP, a Houston-based law firm. He has a broad business practice in the areas of mergers and acquisitions, corporate finance, and energy. He earned a BA degree with honors from the University of Texas and has a JD degree from the University of Houston Law Center.