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Vinson & Elkins at 100: The Rivalry with Baker Botts [Gaille Energy Blog Issue 48]

The rivalry between V&E and BB started in the 1870s—in the small East Texas town of Huntsville.  A young couple moved next door to the forty-something Bakers.  The Bakers’ new neighbors were Walker County Sheriff Elkins and his young wife, Sallie.  The couple would eventually become the parents of James Anderson Elkins—the founder of Vinson & Elkins.

Something happened between the Bakers and the Elkins.  It culminated in a public confrontation between Mrs. Baker and 20-year-old Sallie.  The women hurdled a dead chicken back and forth over their fence until all of its feathers fell out.  While the war of the chicken lives on in Huntsville lore, its origin remains a mystery.  Whatever transpired may have led to the founding of Baker Botts; not long after the incident, then-50-year-old James Baker moved his family to Houston, where he joined the law firm that would become Baker Botts (in 1872).

James Baker the Elder

James Baker the Elder

Back in Huntsville, Mrs. Elkins gave birth to James in 1879.  Sheriff Elkins never lived long enough to know his son.  He was shot dead in 1880, leaving 29-year-old Sallie to raise James and his sister on her own.  Life was hard after that, but by all accounts, the adversity shaped James into a formidable young man.  He went to law school at the University of Texas and went on to serve as Huntsville City Attorney, Walker County Attorney, and Walker County Judge.

Judge Elkins was almost 40 when he followed the Bakers to Houston, co-founding Vinson & Elkins in 1917 (pictured below in 1919).

Elkins-in-1919-copy-e1490108538529

At that time, there were only two law firms with more than five lawyers in Houston.  One of those was Baker & Botts, which “until the late 1920s . . . held a virtual monopoly on the city’s desirable law business” (Texas Monthly, Nov. 1973).  B&B was now run by James Baker the Elder’s son, Captain James Baker.

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Captain James Baker

There is something remote . . . foreign . . . even Yankee. . . about Baker & Botts . . . . From its earliest days it has been the East Coast’s team in southeast Texas, representing Northern brokerage houses, utilities, lumber companies and other absentee landlords, and railroads. From the 1870s to the 1930s, when the Southwest was just another province in an economic system that was centralized in the East, these interests required trustworthy lawyers to cultivate their Texas gardens, and they found them. Baker & Botts grew with its clients. . . . None of the other Houston firms has anything like this sort of tradition. It sustains the B&B lawyer in his serene detachment, a detachment that in turn goads other lawyers to mutter sourly of, ‘the Baker-Botts halo’ and dream of puncturing the self-righteous aura that surrounds the firm. . . . .Lawyers at Vinson Elkins and Fulbright . . . are equally convinced of the superiority of their own firms, but they do not express their feelings with the same self-assured air of patrician certainty as the B&B man does. He seems satisfied to believe that his soul remains in Wall Street, Greenwich, Westchester, or Cape Cod, while his body has been temporarily assigned to these steamy Gulf Coast marshes in furtherance of the Deity’s inscrutable barristerial design.

Texas Monthly, Nov. 1973.

While Baker Botts focused on representing New York corporations, V&E developed a niche with local Houston companies and independent oilmen:

Vinson Elkins, unlike Baker & Botts, built its strength on local business. In the 1930s it was a “four-client firm”: the Great Southern Life Insurance Company, Moody-Seagraves, the production end of United Gas Corporation, and Pure Oil Corporation. All but the last were headquartered in Houston. Judge Elkins saw another resource, however, and exploited it brilliantly. The local independent oil men had never catered to Baker & Botts; they always thought it was too close to the big oil companies and Eastern finance. The Judge, wearing his banker’s hat as president of First National, gave them loans; VE in turn did their legal work. The firm prospered by carrying them on the cuff while they drilled dry holes and collecting when they finally hit. This neat little arrangement catapulted VE into the big time.

Texas Monthly, Nov. 1973.

It was Elkins’ judgment that catapulted V&E into the upper echelon: “‘There wasn’t a man alive who could dominate anything Judge Elkins was in, except Judge Elkins’” (Texas Monthly, Nov. 1973).

JAElkins

Judge Elkins

As Texas Monthly explained shortly after his death:

He made all the decisions at both institutions for practically half a century, never bothering to get anyone else’s approval. Lawyers work on Saturdays, he said, and a hundred VE attorneys attired in coat and tie duly trooped to their desks each Saturday morning until 1969, almost a decade after the other firms had made such appearances optional.  Lawyers wear hats, he said, and hats were worn. It is conceivable that by the mid-sixties, half the hats sold in Houston were purchased by Vinson Elkins lawyers. A young Kennedyesque associate, new to the firm, vowed he would be damned if he would wear a hat. One day as he was leaving, he chanced to encounter Judge Elkins in the elevator. Granitic stares. Uncomfortable silence. Finally: “Young man, I see that you do not have a hat.” Came the abashed and craven answer: “Sir, I did have a hat, but somebody stole it, and I’m on my way out right now to buy another one.”

Texas Monthly, Nov. 1973.

By the time Judge Elkins passed away at 93 years of age in 1972, V&E had surpassed its rival Baker Botts.  It had 186 lawyers to Baker Botts’ 160.

When I practiced law at V&E in the 1990s, the two firms still exhibited different cultures.  V&E was a collection of fiercely independent, larger-than-life personalities—while B&B partners evoked a certain patrician uniformity.  My friends who worked at B&B used the adjective “Bottsian” to describe a certain aloofness and manner.  The more Bottsian a young lawyer was, the better were his or her chances of making partner.

No doubt that both James Baker the Elder and Judge Elkins would be proud to see where their firms are today.  V&E continues to be the largest law firm in Houston, with 284 lawyers to BB’s 217, and both firms’ profits per partner exceeded $2 million in 2016.

Would the two firms be here today if something hadn’t happened between a Baker and an Elkins in 1872?

VE-Party-1925-e1490129801610

V&E Boat Party in the 1920s

About the Gaille Energy Blog.  The Gaille Energy Blog discusses issues in the field of energy law, with weekly posts at http://www.gaillelaw.com.  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of two books on energy law (Shale Energy Development and International Energy Development).

Images available on the Internet and included in accordance with Title 17 U.S.C. Section 107.

What Is an Outside General Counsel? [Gaille Energy Blog Issue 47]

Outside general counsel are outside attorneys (who work for law firms) but take on responsibilities similar to those of in-house lawyers (who are the client’s employees).  Some may have served as the chief legal officers of NASDAQ or NYSE corporations but have since moved back to a law firm—often following the merger, acquisition, or dissolution of their former employers.  In such cases, their board room experience makes them commercially savvy in topics such as corporate governance (and politics), strategy, finance, accounting, risk management, compliance, and ethics.

Examples of outside general counsel roles include:

  • Small Companies with No In-House Lawyers. Small companies rarely have sufficient legal work to support a full-time attorney on their payrolls.  Instead, they establish relationships with outside counsel who manage all of their legal needs.  The outside general counsel directly undertakes legal work but also helps the client select and manage other specialist attorneys, including employment, securities, and trial lawyers.  The business owner works directly with just one lawyer—the outside general counsel.  It’s just like having a general counsel, without the payroll responsibility.
  • Overflow/Adjunct General Counsel. Even at large corporations, there are only so many in-house counsel capable of running major deals.  Rather than hiring an additional in-house lawyer (who may not be needed when the workload subsides), the legal department can retain an outside lawyer as an adjunct general counsel.  This adjunct then becomes the principal legal advisor to the client’s commercial team on certain deals, reporting to an in-house attorney.  The following figure illustrates how the outside lawyer becomes a de facto part of the client’s legal department:

Untitled - Test

  • Advisor to CEO. This arrangement usually arises in mid-size companies, which may have less experienced in-house attorneys.  While the in-house team may be well-suited for day-to-day affairs, the CEO may look to a seasoned outside attorney when material matters arise.  The outside general counsel steps in to take on the strategic and consultative role of general counsel until the transaction/crisis has been resolved.  The following figure illustrates how the in-house legal department continues to handle routine activities while the outside general counsel manages the major matter:

Outside Figure 3

While serving on The University of Chicago Law School’s Visiting Committee, I had the opportunity to discuss careers with many successful alumni.  Those graduating in the 1980s or earlier tended to have one-track paths, working either for law firms or for corporations (almost) all of their lives.  Those of us graduating in the 1990s onward have moved back and forth among in-house positions (including both legal and commercial roles), law firms, and government service.  What has emerged is a group of highly flexible lawyers, who can more easily and effectively serve clients in the capacity of outside general counsel.  As Forbes recently observed, “This is the golden age of the legal entrepreneur, a time when, to quote T.S. Eliot, clients are ‘no longer at ease in the old dispensation.’”

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About the Gaille Energy Blog.  The Gaille Energy Blog discusses issues in the field of energy law, with weekly posts at http://www.gaillelaw.com.  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of two books on energy law (Shale Energy Development and International Energy Development).

 

Do Climate Accords Matter? [Gaille Energy Blog Issue 46]

Talking heads have been complaining about (or alternatively, celebrating) President Trump’s withdrawal from the Paris climate accord.  Lost in their arguing is a simple question.  Can climate accords make (much of) a difference?

We live in a global economy in which goods can be manufactured and sold nearly anywhere in the world.  Energy expenditures amount to ~10% of worldwide GDP.  As such, the cost of energy is a significant component of the prices we pay for goods.

China has relied extensively on coal to generate cheap energy for its industry:

China Coal

The device you are using to read this article was probably manufactured in China, and it cost you less because of coal.  The tradeoff for low-cost Asian manufacturing has been a surge in carbon emissions:

CO2 emissions

The vast majority of Earth’s seven billion people do not care where their electronics are made.  Even if an accord restrains China’s carbon emissions, what about the rest of the world?  Somewhere, someone will build a factory that uses the cheapest form of energy available—irrespective of carbon.  As such, making certain forms of energy artificially more expensive through government action—regulations, taxes, subsidies, and accords—is unlikely to make much difference.  The restrictions will simply be bypassed and overcome by market demand.

The more viable solutions to reducing carbon emissions instead involve using technology to make cleaner energy cheaper.  Examples include:

  • Hydraulic Fracturing. Notwithstanding its critics, hydraulic fracturing has flooded the United States with inexpensive natural gas, which emits about half as much carbon as coal.  The below figures illustrate how and why American energy consumption has shifted toward cheaper shale gas:

US_Electrical_Generation_1949-2011

Picture1

  • Carbon Capture. Carbon capture and storage technology (CCS) captures carbon emissions from plants and then injects them into underground geological formations.  The cost of building plants with CCS also is falling:

graphic-emissions-data_0

    Source: Stanford University

  • Solar Power. Solar technology, too, has made substantial technological gains in recent years:

Solar power cost

Innovation is the invisible hand of climate change.  As Adam Smith said in The Wealth of Nations:

“As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value, every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.  Nor is it always the worse for the society that it was not part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good.”

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About the Gaille Energy Blog.  The Gaille Energy Blog discusses issues in the field of energy law, with weekly posts at http://www.gaillelaw.com.  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of two books on energy law (Shale Energy Development and International Energy Development).

Dynamic Profit Sharing for Startup LLCs [Gaille Energy Blog Issue 45]

Energy ventures often begin with the formation of a limited liability company (LLC).  A handful of founders agree to contribute their skills and relationships toward a common purpose—the success of the LLC.  Just like new parents, the founders are giddy with delight over their creation.  Only later does reality set in.  For example, initial expectations of equal work and contributions by each founder may not be realized.

Posit that there are three founding members of a new LLC: (1) a geologist, who will tap her network to identify potential acquisitions and then evaluate their technical merits; (2) a financier, who will use his relationships with hedge funds and banks to raise capital; and (3) an operator, who will run the acquired asset.  They enter into an LLC Agreement that divides ownership and profit sharing equally (one third each).

During the first year, the geologist toils around the clock pursuing acquisitions.  Similarly, the financier works 3,000 hours, eventually securing the capital needed to purchase an oil field identified by the geologist.  Meanwhile, there’s just not much for the operator to do until a deal closes.

The next four years of the project see a reversal of the first year’s responsibilities.  The operator now works days, nights, and weekends to increase the oil field’s production.  Yet the geologist and the financier clock half as many hours, often taking long weekends to go hunting and fishing.  They even rent a house together in Hawaii for an entire month one summer.  Nonetheless, each founder continues to receive equal profits.

The operator’s resentment gradually builds.  He’s missing kids’ Little League games while watching the geologist and financier flood Facebook with beach photos.  When they return from Hawaii, the angry operator tells them that equal sharing is no longer fair.  The operator demands two thirds of the LLC’s profits—since he is doing two thirds of the work.

The geologist reminds the operator that it was her skills that detected the oil field’s potential from wavy seismic images.  The financier points out that it was his relationship with a New York hedge fund that delivered the project’s capital.  Simultaneously, they both say, “Without me, there would be no project for you to operate.”

This asymmetrical timing of contributions is the dilemma of many startups.  Some members contribute relationships and specialized skills at the front end, but the contributions of others occur later and take longer in terms of cumulative hours.  In such cases, fixed profit sharing may be too rigid and eventually lead to conflict.

One way that Members can mitigate this risk is through a dynamic profit-sharing clause in the LLC Agreement.  For example, the LLC Agreement can establish two series of LLC shares (Units):

  • Founder Units (Entitled to 50% of the Profits). These Units’ profit shares are fixed, based on the skills and relationships that the members contribute at the outset.  In the story above, each of the geologist, financier, and operator would own one third of the Founder Units and would be entitled to one sixth of the LLC’s profits indefinitely.
  • Dynamic Units (Entitled to 50% of the Profits). The allocation of profits to Dynamic Units is adjusted annually, based on the value of each member’s contributions to the LLC during the prior year.  In the example above, the allocation may have been as follows: (Year 1) – not applicable, no profits; (Year 2) – 20 points to geologist, 20 points to financier, and 10 points to operator, reflecting the disproportionate contributions of the former two in the first year; and (Years 3-5) – 25 points to operator, 12.5 points to geologist, and 12.5 points to financier, reflecting the operator’s dominant role in those years.

Ideally, the parties would be able to mutually agree on the dynamic allocation each year, but what happens if consensus cannot be reached?  The LLC Agreement should include an expert determination to resolve such impasses—each member explains the value he or she has contributed, and then an independent expert decides the allocation.

Dynamic allocations need not be perfect.  Simply having a mechanism that recognizes disproportionate contributions helps to defuse conflict among founders.  The early contributors know in advance that their profit distributions are likely to decline; the late contributors expect to be rewarded by theirs increasing.  No one is surprised.

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About the Gaille Energy Blog.  The Gaille Energy Blog discusses issues in the field of energy law, with weekly posts at http://www.gaillelaw.com.  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of two books on energy law (Shale Energy Development and International Energy Development).

The Oscillation of Negotiations [Gaille Energy Blog Issue 44]

At any given moment in the negotiation of a contract—or in the settling of a dispute—the two parties may be more (or less) predisposed toward concession.  Each party’s willingness to compromise is not flat or linear.  It is ever oscillating at different wavelengths.  The following figure illustrates this concept:

Blog 44 slide 1

From one week to the next, each party’s perspective on settlement varies, bringing them closer together or further apart.  Understanding this pattern is particularly important for energy dealmakers because their negotiations often last several months.  Timing can make a difference.

Much of negotiation theory focuses on the actions one party can take to trigger concessions.  Some of these are carrots (e.g., offers of immediate cash) or sticks (e.g., threats).  Others are in the nature of persuasion, such as explaining why the other party’s understanding of the facts (or law) is simply wrong—or at least unlikely to prevail in court.  All of these actions can potentially influence the counterparty, although sometimes they cause movement in the wrong direction.  Offers of money can be perceived as weakness, bolstering the other side’s confidence.  Threats can provoke anger, leading to distrust, defensiveness, and retribution.

Negotiators who are too focused on their own actions sometimes miss how unrelated events may be influencing their counterparty.  These include:

  • Internal Politics. Managers at large companies are under varying levels of pressure to achieve a deal or resolve a dispute.  The boss may demanded results.  Bonus determinations may be imminent.
  • Change of Personnel. Changes in personnel often cause oscillations.  If the successor has inherited a pre-existing problem, he or she may want to settle it quickly—attributing the cost to the predecessor.
  • Financial Distress. Financial distress tends to move counterparties toward conciliation.  The company may need the new deal to survive, or it may want to stem the flow of legal fees.
  • Sale of Company.  The current owners may be willing to accept worse terms in preparation for selling the company—at the expense of long-term erosion of value (that will be someone else’s problem). Disputes also need to be resolved, as they can scare off potential buyers.
  • Going Public. Similarly, planned IPOs can cause a counterparty to be more amenable to compromise.  For example, material disputes must be disclosed on public filings.

The following figure illustrates how such factors can predispose a party toward concessions:

Blog 44 slide 2

Imagine two people holding opposite ends of the same rope.  It’s easier to pull the other closer if he or she is moving (or leaning) toward the middle.  If the other person is pulling in the opposite direction, it’s much harder.

Negotiators must be good listeners and keen observers, always being sensitive to changes in their counterparties.  If one detects that something has caused the other party to shift toward resolution, that is the time to pull hardest.  Pulling hard usually means making reciprocal concessions, which tend to accelerate the matter’s conclusion.  There is no better time to close a deal than when the adversary is moving in your direction.

The best and most experienced negotiators can sense such moments.  They may discover them in a change of tone (in voice or text), by a sense of urgency in scheduling, or in the substance of proposals.  The last thing a negotiator wants to do is miss such an opportunity and discover that the counterparty is moving away again.  As Thomas Hobbes said in Leviathan, “Hell is truth seen too late.”

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About the Gaille Energy Blog.  The Gaille Energy Blog discusses issues in the field of energy law, with weekly posts at http://www.gaillelaw.com.  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of two books on energy law (Shale Energy Development and International Energy Development).

Handbooks for Energy Contracts [Gaille Energy Blog Issue 43]

Transactional lawyers tend to disengage after the closing. That’s a mistake in the energy industry. Our joint venture agreements endure for decades. Our construction contracts last for years. After the closing, non-lawyers usually assume responsibility for implementing documents spanning hundreds of pages.  These administrators have their own ideas about how each contract works, which may be incomplete—or wrong. Sure, they may consult with counsel from time to time, but how often are issues missed?

One of the best solutions for multi-year compliance challenges is the agreement handbook. What’s an agreement handbook?  The handbook is a CliffsNotes-like summary of the contract’s principal terms designed for use by non-lawyers.  My handbooks share the following characteristics:

  1. Alphabetical Entries.  The overall organization of the handbook is encyclopedic.  There are entries for major topics in alphabetical order.  For example, a construction agreement handbook starts with Acceleration and continues through Adjustments (Price and Time), Adverse Weather, Amendments, Auditing, Change Directives, Change Orders, Change Requests, etc.  Non-lawyers can easily flip pages, locating entries by their common names.
  2. Procedural Flowcharts.  Agreement procedures should be expressed graphically with a flowchart.  Flowcharts help administrators capture and enforce deadlines.  Below is an example flowchart for well proposals by non-operators:  picturea
  3. Figures for Tests/Standards.  A party’s rights often depend on certain conditions being met. Figures are useful for visually capturing applicable requirements.  In the example below, the contractor is only entitled to an extension of time for bad weather if all of the criteria are satisfied:  weather-final
  4. Comparison Tables.  Certain rights and obligations are best expressed in comparative tables.  A typical example would be termination rights. Either party has the right to terminate the agreement for cause (based on the other’s breach), due to prolonged force majeure (events beyond either party’s control), or for convenience.  A table can capture the relevant differences between three forms of termination—showing under what circumstances each can be exercised, the timing for doing so, and applicable remedies (e.g., liquidated damages).
  5. Index.  At the end of each handbook, I include a full index, which further helps administrators locate applicable provisions that don’t rise to the level of a topic heading.  I also provide a searchable PDF version of the handbook.
  6. Cross-References.  Each reference in the handbook should include citations to the relevant sections of the agreement.

While handbooks are usually created for contract administration purposes (post-closing), they also can be helpful during negotiation of model (or form) agreements. Energy companies often rely on models as the starting point for their negotiations.  Having a handbook for each model deepens the negotiators’ understanding of its nuances, which translates into fewer giveaways at the negotiating table.  After closing, the model’s handbook can be modified to reflect the deal-specific terms.

A handbook works best when it’s supplemented by training.  I introduce the handbook at a half or full day session, walking through its key flowcharts, figures, and tables. It’s a great opportunity to field questions and correct misunderstandings about how the contract works. Depending on the life of the contract and turnover of personnel, refresher training sessions may be needed.

Handbooks range from 20 to 50 pages and take considerable legal work to complete.  Narratives have to be drafted.  Figures and tables must be created. Notwithstanding this, I’ve invariably found that handbooks pay for themselves many times over.  While bound agreements collect dust on shelves, handbooks get marked-up, flagged with post-it notes, and carted along to meetings. All of this translates to the client’s bottom line with improved compliance and better enforcement of contractual rights.

About the Gaille Energy Blog.  The Gaille Energy Blog discusses issues in the field of energy law, with weekly posts at http://www.gaillelaw.com.  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of two books on energy law (Shale Energy Development and International Energy Development).

 

 

Rick Perry’s Energy Policy [Gaille Energy Blog Issue 42]

I first met Rick Perry when I was Legislative Aide to Texas Representative Harvey Hilderbran.  Back then, Perry was a three-term Democratic State Representative—albeit a fairly conservative one.  The Young Conservatives of Texas rates lawmakers on a scale from 0 (most liberal) to 100 (most conservative).  Representative Perry received YCT ratings of 73, 90, and 61, respectively, over his three terms.  Nonetheless, Perry worked for Democrat Al Gore’s presidential campaign in 1988.  While historians debate whether Perry was Gore’s Texas campaign coordinator or co-chair, the former speaker pro tempore of the Texas House confirmed that whether he “was a coordinator or co-chair, (Perry) was involved.”

It turned out that Gore’s campaign was Perry’s last stand as a Democrat.  Less than a year later, Rick Perry held a press conference and announced he was switching political parties.  Now a Republican, Perry’s star rose quickly: (i) 1994-1998 – Texas Agriculture Commissioner; (ii) 1998-2000 – Texas Lieutenant Governor; and (iii) 2000-2015 – Texas Governor.  He also sought the Republican nomination for President of the United States.

Since leaving office, Governor Perry has been active in the energy industry.  He serves on the Board of Directors of Energy Transfer Partners, which operates ~71,000 miles of natural gas and oil pipelines.  Energy Transfer has been in the news a lot lately as its Dakota Access Pipeline has been frequently protested by Native American activists.

But what kind of energy policy can we expect from a Secretary Perry?  Below are Perry’s own words on five key issues:

  • Climate Change“The science is not settled on this. The idea that we would put Americans’ economy in jeopardy based on scientific theory that’s not settled yet, to me, is just nonsense.” Nonetheless, Perry supports an all of the above approach to energy, stating “I clearly believe that there is an important role for green energy sources as a part of our generation mix.”
  • Carbon Taxation and Subsidies“We don’t need to be subsidizing energy in any form or fashion.”  Republican strategist Grover Norquist also believes that carbon taxes are off the table: “one of the things I’d not worry about is a carbon tax.  I’d worry about big spiders eating New Jersey first.”
  • Regulations“We will return greater regulatory authority to the states to manage air and water quality rather than imposing one-size-fits-all federal rules.”  The combination of Texas’ Perry at DOE and Oklahoma’s Attorney General Scott Pruitt at EPA should lighten the regulatory burden on the energy industry.
  • Infrastructure Projects.  Perry supports “authorizing the export of American natural gas” and “approving the construction of the Keystone pipeline.”
  • Drilling on Federal Lands and Waters“[W]e will open several American oil and gas fields for exploration that are currently off limits because of political considerations.”

21st century energy policy is largely a means to other ends.  Democrats use it to further their climate change agenda.  Republicans like Rick Perry use it to advance economic growth.  As Forbes recently explained:

“Affordable energy is a powerful economic stimulant. Energy costs are a factor in virtually all goods and services bought and sold in our economy. When energy prices are lower, the costs of producing goods and services are lower, which operates like a tax cut. People and businesses can purchase more goods and services at lower prices. Also, people and businesses have more money left over from their direct energy bills. This extra money allows people to buy more goods and services that make life healthier, longer-lasting, and more enjoyable. The extra money also allows businesses to expand and hire more workers.”

Just as President Obama’s selection of Nobel Laureate Chu as his Energy Secretary signaled a focus on climate change, so too does Perry’s appointment herald a new one: economic growth.

In a year of extraordinary turns, leave it to President-elect Trump to nominate Al Gore’s former disciple as his Secretary of Energy.  Vice President Gore believes that Americans need to make hard economic sacrifices to reduce their carbon emissions.  Gore’s documentary on the subject, An Inconvenient Truth, so galvanized the Democratic Party that its national platform now calls for America to end its reliance on fossils fuels—entirely.  Now along comes Rick Perry, once Al Gore’s follower, to knock climate change from its pedestal.

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About the Gaille Energy Blog.  The Gaille Energy Blog discusses issues in the field of energy law, with weekly posts at http://www.gaillelaw.com.  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of two books on energy law (Shale Energy Development and International Energy Development).

 

Teaching Energy with Simulations [Gaille Energy Blog Issue 41]

A decade ago I developed my first energy simulation for Rice University’s Graduate School of Business.  It was designed to teach international energy development using exploration blocks in the Republic of Angola.  My Angola simulation has evolved over the years, but remains a central component of my courses at Rice and The University of Chicago.  I also have taught the Angola simulation in corporate environments—from Chevron’s San Ramon headquarters to Marathon’s Equatorial Guinea office.  For young energy professionals, simulations are an effective tool for fusing theory with practice.

I currently run two simulations in my courses: (i) the Angola exploration bid round and (ii) shale joint ventures.  Each divides the class into ten teams.  I usually appoint the team “captains” who then commence a draft, with the captain picking the second team member, the second choosing the third, and so forth.  The same teams participate in both simulations:

Angola Exploration Simulation.  Teams are presented with budgets, auction rules, and summaries of ~15 petroleum licenses, including the number of drillable prospects, well cost, chance of discovering oil, and, in the event of a discovery, expected oil reserves. Students then develop their own basic economic models, which drive teams’ bidding strategies. The first session is devoted to a live, sealed-bid auction during which teams competitively bid on licenses in sequence.  The team with the highest bid wins each block, and there are enough blocks that every team secures at least one.  After the auction concludes, groups engage in negotiations to acquire and/or divest interests in licenses.  Some teams opt for concentrated positions (in one or two blocks) while others seek to create diversified portfolios of smaller interests from many blocks. Because the negotiation workshop is multilateral, uncooperative negotiators may be bypassed.  Finally, the simulation concludes with the rolling of dice to see which wells discover oil, thereby driving home the reality of risk.  The team that ends the simulation with the most net present value wins the game.  The Angola simulation thus teaches students: (i) how to participate in energy bid rounds (following auction rules and formulating bids); (ii) how to conduct multilateral negotiations (where there are many potential assets owned by many counterparties); and (iii) how to manage the inherent risks of the energy industry, as the luck of the dice roll propels some teams but frustrates others.

Shale Joint Venture Simulation.  Each team is provided with a card showing its scores for three different characteristics: (i) available capital; (ii) operating capability; and (iii) quality of shale asset base. Half of the teams are capital rich but lacking to some degree operating capability or shale assets.  The others are capital poor but stronger in the remaining two criteria.  The first session focuses on due diligence, with teams interviewing each other in search of suitable partners.  It’s followed by a multilateral negotiation focused on JV sharing ratios.  If two teams partner, how will they divide the proceeds?  Teams must consider both the sums of their characteristics and the sharing ratio in their JV decisions.  After partners are chosen, the resulting five JVs make board presentations justifying their combinations.  The simulation concludes with the JVs rolling dice to see how well each performed with respect to capital, operations, and asset base.  The shale JV simulation thus teaches students: (i) how to search for JV partners to fill and strengthen their own gaps; (ii) how to conduct multilateral negotiations (with multiple potential JV partners); and (iii) how to make a board presentation defending one’s decision.

Real-time feedback is an important element of my simulations.  Throughout the sessions, I comment on teams’ models, strategies, and negotiations, always seeking to reinforce the skills being taught.  I also infuse the games with stories of my own experiences.  What is it like to place nine-figure sealed bids into a glass box in Islamabad, Pakistan?  How do industry leaders like EOG Resources negotiate with smaller joint venture partners?  When properly designed and executed, simulations build confidence and better prepare energy professionals for industry success.

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About the Gaille Energy Blog.  The Gaille Energy Blog discusses issues in the field of energy law, with weekly posts at http://www.gaillelaw.com.  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of two books on energy law (Shale Energy Development and International Energy Development).

Energy Incubators [Gaille Energy Blog Issue 40]

The oil crash has unleashed thousands of accidental entrepreneurs on the energy industry.  Many spent their previous careers safely ensconced at Fortune 500 companies.  Now they are on their own, looking to leverage their experience in startups.

Business incubators “help new and startup companies to develop by providing services such as management training or office space” (Wikipedia).  Most incubators focus on the technology sector:

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While there are ~1,500 technology incubators, where are the energy incubators?  One example is Houston’s Surge, which was founded in 2012 by Kirk Coburn.  Given Coburn’s experience as a former Dell executive, it’s not surprising that Surge focused on the intersection of energy and technology.  Surge’s offerings resembled those of pure technology incubators—office space, networking, mentorship, and seed capital.  When Coburn closed Surge earlier this year, he complained that the energy “industry just did not buy into our model, idea, team, and/or innovation.”

Not all incubators follow the technology model.  Others focus on the legal and regulatory needs of startups.  For example, Tusk Ventures “help[s] startups navigate the political, regulatory, and media hurdles that come with reshaping entrenched industries.”  Tusk Ventures was founded by Bradley Tusk, a graduate of the University of Chicago Law School and former campaign manager for Michael Bloomberg.  Among Tusk’s achievements is helping Uber with the regulation of hired vehicles.

What if the flaw in Surge’s business model was offering the wrong services to energy startups?  I left Occidental Petroleum in 2007 to be president of an energy startup that was acquiring exploration blocks in Madagascar, Cameroon, and South Africa.  My startup needed: (1) financing (secured with a $40 million line of equity); (2) geological analysis (obtained from my network of G&G experts); and (3) many complex contracts (for which I utilized my own experience as an energy lawyer).

I could do without most of the services being offered by technology incubators:

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Energy startups tend to be comprised of experienced executives with established track records and widespread networks.  They do not need connections, much less mentors.  Nor do they require any help with project management or accounting.  Energy startups rarely even have a physical office.  The first year is consumed chasing money and deals, and founders are happy to meet in their own backyards (for a while).

Energy startups typically are missing only two ingredients for success: (1) acquisition capital; and (2) legal support.  The world of energy finance is well-developed, and many firms raise startup capital in exchange for equity and/or a contingency fee.  By doing so, energy bankers share the startup’s risk of failure.

Such is not the case with legal support.  Energy law firms charge hourly fees, requiring up-front deposits before work begins.  The legal cost of startups is magnified further by the number and complexity of energy agreements.  Before a venture sells its first barrel of oil, it must negotiate at least three suites of contracts:

  • Management Team Equity. Every startup management team thinks it will last forever—“One for all, and all for one” (Alexandre Dumas, The Three Musketeers). That’s unlikely.  Even the brightest stars at a big company can struggle in a startup.  Then there is the matter of institutional investors with their own ideas about team composition.  Funds may jettison one or two founders, replacing them with others of their own choosing.
  • Financing Arrangements. The startup likely will retain an investment banker through an “engagement letter.”  Banker engagements often make it difficult (or expensive) to terminate the banker, even a failing one.  Investor term sheets will follow (hopefully), and then the definitive financing agreements.  In the emotional rush to be funded, startups may accept affirmative and negative covenants that they come to regret.
  • Asset Acquisitions. Sellers often want to retain participation in the asset being sold. What form should it take?  Does the Seller receive an “earn out” or bonus payment if oil prices rise within the next year?  How much of the consideration is cash (up front) versus carrying the seller’s share of future wells?  Such commercial arrangements spawn complex agreements, each with dozens of exhibits.

Even worse, these agreements must be completed in parallel before the startup has raised any capital.  It’s a classic “chicken-and-the-egg” situation in which investors will not advance money without an asset, and the owner of the asset wants proof of funds.  How do energy startups afford all this legal paper?  They typically pay fees out of their personal savings.  401ks get depleted.  Corners also are cut.  Many lawsuits involving startup founders could have been prevented with better legal documents.

Energy incubation requires non-traditional attorney compensation, such as contingent and/or equity-based legal fees.  For example, Tusk Ventures “takes equity in lieu of cash” (Fortune).  Lawyers also can make their fees subject to the closing of transactions, thereby “taking on increased risk in exchange for increased reward—they have skin in the game” (Ari Dropkin, Skin in the Game: The Promise of Contingency-Based M&A Fees).  By doing so, they can help startups manage the risk that founders will incur five- or six-figure legal bills.  What the energy industry really needs is more energy incubator law firms.

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About the Gaille Energy Blog.  The Gaille Energy Blog discusses issues in the field of energy law, with weekly posts at http://www.gaillelaw.com.  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of two books on energy law (Shale Energy Development and International Energy Development).

 

 

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