Competitor Collaborations in the Exploration and Production Industry: Lawful or Unlawful
A variety of agreements among competitors that are common in the energy industry (such as joint operating, joint bidding, joint venture, teaming, alliance agreements and even gas and oil participation agreements) can raise significant antitrust issues and expose the participants to both criminal sanctions and civil treble damages. In oil and gas production, in particular, joint collaboration is commonplace because it helps companies defray costs, share risks and raise money from public and private sources more easily.
The Antitrust Division of the Department of Justice recently has been looking carefully at joint bidding activity in the exploration and production ("E&P") segment of the energy industry in part because there has been a huge upsurge in drilling activity, particularly in unconventional gas and oil shale plays, but also because much of the drilling is on federal and state-owned lands and the injured party to an unlawful activity would be a governmental entity. These enforcement actions suggest that prudent E&P companies may want to carefully review all ongoing and future arrangements with competitors.
Recent Enforcement Activity
A. U.S. v. Gunnison Energy Corporation.
One of the most recent enforcement actions involved allegations that Colorado-based Gunnison Energy Corporation ("GEC") and Texas-based SG Interests Ltd. ("SGI") entered into a written agreement under which they agreed that only SGI would bid on future Bureau of Land Management ("BLM") leases in the Ragged Mountain Areas of Western Colorado and then would assign GEC a 50% interest in any leases SGI won. The agreement which remained in effect for a year, applied to four BLM auctions, at which SGI bid and won leases. The DOJ challenged the agreement as anticompetitive bid rigging which is per se unlawful under Section 1 of the Sherman Act. The matter was resolved with a civil contempt order and a fine.
The DOJ found the GEC/SGI agreement to be both fraudulent and anticompetitive. It was fraudulent because SGI had certified to BLM that its bid was not the product of collusion with another bidder. It was anticompetitive because "it was not part of any procompetitive or efficiency enhancing collaboration." It was rather a "naked restraint of trade" which could easily have been criminally prosecuted but was not due to certain extenuating circumstances, including the fact that the parties had actively planned and had intended to enter into a formal joint venture structure.
B. Grand Jury Investigation Of Chesapeake Energy Corporation And Encana Corporation.
A second government investigation involves public reports of alleged discussions between Chesapeake Energy and Encana to potentially affect land prices and limit bidding against each other in the Collingwood formation in Northern Michigan. According to a newspaper article quoting a Chesapeake spokesperson, the two companies were in preliminary talks to form a joint venture to acquire and develop shale leases in the area but the actual agreement was never executed prior to certain alleged statements about the bidding process having been made by one or both companies. We have no knowledge as to whether such statements were actually made and are commenting only on what has been publicly reported.
The critical issues in the Chesapeake/Encana matter appear to be whether the parties reached any understandings with respect to the bidding process and whether there were any unilateral communications, with potential anticompetitive effects, that could constitute a violation of the antitrust laws. The former could be a potential criminal § 1 Sherman Act violation; the latter, under certain circumstances, could be prosecuted civilly under § 2 of the Sherman Act or § 5 of the FTC Act as an invitation to collude. See, e.g., United States v. American Airlines, 743 F.2d 1114 (5th Cir. 1984) (proposal by one airline to another to raise fares found to constitute attempted monopolization).
The Chesapeake/Encana investigation is ongoing and we do not know whether any enforcement action will ensue or whether the investigation will simply end with no finding of any wrongdoing by the parties. Chesapeake has denied any anticompetitive conduct and confirmed the investigation in a recent SEC filing. Encana has announced that it is conducting an internal investigation.
The GEC/SGI and Chesapeake/Encana matters would suggest that every E&P joint venture or other collaborative activity with a direct competitor should be subjected to at least a cursory antitrust analysis. The analysis, as presented by the Joint DOJ/FTC Antitrust Guidelines For Collaboration Among Competitors (2000), essentially suggests four inquiries:
Question 1: Is the joint venture acting as a single firm or as a collaboration of independent competitors engaged in a potential conspiracy in restraint of trade?
The initial question here is whether the firms have established a single entity or operate as a collaboration of independent competitors. The test does not simply look at whether there is a single corporate or partnership entity but at whether the firms have pooled their capital and share risks of loss as well as opportunities for profit. A mere shell corporate entity, which is only a cover for collusive activities, will not pass the test. Also, the venture must be in operation at the time of any collaboration or joint bidding and not simply in the planning stage. If the joint venture is a single entity for the purpose of antitrust analysis, then the actions of such an entity generally would be attacked under Section 2 of the Sherman Act or Section 5 of the FTC Act (which may require a showing of monopoly power in the market) and not under Section 1 of the Sherman Act (which prohibits all contracts, combinations and conspiracies in restraint of trade and has criminal sanctions).
Question 2: If the joint venture is acting as a collaboration of independent competitors, then is its conduct a type that always or almost always tends to raise prices (or lower prices in a buying situation) or to reduce output?
Agreements between two independent firms that fix prices or output, rig bids or share or divide markets are usually per se (i.e., presumptively) unlawful. These agreements are inherently suspect because of their pernicious effect on competition and lack of any redeeming virtue. In considering whether a particular agreement within a joint venture is per se unlawful, courts and enforcement agencies also will look at whether the venture itself is an efficiency-enhancing integration and whether the restraint in question is reasonably necessary to attain efficiencies. If the restraint could be achieved by less restrictive means, then the agreement will not be considered reasonably necessary and the per se rule will apply. If both justifications are present, each of which will be carefully scrutinized, the venture may be reviewed under the more lenient rule of reason standard.
Question 3: If the joint venture is not per se unlawful (i.e., it is subject to the rule of reason), will the venture actually cause actual anticompetitive harm?
A rule of reason analysis focuses on the state of competition with and without the relevant collaboration. It is a flexible analysis which considers the nature of the agreement, how the industry operates, the markets in which the agreement operates, the market power of the participants, the duration of the agreement, the likelihood of anticompetitive information sharing, etc. No one factor is dispositive of the analysis and enforcement by the government, if any, tends to be of a civil nature. If the analysis suggests that there is no potential for anticompetitive effects, the joint venture will be considered legal without further review.
Question 4: If there remain anticompetitive effects from the joint venture, is the overall competitive effect of the joint venture such that the procompetitive benefits outweigh the anticompetitive harm?
This is a typical balancing test which assesses the business reasons for the agreement against the anticompetitive harm without any presumptions of illegality. The benefits must be verifiable, not vague or speculative, and the challenged restraint of trade must be reasonably necessary to achieve those benefits. In addition, the DOJ/FTC Guidelines contains a safe harbor. Provided the participants have a combined market share in the relevant market of no more than 20 percent, the joint venture generally will be considered per se lawful provided we are operating under the rule of reason standard.
E&P joint ventures are receiving increased scrutiny by the Department of Justice and it would be a mistake to assume that the GEC/SGI and Chesapeake/Encana investigations are the only transactions under review. Moreover, as DOJ learns more about the E&P industry, they are likely to explore other areas of the country and other competitors for similar activity. The next case also may involve criminal prosecution and, hence, potential incarceration of involved executives. Traditional oil and gas participation agreements, where one party provides the land and the other the money, are less likely to present problems but, when you have two head-to-head competitors competing for land deals, agreements of any kind should be closely reviewed.
Application of the four part test above to any joint venture agreement in which your firm is currently participating or intends to join should become a regular business practice. Moreover, unilateral communications to direct competitors, delivered privately or through the press, also should be carefully scrutinized for their purpose and effect.