SEC Issues Guidance on Resource Extraction Issuer and Conflict Minerals Rules—Impact on Energy Industry Companies
On May 30, 2013, the Division of Corporation Finance of the Securities and Exchange Commission issued guidance, in the form of responses to frequently asked questions, regarding the SEC’s resource extraction issuer rules and conflict minerals rules. The FAQs can be found here and here. For an overview of the resource extraction issuer rules, please see our August 23, 2012 Corporate Update, found here.
The FAQs are not expansive but should provide some welcome relief (or at least clarity) to energy industry companies, and are particularly helpful to oilfield services issuers. We have highlighted below several of the points most relevant to energy companies.
Resource Extraction Issuer FAQs
Clarification for Oilfield Services Activities. The resource extraction issuer rules require disclosure of payments made to governments if the issuer engages in the commercial development of oil, natural gas or minerals and is required to file annual reports with the SEC. “Commercial development” of a resource is defined in the rules to include exploration, extraction, processing and export activities. In adopting the final rules, the SEC expressly declined to narrow the scope of commercial development to include only upstream activities, but noted that “the definition of ‘commercial development’ is intended to capture only activities that are directly related to the commercial development of oil, natural gas, or minerals. It is not intended to capture activities that are ancillary or preparatory to such commercial development.”
Whether a particular company is or is not engaged in the commercial development of a resource is unambiguous in many cases—typical exploration and production activity, for example, would make a company a resource extraction issuer, while typical refinery operations would not. However, the question was less clear for many oilfield services companies, notwithstanding the SEC’s commentary in the adopting release. Was the provision of drilling or hydraulic fracturing services, for example, directly related to the commercial development of oil and gas, or would such services be considered “ancillary or preparatory” to such development?
This question is addressed directly in the FAQs, and the guidance is fairly clear: the provision of services associated with exploration, extraction, processing and export does not make a company a resource extraction issuer. The relevant FAQ reads in part as follows:
Is a company that provides services associated with the exploration, extraction, processing and export of a resource considered a “resource extraction issuer”?
No. A company providing only services associated with exploration, extraction, processing and export generally would not be considered to be a resource extraction issuer. We recognize that many companies are involved in activities related to the commercial development of resources, but these companies may not be conducting activities that are considered to be one of the activities covered by Section 13(q) and the rules issued thereunder. For example, we do not believe companies that provide hardware and logistics to help companies explore for or extract resources would be considered to be exploring for or extracting the resources even though their services are being used to explore or extract. Similarly, we do not believe a company engaged by an operator to provide hydraulic fracturing services or drilling services for the operator, thus enabling the operator to extract resources, would be considered to be a resource extraction issuer.
The scope of the “services exception” to the resource extraction issuer definition is broad—while specific services are mentioned as examples (e.g., fracturing and drilling services), the guidance generally covers all services associated with exploration, extraction, processing and export. Nevertheless, before concluding that they are not resource extraction issuers, oilfield services companies should undertake appropriate inquiries to determine whether their business activities are limited to services only—some services companies own and develop oil and gas properties or extract minerals used in their products, equipment or consumables. Even a small amount of such activities would bring a company within the scope of the rules, although the required disclosure would be limited to payments made in furtherance of those activities.1
Oilfield services companies should also be mindful of the following:
- “Processing” a resource constitutes commercial development and would cause a company to be a resource extraction issuer. In the adopting release, the SEC stated that “processing” includes field processing activities, such as the processing of gas to extract liquid hydrocarbons, the removal of impurities from natural gas after extraction and prior to its transport through the pipeline, and the upgrading of bitumen and heavy oil. The services exception applies to services associated with processing, but given the language in the adopting release, the scope of the exception in this context is unclear.
- As noted in the FAQ cited above, when a service provider makes a “payment” to a government on behalf of a resource extraction issuer, the resource extraction issuer will be required to disclose the payment. Accordingly, services companies should be aware that while they may not be required to report such payments themselves, they may need to track such payments to facilitate their customers’ reporting obligations.
- The rules include an anti-evasion provision that requires disclosure with respect to an activity or payment that, although it does not in form or characterization belong in one of the categories specified under the final rules, is part of a plan or scheme to evade the rule.
Other Clarifications. The other FAQs on the resource extraction issuer rules address less fundamental issues but are important to note. They include clarifications of the terms “mineral” and “export” for purposes of the rules, and elaborate on the types of government payments required to be disclosed and the method of reporting. They also confirm the commonly-held view that the failure to timely file a Form SD would not cause an issuer to lose S-3 eligibility.
Conflict Minerals FAQs
The conflict minerals rules require disclosure regarding the use of conflict minerals or their derivatives (generally gold, tin, tantalum and tungsten) from the Democratic Republic of Congo or adjacent countries. The first step of the analysis for any particular company is to determine whether conflict minerals are “necessary to the functionality or production of a product manufactured or contracted by that registrant to be manufactured.” If the answer to this question is “no,” the issuer is not subject to the rules and no additional inquiry or disclosure is required.
A significant ambiguity for some oil and gas companies concerned whether they were providing “products” to their customers that would need to be analyzed for conflict minerals. For example, drilling contractors generally view themselves as selling drilling services, not the rigs and other equipment used to provide the services, and therefore they would argue that such equipment would not be a “product” under the rules. Helpfully, the conflict minerals FAQs validate such an argument, stating that equipment used to provide services is not a product if the equipment is used for the service provided by the service provider and is retained by the service provider, is required to be returned to the service provider or is intended to be abandoned by the customer following the term of service. The guidance notes, as an example, that issuers operating cruise lines are not required to file reports regarding the conflict minerals in their cruise ships. The FAQs also clarify that a piece of equipment used to manufacture products is not itself a product, and selling such equipment after use would not turn the equipment into the product of the service provider.
Note that in order to take advantage of the FAQ guidance companies should be able to conclude that they are in fact providing services to their customers, and not equipment or other products—rentals without related services or bareboat charters, for example, are not addressed in the guidance and might present more difficult issues. Similarly, any sales of consumables, parts and equipment to customers (or reimbursements by customers for such items), even if made in connection with the provision of services, should be carefully analyzed. For example, if consumables are sold by the service provider in fixed quantities, whether or not used in connection with services, and are retained (and not abandoned) by the customer after completion of work, the case would not fit squarely within the guidance of the FAQs and would require further analysis.
This SEC guidance is helpful, but many open issues remain which will require reasonable judgments to be made. Please contact a member of your regular Baker Botts team for more information on the FAQ guidance or the resource extraction issuer and conflict minerals rules generally.