Mr. Dolapo Oni is the Head of Energy Research at the Ecobank Group, based out of Lagos Nigeria. He is responsible for research and market intelligence on the energy sectors of countries in Sub Saharan Africa, especially countries where Ecobank is present. His role covers the provision of business information and research intelligence on the oil and gas value chain, power, renewable energy and fertilizers in Ecobank focused countries. Energy Mix Report caught up with Mr. Oni to get his opinion on the fate of Nigeria’s oil and gas sector in light of the persistent drop in global oil prices.
Q: In what ways has the drop in the price of crude oil from around $115 in June 2014 to below $50 in January, affected upstream oil companies in particular and the entire oil and gas industry in general in the areas of investment, capital expenditure and staffing for 2015? Do you envisage any layoffs?
A: Quite as expected, the drop in oil prices has enforced a measure of fiscal discipline and operational efficiency on oil companies. This essentially has meant even lower focus on exploration (considering that it was already low in Nigeria with only about 41 exploration and appraisal wells drilled in 2013). A number of rigs hired for exploration purposes have been decommissioned; drilling contracts have been cancelled. Some operators that have pretty robust field development and work-over programs have found ways to reduce the amount of drilling activity on their fields to conserve cash and reduce expenses in line with the drop in oil revenues. Across the world capital expenditure has reduced, especially in the US, where we have seen cuts as high as 75% by some companies. However in Nigeria, capex in the indigenous and even IOC segment has typically been more focused on development of new and existing fields. Hence there really isn’t much need to cut, instead there is need to intensify efforts to ramp up output to boost revenues. This requires spending. So we’ve seen more of a realignment of capex budgets targeting field development to boost product. In some cases however, since this cannot be achieved without drilling, operators have chosen to maintain status quo. I think on the operational end of things, contract staffs have borne the brunt of the efficiency measures implemented by the companies, especially among the foreign operators. The IOCs have global efficiency measures that also affect their Nigerian operations in addition to other localized job cuts. However the labour unions NUPENG and PENGASSAN have reacted on two occasions – notably last year when they went on a 3-day strike in December. Negotiations are still ongoing.
Q: More recently, we have seen oil prices rebound and prices are currently hovering around the $58-$62 mark. Do you see oil prices recovering to anywhere near $100 per barrel this year?
A: We do not see price recovering to the $100 level within the next two to three years. This is because there has been a fundamental shift in the global oil market. Supply has risen above demand creating a supply gap that is exerting downward pressure on oil prices. As with any market with more supply than demand, prices are likely to stay low. There are now a lot more oil producers compared to previous years when we saw similar declines. In Africa alone, we’ve seen countries such as Ghana, Chad and Niger join the league of oil producing countries in the past five years. We have also seen US ramp up oil production from shale formations in Texas and North Dakota. US oil output has risen from 5 million bpd in 2010 to 9 million bpd in 2014 and could reach almost 10 million in 2015. However, this supply growth is coming at a time when demand is a little weaker due to the fragile global economic recovery. Furthermore, as US oil production continues to rise, US oil imports are falling. Within the last four years, the US has reduced its demand by 4 million bpd due to growth in supply. In addition, we are likely to see some considerable volatility in oil prices in the rest of the year as demand falls off after buying into storages wind down. Storages around the world are filling up and soon oil importers will have to cut demand from current levels. The cut in demand could also be exacerbated by the commencement of refinery maintenance in the second and fourth quarters of the year. However geopolitical tensions in the Middle East and North African (MENA) region could counter these downside pressures, as well as lower output from countries.
Q: Around what price range could you safely say we should expect oil prices to remain for most of 2015?
A: We have forecasted oil prices to average $56.54 in 2015. This is lower than an average of $58 forecasted by a collection of nearly 30 banks and financial institutions around the world. However, the level of volatility in the market, which is typically around 20 – 25% deviation from the median, could increase this year. We think prices could range from as low as $35 to as high as $75, implying volatility in the region of 31%.
Q: Indigenous and marginal oil field operators are particularly hard hit by the drop in oil prices. Most are unable to service loans and are in real danger of having some of their marginal field licenses revoked. Do you see more mergers taking place among smaller indigenous companies so as to offset the financial challenges created by the drop in oil prices?
A: That would be one of the ways to pull through this difficult time when revenues have fallen and fixed borrowing costs threaten to erase profit margins. We have seen Canadian oil explorer Mart Resources, South Africa’s SacOil all making efforts to exit their Nigerian assets for various reasons in addition to the oil situation. However, Nigeria remains a low oil producing region. Operating costs per barrel ranges between $6 to about $20 for most operators, who have already sunk in the bulk of their field capex requirements. Thus, even at $40, most are still liquid and still cover their liquidity requirements. But due to huge exposure to expensive loans from Nigerian banks, they may require some restructuring to avoid defaults. Let’s not forget that only about 9 of the 31 or more companies that were granted marginal field licenses have started production from the fields. Among the remaining, some are likely to avoid having their licenses revoked if they are able to secure financing. Operators such as Sirius Energy who is close to concluding financing to commence development from the Ororo marginal field. Lekoil, which bought into the Otakikpo field in May 2014 and raised additional funding for the field development program in June has already upgraded the field’s oil reserves from contingent to proven reserves of 15 million barrels. The field could be brought into production by early 2016. The DPR is likely to be favourably disposed to oil companies who are advanced in developing their marginal fields and not revoke their licenses.
Q: Do you feel that Nigerian banks are overexposed in terms of the various loans and funding given to oil gas companies especially with the drop in oil prices?
A: The last Financial Sector Stability report published by the CBN in November put the loans to the oil and gas sector at about 24% of banking loans in the first half of 2014. This is high and indicates overexposure to the sector from the lending angle as it leaves only about 76% of the loan book for other sectors. Another angle to the exposure is the fact that the oil companies are the key source of low cost foreign currencies to the banks via their foreign currency deposits. These deposits enable banks issue foreign currency loans. The decline in revenues has meant a considerable drop in access to these low cost funds and banks have had to resort to raising Eurobonds to get foreign currencies. These Eurobonds are more expensive and place a floor on the profit that banks can make from lending them out. When you borrow in dollars at LIBOR plus 7%, you’ll have to lend at minimum LIBOR plus 8% but there are few customers willing to take those rates from the banks.
Q: How would you rate Nigerian financial institutions’ performances in recent years? Do you feel Nigerian banks have come of age with regard to providing the required level of financing for complex oil and gas transactions?
A: Definitely, especially when it comes to funding upstream oil and gas operations. We’ve seen banks fund over 80% of oil and gas deals in the upstream segment in the past few years. This is largely because there has been a lot of mobility between the oil and banking industry, allowing for transfer of understanding. It is no longer strange to see former bankers who now run the corporate finance teams of oil and gas companies, and bankers who were once oil and gas company employees, especially from the finance departments. However, there are still some knowledge gaps on the oil field servicing industry, coupled with other structural issues that have limited funding for the sector.
Q: Nigeria should actually be more of a gas producing nation given its vast reserves. What do you feel is required to increase investment in gas exploration, production and utilization? Also what do you feel is required from a financial perspective to encourage more LNG projects in the country?
A: Nigeria has about 185 trillion cubic feet of proven natural gas reserves. According to the USGS, the country could be seating on over 600 trillion cubic feet of undiscovered natural gas reserves. However investments in the gas sector have been held back by several reasons, chief among which include the lack of proper regulations. The gas sector is still regulated by the associated gas framework agreement (AGFA) of 1991 and 1992. The National Gas Master plan drafted in 2008 is yet to be fully implemented. The PIB could help provide more clarity on gas regulations but is yet to be passed into law and some of the amendments that have been made are yet to be made public. Pricing is a critical issue in the segment as investors need a price that covers the cost of investments and offers a good return to invest in gas production. On the banking side, I think financiers are always keen to first see good and credible parties that are ready to offtake the gas. This is because there’s really no profitable way to store gas in its raw gaseous form so it can only be produced when there is offtake or it can be converted to another form. The alternative for associated gas is flaring. Thus companies have to find off-takers with the financial capability to cover repayments for the gas. This is an issue for even the power sector at the moment, which is meant to be the major domestic off-taker for natural gas. LNG projects in West Africa are facing major competition with shale gas in the US, which has made gas supply cheaper than a price at which West Africa can supply. Thus most of the LNG out of West Africa is Europe facing and then the balance goes to Asia. In recent months, China and South Korea have intensified purchases from West Africa. But even this is likely to be a short to medium term increase, which is likely to fall when LNG projects come online in Australia and East Africa. Whereas, there’s a huge market for gas in the domestic market that remains unfilled. Thus, it’s not really financing that’s stalling LNG projects in Nigeria. It is more about the economics of the market.
Q: We have seen fuel queues resurface as a result of petroleum marketers protesting the devaluation of the naira as well as unpaid subsidy claims which they say are affecting their business operations. This once again, clearly buttresses the need for more investments in refineries in Nigeria. Till date however, only Dangote has seriously taken up this mantle. What are some of the financial considerations to be taken into account to encourage more entrants into the refining sector?
A: I think investors in the sector require some form of guarantee of feedstock crude oil supply. This could take the form of access to government’s equity crude oil from joint ventures or access to ownership of oil blocks, especially in close proximity of their refinery plants. They will also require market determined fuel prices to be able to pass on their costs. This will also breed competition and efficiency as petroleum marketers will opt for the cheaper option. The refineries may however face some competition from fuel imports from the US, which are likely to be cheaper to import as they are produced from crude oil priced off the lower WTI. Refiners in Nigeria will have to pay the same Brent-based prices as international buyers. Thus, they may require some discounts or other tax incentives to compete effectively.