Amid the ongoing divestments in the upstream sector, Noma Garrick of Energy Mix Report recently caught up with Mr. Steven Fox, a partner at leading international law firm, Clifford Chance LLP’s oil and gas practice to give an insight as to what to expect from the sector going forward.
Q. The past few years have been a busy period in Nigeria’s oil and gas industry with regard to oil and gas asset divestments. What do you think are the reasons for this?
Numerous reasons have been espoused for the on-going oil and gas divestments in Nigeria by the IOCs. These range from operational challenges and concerns about security through to issues of uncertainty, for example as a consequence of the prospect of the Petroleum Industry Bill. Whilst any or all of these may be a factor in one way, shape or form as to “why Nigerian divestments?”, the fundamental reason for such divestments goes back to simple economics and, more specifically, the demands that the majors are facing from their own shareholders; for example demands for greater returns on investment, reduced capex and greater free cash flow. Nigeria provides a good environment for companies looking to satisfy their investors and rebalance their portfolios by monetising assets because (a) the IOCs are able to divest of lower producing onshore and shallow water assets whilst retaining offshore production in Nigeria, offering higher return on investment and (b) as has been demonstrated to date, there is a wealth of potential purchasers including local operators and diverse partnerships from independent oil and gas companies as well as private equity funds. As such, Nigeria will remain a key market for the IOCs as well as providing a more diverse and indigenous based investor base.
Q. The Petroleum Industry Bill (PIB) has still not been passed several years after its inception. How much of a factor do you think this has played in the IOCs decisions to divest and also how do you feel this delay will impact on potential investments across the oil and gas value chain in Nigeria in the short to long term?
No industry likes uncertainty and the oil and gas industry is particularly sensitive to that, not least given that the sector is fundamentally about making long term capital commitments with commodity prices that rise and fall daily and an exploration environment that is ever more challenging. The need for some reform in Nigeria is largely undisputed but the need for clarity and decisions is now long overdue. Continued delay will only impact further on future investment, especially in new offshore projects where the IOC’s are moving their focus. In particular, a level of certainty is essential on the future legal framework, operating structure and fiscal environment (including royalties, taxation and allowances), without which it is impossible for the IOCs to conclude their economic evaluation studies and, in turn, make the requisite long term technical and capital intensive commitments.
Q. What are some of the critical issues that buyers should look out for when it comes to divestments or asset sale transactions?
The critical issues will generally vary from transaction to transaction, impacted in no small part by the identity of the buyer, the seller and the nature and location of the assets in question. As a general rule though, four key issues typically spring to mind:
The first issue is that of “third party consents”.It is imperative for the parties to have as clear an understanding as possible on the consents required, and in particular the regulatory consents needed. Early (and frequent) engagement with the regulator can often assist in procuring ministerial consent in a timely fashion, thereby reducing delays in completing a transaction.
The second is “financing”.As exemplified by the dispute between Chevron and Britannia-U, it is important for buyers to ensure that appropriate financing arrangements are in place (and documentary evidence is capable of being provided as necessary) suitably in advance of signing. This includes not only the acquisition finance, but the need to refinance or renegotiate the facilities of any business being acquired.
The third issue is “incentives”.A thorough evaluation should be carried out of the incentive frameworks that exist for specific segments of the oil and gas industry so that the buyer can capitalise on all reliefs available (both at the stage of investment or purchase and for ongoing operations).
The fourth is “certainty of terms”.It is important to be clear on the position of responsibility and liability, principally through the relevant sale and purchase agreement(s). This includes not only the contractual protections afforded by warranties and indemnities, but also the requisite obligations of each party in the period to closing, termination rights, so called “trailing liabilities”, separation issues and post completion adjustments.
Q. There have been some legal issues with regard to the Chevron assets sale recently. What should the sellers also look at to ensure that the sale moves ahead smoothly and avoids any legal problems?
There appear to be a number of examples of Nigerian asset sales being beset by misunderstandings on the buyers’ ability to finance the transaction. As referred to above, this is a critical aspect of any transaction – and in particular, those with relatively significant periods between exchange and completion. In addition to the matters identified above, key considerations for sellers include:
- Ensuring that the buyer has the sufficient know-how, substance and connections in place to ensure that deals are carried out as swiftly and seamlessly as possible.
- Contemplating vendor due diligence in order to assist in achieving a swifter sale process.
- If a share sale is being undertaken, effecting a pre-sale internal restructuring in advance so as to carve out any assets or liabilities to be retained by the seller.
- Considering the pre-emption rights of partners in the relevant blocks. If pre-emption rights apply, the effect of this on the sale strategy should be considered.
- Ensuring that the sale and purchase agreement places a longstop date by which financing and other conditions must be fulfilled by the buyer, failing which the seller will be able to sell to another purchaser.
Q. From an international view point, what impact do you feel the current state of insecurity in Nigeria and also the upcoming Nigerian general elections in 2015 may have on some of these ongoing transactions and also with regard to more potential divestments in the next couple of months?
The state of insecurity in Nigeria is sad to see but whilst that insecurity does from time to time result in IOCs declaring force majeure e.g. due to theft and sabotage, the impact is much the same now for the operators in the country as it has previously been. The real tragedy, and the need for change, is the impact the insecurity is having on day to day life in Nigeria and the social environment in the country. The impending general elections are however, undoubtedly going to have more of an impact on oil and gas activity given the uncertainty that any election in any part of the world brings to that jurisdiction – and in particular, the oil and gas industry in that jurisdiction. This is exacerbated in Nigeria given the background of the PIB and the fact that it is doubtful that the PIB will be approved before the election. The IOCs in particular, will pay close attention to the positions of the key presidential candidates with respect to the PIB’s proposed reforms.
Q. According to the Minister of Petroleum Resources, Mrs. Diezani Alison-Madueke the sale of oil blocks by the IOCs is a good opportunity for indigenous independent players to get involved in the upstream sector. What is your projection for the involvement of indigenous independents in the Nigerian E&P space in the next 2 to 5 years?
The divestment programmes of the IOCs undoubtedly present an opportunity for greater participation of indigenous companies in Nigeria’s oil and gas industry and that must on its face be a good thing, not only for those companies and their investors but also for the development on the ground in Nigeria of the requisite supporting, technology based industries that underpin the operations of those companies. The continued success of independent E&P companies such as Afren, Oando and Seplat, as well as more recent arrivals, should ensure healthy investment and continued opportunities – as well as the benefits of a more diverse base of participants. It is essential though that not only do those companies continue to strive to deliver on their projects and their commitments to good corporate governance, but also that the government provides the stable environment for them to be able to do so.
Q. The 2013 marginal fields bid round is in progress, however there are some concerns over the technical and financial capabilities of certain indigenous oil firms as has been showcased by several undeveloped fields acquired during the 2003 bid round. What do you think indigenous oil companies need to do to develop the financial and technical capacity to operate some of these blocks that are looking to be acquired from the current round?
Building up indigenous capacity in the upstream sector is a laudable and sensible aim. It is not though something that can be done overnight and the lessons learnt from the 2003 licensing round is that there is still further work, or support, that is needed on the financial and technical side. The latest licensing round seeks to address some of those challenges by encouraging the participation of non Nigerian oil companies, whether as part of a biding consortium or subsequent to license awards, to support the technical side. Similarly, ensuring the environment remains attractive to retain the interest of overseas funding as well as to encourage participation by domestic banks, is important. The changes to the 2013 licensing round to address the bankability of marginal field projects should go at least some way to encouraging the availability of the requisite finance.
Q. With particular regard to the Oando-ConocoPhillips transaction, there has been an issue of ministerial consent. How does this apply in a jurisdiction such as the United Kingdom, are there any similarities with the Nigerian legal requirement for consent and how do you think this could affect future transactions in Nigeria?
At its heart, the requirement for ministerial consent is broadly the same in the UK (through the Secretary of State for Energy and Climate Change) as it currently is in Nigeria (through the Minister of Petroleum Resources). The fundamental difference though between the two processes can be summarised as one of credibility and transparency of policy and procedures. In the UK, companies seeking approval are able to provide information of the appropriate type and scope required to enable approval to be obtained without unnecessary delays. In Nigeria, the experience of current participants is that the rules are at best unclear as to timing for the grant of consent, resulting in delays to closing transactions that could be upwards of two years. Rather than making the regulatory process more transparent, the current draft PIB envisages the provision of extensive powers to the Minister of Petroleum Resources, thereby introducing an additional layer of uncertainty. Again this lack of efficiency and transparency only fuels uncertainty which, in turn, can only hinder future investment.
Q. The issue of funding is of fundamental importance to acquisitions and traditionally, local funding for a lot of these types of acquisitions by Nigerian financial institutions has been minimal. Do you think there will be a growing trend towards more domestic funding for acquisitions going forward?
The uncertainties posed by the PIB will continue to add to the challenges of obtaining financing from both international and domestic banks. However, there is clearly benefit in making the environment in Nigeria more attractive for domestic bank support and, as stated above, changes to the 2013 licensing round to address the bankability of marginal field projects should go at least some way to encouraging that. In addition, a return of appetite in equity capital markets could also provide a much needed boost to obtaining finance (for example, Oando’s decision to raise US$193 million in a share issue to assist in financing its purchase of ConocoPhilips’ interests and Seplat’s recent IPO).
Q. The issue of operatorship has been topical in several transactions that have occurred recently, with NNPC (or its subsidiary; NPDC) insisting on operating some divested assets. How do you think this might affect future asset sales and what can potential buyers do to circumvent this issue?
This is a trend that is not peculiar just to Nigeria. The primary concern clearly is that the NNPC might not have the sufficient technical and/or financial competence to operate all oil blocks sold by the IOCs. There is also a concern that this “operator risk” will impact on the ability to finance the relevant project. Given the nature of the NNPC’s right, there is little that potential buyers can do to circumvent the issue other than engage with the NNPC to reach a satisfactory position.
Q. With the spate of oil and gas discoveries and developments across Africa as well as the United States’ (a former major consumer of Nigeria’s crude oil) discovery of shale, where do you see Nigeria’s oil and gas industry in the next 5 years? Do you think it will still maintain its top spot in terms of Sub-Saharan African oil producers?
Yes, I do think it will maintain its top spot provided it diversifies its “customer base” by attracting new investment into its oil and gas sector. While the US may have all but ceased imports of Nigerian oil, at its lowest level in 40 years, European refiners are however increasingly purchasing Nigerian oil to offset the decline in production in, for example, the North Sea and Libya. As such, Europe has become the largest importer of Nigerian oil.
Other factors beyond the shale risk are relevant in Nigeria’s ability to maintain its standing as a top oil producer, including (at the risk of harking back to the same theme) the uncertainty concerning the passage of the PIB and any deterioration in the country’s security. In August 2013, the Oil Producers Trade Section—an association of energy groups including Shell, ExxonMobil and Total—stated that Nigeria risks losing out on approximately US $185 billion of investment within 10 years as a consequence of higher taxes and royalties.
Q. Based on your experience from advising IOCs on several transactions what would you say Nigeria needs to get absolutely right in the coming years to increase investments in its oil and gas sector?
I would suggest the following as some of the key factors that Nigeria might want to consider:
- First, alleviating the regulatory uncertainty surrounding the PIB, while ensuring that it strikes the right balance between incentivising investors and creating economic opportunities for the Nigerian people.
- Secondly, minimising the political interference within the NNPC. In particular, there have been some interesting suggestions that the NNPC should become more independent by being managed at arm’s length in order to increase its effectiveness and profitability as well as to minimise political interference. (Clearly the PIB currently diverts from this goal as it envisages the split of the NNPC into three entities, privatising two of them. The Asset Management Corporation will be the sole remaining governmental body and retain the government’s share of joint venture operations with major oil companies, thereby rendering such activities susceptible to political interference.)
- Finally, creating a more transparent licensing regime for upstream oil and gas projects. The PIB foresees the allocation of a discretionary power to the President of Nigeria to grant licences and leases without any competitive process. In this respect, an auction system for the allocation such licences and leases would assist in addressing accusations regarding preferential treatment.
Q. What are the mediums by which interested parties in the oil industry can contact you or Clifford Chance LLP for legal advice on international related issues with regard to oil and gas transactions in Nigeria?
Clifford Chance brings international insight, local expertise and a long term commitment to key oil and gas markets the world over; and nowhere more so than Nigeria. We advise clients on their most critical and complex instructions, in an industry where experience matters more than ever before. The team, comprising in excess of 50 market leading lawyers, regularly works on some of the sector’s most prominent projects and matters. For further information, I would be happy to be contacted at:
Clifford Chance LLP
10 Upper Bank Street
London, E14 EJJ
Direct Dial: +44 20 7006 4827
E-mail: [email protected]