Bruised, but standing
MERGERS and acquisitions (M&A) and project finance activity in the energy sector suffered last year, as declining staff numbers in banks reflect. But despite political disruptions and the tottering world economy, there remains a steady if reduced flow of business for banks, and activity is robust for lawyers and accountants.
Petroleum Economist's annual analysis of energy finance and services highlights last year's main trends and predicts where activity will be focused in the coming months. Russia features prominently. Recent deals - BP/Tyumen Oil (TNK) and Yukos/Sibneft - have lifted morale in the banking sector from the abyss and slapped some meat on an otherwise lean corpus of global M&A activity. Corporate reorganisation will naturally generate demand for the services of lawyers and accountants.
Russia has always had vast potential, but foreign companies have not generally been prepared to invest heavily because of high political risk. When they have BP/Sidanco - the experience has often been unpleasant. But political stability fostered by President Vladimir Putin has improved the economic outlook and the conditions for investment, as the breakthrough of BP's TNK acquisition shows.
Ironically, none of that means Western companies will necessarily take a much bigger role in the Russian oil industry. Russian firms seem capable of putting up most of the money without outside help (upstream spending is expected to be about $6bn this year - roughly level with investment last year). Results are good - output rose by about 11% in the first four months of this year, compared with the year-earlier period, following a 9% year-on-year increase in 2002.
Success in attracting investment and raising output has diminished the incentive for the government to create special conditions for foreign companies. As a result, there have been steps towards scrapping production-sharing agreements (PSAs). Probable exceptions include certain particularly capital-intensive or technically difficult projects, such as the Sakhalin Island developments.
Taking on the Russian risk
Yet even without the comfort of PSAs, foreign companies seem increasingly prepared to take on Russian risk. The country is simply too big to ignore, as the words of Philip Watts, the Shell chairman, suggest: I can't see a future for Shell as a global company without involvement in projects in the Russian Federation. BP obviously takes a similar view, having just spent several billion dollars buying half of TNK.
The stance of US companies, which have generally been averse to investment in Russia without the security of PSAs, is also changing.
As Stephen O'Sullivan, head of research at UFG, puts it: You accept that if you want to work in Russia, it is not going to be through PSAs, but there is a belief that the situation is sufficiently stable and safe that the rewards outweigh the risks.
The Middle East also presents a wealth of prospects in the near future. Iraq will suck in billions of investment dollars. Other resource-rich and politically stable nations, such as Qatar, continue to create openings. The size and availability of resources in the Middle East tend to go a long way towards mitigating heightened political risk.
But, in the cases of Saudi Arabia and Kuwait, much will depend on whether they can bring themselves to open their doors to foreigners.
In Algeria, the 1990s' civil war failed to deter foreign investors, but recent attempts to change the law to make hydrocarbons activities more accessible to the private sector have never been straightforward.
There is more good news from Africa. The successful financing of the $1.97bn Nigeria LNG Plus project last year could lead to more projects in the country and across the continent. Financiers are increasingly willing to overlook some of the region's problems in view of the substantial reserves of oil and gas that companies in the region are sitting on. Angola's state-owned Sonangol's $1bn, largest-ever oil-backed structured trade financing, announced last month, is a case in point.
China, meanwhile, also offers attractive prospects. Not only is the size of the market tantalising, but the government has also done a great deal to improve market structures to attract badly needed private capital. More needs to be done, such as reforming the structure of gas and power markets so that end-user prices justify large up-front investments in infrastructure. But, importantly, there seems to be a perception among investors that such changes will occur.
There are many other bright spots. Although M&A volumes are a shadow of the boom of the late 1990s and 2000, new areas of work have emerged. The structure of asset ownership in the North Sea has shifted, with a new breed of independent eroding the share of the majors, generating advisory and financing work. Asset-disposal worldwide is expected to provide rich pickings for the financial and legal sector over the next year or so.
Liquefied natural gas projects covering production and consumption should also provide a steady flow of business for the financial and legal sectors in the next five years and beyond. And energy firms are starting to look for future ways of funding gas-to-liquids projects.
But despite these market strengths, the picture overall has been undeniably weak in comparison with the good old days of 2000. And confidence is not replicated across all emerging markets. China aside, Asia is expected to yield only a handful of significant energy projects in the next 12 months. Political and commercial risk in some countries of the region, especially in Southeast Asia, mean a disproportionate amount of direct foreign investment in Asia is expected to find its way to China.
Confidence in Latin America is threatening to evaporate. The region has been bedevilled by the collapse of the Argentine economy, chronic unrest in Colombia and the Venezuelan strike. Also, although early indications of policy intentions are positive, reforms must be implemented in Brazil sooner rather than later. Last month, this column highlighted areas of energy policy that urgently need to be changed if private investment is to be kept up.
That argument was endorsed by companies at last month's Offshore Technology Conference in Houston. A panel of executives from international oil companies with operations in the country said that unless certain important changes are made, including adjustments to taxation, investors could lose interest.
Petroleum Economist has for many years undertaken qualitative research to ascertain energy companies' views of the competence of their banking, legal and accounting service providers. The demises of Enron and Andersen have resulted in a drastic shake-up in the way services are supplied to the energy industry, as well as important shifts in corporate culture generally.
Across the industry, as in others, new relationships have had to be forged and business continues to adapt to new circumstances. As a result, Petroleum Economist has not undertaken its usual detailed research for 2002, providing instead its own analysis of trends in each sector.