Independents drawn to African opportunities
Weak market sentiment for oil and gas stocks is opening E&P opportunities in Africa for private equity and small cap companies—and leading governments to rethink their fiscal terms to attract them
Few people in the oil and gas industry would disagree that Africa is the most exciting continent for exploration in the world, with the greatest concentration of unexplored basins and recently proven reserves.
“Africa has a lot of outstanding opportunities,” says Keith Hill, president and CEO of Africa Oil Corp. “There are only two great places to be looking in unproven basins—Russia and Africa. Africa is probably the greatest frontier."
The problem is that E&P has fallen out of fashion globally, with institutional investors piling pressure on listed companies about expensive and risky long-term investments, particularly while demand for oil and gas is clouded by doubts over the speed of the energy transition and ESG considerations.
“Exploration is still a dirty word—nobody is doing it and people are not in the data rooms looking at buying smaller, non-operator development fields,” he says. “We are in a world where majors are divesting assets and there is not a huge number of buyers so we think there might be some good opportunities.”
Africa Oil Corp, set up a decade ago to develop discoveries in Kenya, is hoping to finalise a deal with Petrobras by the end of 2019 for a share in fields producing 450,000 bl/d in Nigeria operated by Chevron and Total. It has also invested in three pure-play exploration companies seeking further opportunities, including a major one in South Africa.
“This is a great time to be in the industry and go out and buy things, especially producing assets. There is going to be a lot of stuff from majors on the market to be able to pick up at reasonable prices for good quality assets, like we have done in Nigeria,” he adds.
It is far from the only independent attracted by the opportunity. “Part of the reason Boru Energy was set up was to capitalise on what we hope and expect will be a number of asset opportunities across a variety of countries in West Africa, whether they be national oil companies (NOCs) selling down, or maybe major companies rebalancing,” says Tom Hickey, CEO of the Africa-focused exploration and production (E&P) company and a former a CFO of Tullow Oil.
The opportunities are also attracting private equity (PE) houses, but market conditions are shaping investment models away from the traditional formulation of purchasing in weak market and adding value before seeking an IPO when the market strengthens.
“That is not the way to build sustainable businesses with longevity,” says Khash Mohajerani, director of Apex International. “We are looking to build self-sustaining free cash flow generating businesses… and set up its capital structure and operations in such a way that we never have to sell it.”
For majors to be leaving opportunities on the table is a boon for independents but this comes with an obvious downside—when the assets mature it is far from certain that there will be a market to facilitate an exit at a reasonable price. Mohajerani says that the “apathy” in public markets means that he no longer considers an IPO to be the most likely exit strategy.
Investing in assets that can generate material cash flows is therefore doubly important, as he says such assets are “most straightforward” to sell and, if a buyer cannot be found, the PE house can anyway hold them long term and collect the stream of dividends.
“We are starting to see a little bit of an evolution on the private equity side, especially among large cap private funds, of raising evergreen pools of capital that don't have specific redemption date so that they can build those businesses and generate cash for 10 to 20 years,” he adds.
Exploration is a financially risky business even in the most benign economic circumstances, and the economic outlook means risk aversion pervades investment markets and banks’ lending strategies. “It is very hard to fund,” says Hill, suggesting that banks heavily discount investment in exploration when evaluating oil companies’ balance sheets. “That is just the reality.”
Boru Energy’s Hickey suggests that funding should be approached on a project-by-project basis. While reserve-based lending (RBL) is a commonly used funding method “it doesn't suit every project and [particularly] doesn't suit development projects,” he says. “And there are a lot of countries where it has never been implemented so you would have to be innovative”.
He does not entirely discount the possibility of listing, as he detects rising optimisim among financiers, especially for assets that reliably produce cash flow, but says many options can be explored.
“There will be times when there is the need to develop new products and types of security, a new way to get indigenous resources developed over the longer term. Certainly, small and medium-sized companies are trying a variety of innovative approaches. Good companies with the right core structures and right strategies will find capital in due course. It is just quite a challenging voyage of discovery.”
As some of the most interesting exploration opportunities in Africa have had little connection to international financial markets, it is perhaps inevitable that additional due diligence is required by financiers. “Clearly, you're dealing with a lot of different and additional above-ground issues in Africa that you would not in OECD countries,” says Mohajerani. “There is a worthwhile debate to be had, to establish what people mean when they talk about above-ground risk. But they clearly have heightened sensitivity around Africa.”
While there is substantial interest from independents, the balance of supply and demand for E&P opportunities has undoubtedly shifted towards it becoming a buyer’s market. It is not the right time for governments to be over ambitious in their fiscal demands and terms are reportedly starting to shift in favour of oil companies.
“It is government's job to charge the worst possible terms and still have people turn up to the bid rounds,” says Hill. “But now people are starting to not show up.” He says that attaching requirements, such as for foreign direct investment, can be a “killer” for interest in bid rounds. He notes that, on average, governments receive 70pc of profits and are unlikely to be able to secure any more, at least for unexceptional opportunities.
If an African country has “difficult exploration and development that has sat dormant for 20 years” the government is “going to have to give an incentive”, according to Hill. “Governments are starting to realise they need to offer better terms to attract investment, so we will see that trend continuing.”
While incentives may need to be improved to secure investment in licensing rounds and E&P, African governments need not sacrifice professionalism and reliability in its chosen partners. “A lot of it is about creating expectations and understanding and certainly among government stakeholders about the types of owners that they're going to have in the next wave of activity,” says Boru Energy’s Hickey.
“There is always a job to do on our side, as the industry, to lead the process of preparing governments and their communities, and civil society stakeholders, that the future will be different from the past. The new investors and players that participate will be equally responsible, participative and respectful of communities as the bigger companies have been in the past.”
The people quoted in this article were interviewed or spoke on a panel at the Oil & Gas Council’s World Energy Capital Assembly