Arrested development in Africa
Africa will experience deep cuts and long delays to discretionary capex. But preparatory work continues for when the market recovers
The retrenchment of the oil and gas industry will be felt severely in Africa. Global capex cuts, perhaps averaging one-third, will fall disproportionately on the continent and NOCs will be in no position to make up the shortfall.
The pain will not be spread evenly. Developments requiring capex will be hardest hit. Operationally “all new projects are frozen”, according to a banker at a multilateral institution who spoke to Petroleum Economist.
Exporters will also be harder hit than those supplying power generation in domestic markets. While majors have been quick to reassure investors with massive headline cost-cutting figures—such as 25pc for Italy’s Eni and BP—in such a fluid environment, they have been, understandably, less forthcoming about specific projects. But the market is in little doubt about the outcome.
“Discretionary capex is a huge factor for many companies,” says Katherine Roe, CEO of Tanzania-focused E&P firm Wentworth Resources, which is able to proceed unchanged with its own modest $4.6mn capex plans due to its debt-free position.
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“We see that across the board from majors down to small independents. Any capex that can be reined in, at a time like this, absolutely will be. A lot of companies with debt payments and leverage are going to struggle.”
However, Roe notes that, while independents linked to international markets have gone into “survival mode” there is “a different set of parameters” when operating in a domestic African market. For example, in Tanzania, gas production and spend on it is not discretionary as there is such a “desperate need” for power.
African projects in construction are already facing difficulties as global supply chains are disrupted, according to the banker at a multilateral institution, with further pressure added by debts not being repaid on time and the impossibility of senior managers travelling to certify completion.
A number will invoke force majeure. There are also logistical problems resulting from Covid-19 that will impact on capex.
The Italian base of Eni, Africa’s largest producer, is contending with the worst outbreak in Europe. It could be devastating if the virus spreads across Africa—of course, on a humanitarian level—but also for economies and industry.
Nigerian cities are so densely populated that an outbreak would be uncontrollable. South Africa has the best health facilities on the continent, but nowhere near sufficient.
“Every company I know is working around the clock and putting their people first,” says Tabrez Khan, director, Africa oil & gas transactions leader at financial services firm EY. “Lives come before working out how to operate. Then comes managing customers, suppliers and stakeholders. Only then comes the liquidity, even though it is, of course, very important.”
Many African economies are extremely dependent on oil revenues. Indebtedness was alarming in 2019 but the issue will multiply this year. Nothing will be available to replenish NOC’s coffers.
The Brookings Institution thinktank notes that Africa’s biggest oil producer, Nigeria, is particularly vulnerable to low oil prices, as oil exports make up 90pc of its exports and it needs $60/bl to balance its budget. The same is true for the second biggest African producer, Angola, but it is even more dependent on oil, accounting for 50pc of its GDP.
“Akin to the last oil price crash, Nigeria is likely to suffer an economic downturn as it is still a largely oil-depenedent state,” says Khan. “When the oil price crashed in July 2014, the economy was significantly affected and the naira lost 60pc of its value. The government intervened to peg the naira to stem the collapse.”
Tax income will be severely diminished as receipts typically fall even harder than the commodity’s price. And producing NOCs will suffer reduced fiscal takes and sales proceeds. Unfortunately, African NOCs are typically very wary of hedging prices, according to the banker at a multilateral institution, even while NOCs elsewhere have become much more comfortable with risk management strategies.
“They will be impacted immediately and will have to work very hard to continue attracting capital,” says Khan. “For all companies, it will be a Herculean task to find new money to finance a new development.”
Beyond the major producers, there are a range of countries on the verge of either starting or massively increasing production. “These will be the ‘new sufferers’,” says Khan. Anglo-Irish producer Tullow Oil, for example, announced a 30pc reduction to its capex budget and a delay to its Kenyan project, although its Uganda one is apparently on track.
While it is unlikely any significant project will soon receive FID, some projects will fare better than others. Scott McMillan, managing director of Australian oil and gas exploration company Invictus Energy, which has a portion of the Cabora Bassa Basin in Zimbabwe, says some resource-rich projects are being delayed due to the capex required by their location.
“They have relatively small local oil markets and are a long way away from any infrastructure,” he says. “The majority is destined for export and securing export routes has been very challenging.” Invictus has “learned from projects like that, particularly in terms of the evacuation routes and building provisions into our PSC”, he says.
“Inevitably, there are going to be some delays because of Covid. But we are looking at drilling in Q1 or Q2 next year and that will probably still be okay.” Invictus is targeting the regional gas market, where there is large untapped demand that McMillan expects to become acute in 2023-24, with fixed price contracts.
It is an approach shared with Wentworth Resources, which has had a long-term fixed price contract in place since 2014. It supplies pipeline gas domestically, rather than LNG to international markets. It is “business as usual” according to Roe.
“We clearly have ambitions to grow in Tanzania,” she says. “In time, we would like to supply more out of Mnazi Bay.”
Bowleven, a Cameroon-focused independent explorer, is working on the shallow water Etinde field with Russia’s Lukoil and its operator, Jersey-headquartered NewAge.
“We are trying to see how the recent fall prices falls could have an adverse effect on Etinde,” says Bowleven CEO Eli Chahin. “The situation is so fluid, it is purely speculative. Whatever anyone says, there is a lot of uncertainty at the moment and people are trying to recalibrate. We will pursue our ambition of FID in 2020 but there is potential for slippage—anyone that tells you otherwise is probably not cognisant of what is happening in the market.”
For all projects, if capex cannot be funded from revenues or debt, the next logical move would be to seek finance at the corporate level. However, reaching an agreement on valuation is a huge hurdle amid extreme volatility.
Mergers and acquisitions
The banker at a multilateral institution says M&A activity is “frozen as buyer seller expectations are too wide, and debt will not be available for a number of months”.
Anecdotally, EY’s Khan was working on three projects before the Saturday Opec+ fallout and by Monday the number had reduced to one. He says sales processes have slowed or stopped as “people cannot travel, meet in a data room, visit facilities, arrange financing or operate a typical M&A process”.
Bargain hunters will likely only find assets that need immediate capital. “Every cash-rich buyer assumes there will be great acquisition opportunities at very low cost,” says Khan. “That is a myth as the best assets do not fall into distress. What will float around are projects that need capital that the owner does not have.”
Khan suggests instead striking strategic partnerships, with a cash-rich firm co-investing in an asset of a firm that needs liquidity, or taking a direct stake in it. “It will not work for all companies because it requires a lot of stars to align.
But smart managements will see that it is a way to do good deals.” Africa is unlikely to be the first continent to experience bankruptcies as lenders are likely to provide some breathing room, especially where breakeven costs are low.
Financial hedges will also provide respite, where they exist, protecting revenues and reserve-based lending (RBL) determinations, until perhaps September when hopefully the coronavirus has passed.
“There is a window of protection,” says Khan, who says lenders may wait-and-see approach for three or even six months. “But if things do not change before everybody starts to renegotiate loans and look for new money, it is going to be a very capital constrained situation.”