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Low prices cast doubt on African oil projects

Low prices cast doubt on African oil projects

When global oil prices began to spiral downwards last year, some companies hoped the change would be only temporary. They argued that oil-producing states in the Gulf would rein in production to drive up prices, while American shale producers – responsible for much of the supply glut – would quickly go out of business. Yet more than a year later, and Brent prices continue to fluctuate around the $50 mark.

The impact on the oil and gas sector has been dramatic. A study released in June by energy consultancy Wood Mackenzie found that companies have deferred an eye-watering $200bn of capital spending, affecting 46 major oil and gas projects worldwide. The report identified two principal reasons for the deferrals. First, companies are seeking to free up capital to balance the books in a period of low revenues. Second, by delaying final investment decisions, more time can be given to improve production capacity and weigh up other ways to reduce costs. The result has been that more than 20bn barrels of oil equivalent have been deferred worldwide until investment conditions improve.

Many of those deferrals are found in Africa. For a number of reasons, the economics of oil and gas projects in Africa are such that they require a higher oil price to break even. Common issues in many African countries, including poor infrastructure, security concerns and challenging regulatory requirements can all drive up costs.

As the latest wave of investor interest in the continent took place in the decade before the price collapse, many companies based their assessments on the assumption that prices would be at least $90 per barrel. Companies are now having to work out how they can make the same projects work on predicted prices of $60-70 per barrel.

Complex projects at risk

This has had serious consequences for the increasing amount of offshore activity taking place all along Africa’s coastlines. From Angola to Senegal and Kenya to Mozambique, investors had been snapping up oil and gas blocks in the hope of making the sort of game-changing discoveries that have been found off East Africa in recent years. In more established oil fields, such as Nigeria and Angola, this has seen explorers move further and further offshore in search of new deposits. Wood Mackenzie estimates that these sorts of technically complicated “deep and ultra-deep water” developments will make up more than half of the reserves facing delays due to the price drop.

A sure sign of this came in November, when Maersk Oil revealed its high-cost deep-water Chissonga field in Angola was under review. Shortly after, the company said it would be forced to shut some of its sites if prices remain around $60 per barrel.

Obo Idornigie, an analyst who worked on the Wood Mackenzie report, told African Business, “This statement from Maersk provides a lens into the wider offshore industry in sub-Saharan Africa. A number of offshore projects, particularly in Nigeria and Angola, have been delayed as companies go back to re-work field development plans and push for lower rates from supply chain companies.”

Exploration in landlocked countries may also encounter difficulties. The cost of constructing pipelines and roads to remote oil fields thousands of miles from the coast has cast doubt on newer projects in landlocked Africa. An exploration licensing round announced by Uganda in February only managed to attract interest from one of the three companies – Tullow Oil – that are already operating in the country. The campaign group Global Witness noted in a research brief in August that low prices combined with questions over taxes were probable causes for this.

The low prices did not, however, prevent President Yoweri Museveni of Uganda from agreeing a new oil pipeline with his Kenyan counterpart Uhuru Kenyatta on 10th August. The pipeline is estimated to cost $4bn and will transport Ugandan crude from Lake Albert to the Indian Ocean port of Lamu, via Kenya’s fields in the Lokichar Basin.

Service companies under pressure

Among the greatest victims of the price fall are oil field services companies, who provide the equipment and skills necessary to make exploration and production a reality. These companies have seen their revenues plummet in the past year amid mounting pressure from upstream operators to reduce costs. By some estimates, ultra-deepwater drilling rigs, which cost hundreds of thousands of dollars to hire each day, have fallen by a third since October. The effects on those companies have been huge. Industry leaders Schlumberger and Haliburton have each axed 9,000 jobs, while Baker Hughes has cut 10,500.

While these cuts are being made globally, they present particular challenges to companies in Africa. Many African countries have imposed strict laws and regulations that demand a certain proportion of a company’s workforce is made up of local citizens. The aim is to promote the host country’s participation in the sector and transfer skills to the local workforce. But reductions in headcount frequently make these requirements unworkable.

In Angola, for example, companies are required to have a workforce that is at least 70% Angolan, a level that few oil firms adhered to even before the price fall. Further reductions to headcount will be a controversial move at a time when the government is already suffering the effects of reduced oil revenues.

Streamlining

It is not all doom and gloom, however. Chris Bredenhann, who leads PwC’s Africa oil and gas team, argues the price depression has given the companies the opportunity to “re-set, re-strategise and plan” for when prices eventually begin to strengthen. In a survey of industry players from across the continent, entitled “From fragile to agile”, his team argues that those who survive the current downturn will emerge as much more effective organisations when prices pick up.

Bredenhann told African Business that not all cost-saving initiatives will be based around redundancies. Investments in technology and infrastructure will also be used to optimise operations to enhance production.

The price depression has also served as an incentive to African governments to think about ways they can make their investment climates more competitive. The fall in prices comes as many African countries are reviewing oil and gas legislation in response to investor demands for greater clarity. Mindful of the price environment, governments are having to consider legislation that sets clear parameters and assurances for investors, irrespective of the volatile economic context.

Mozambique is setting a good example in this case. In November the government passed a law that establishes legal and fiscal terms for companies looking to invest in multibillion-dollar liquefied natural gas projects.

The law lays out provisions to ensure companies can recover their initial investment before the government can seek to increase its revenues. It also reflects that price fluctuations are a natural aspect of long-term oil and gas investments, by providing a legal framework that covers the 30-year duration of exploration and production concessions, with reviews at 10 and 20 years after the delivery of the first gas shipments. The International Monetary Fund was so impressed by the legislation, it said it would serve as a “benchmark” for future agreements elsewhere.

When prices will improve is anyone’s guess. Saudi Arabia’s quest for market share and the continued growth of shale suggest any change is unlikely to be immediate and few expect a return to $130-$140 per barrel any time soon.

Most oil and gas companies in Africa are, however, planning for a gradual increase. According to the PwC survey, 90% of industry players in the region expect to see a gradual increase in prices over the next three years, reaching $80-90 by 2017. Other industry analysts are less optimistic and predict prices may only reach the mid-$70s by 2018. That will be enough for some of the more conservative projects, says Bredenhann, but companies may have to rethink some of the more technically challenging to be cost effective.

Charles Pembroke

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Written by African Business Magazine

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