A global slump in crude prices will throw up winners and losers in Nigeria’s oil and gas sector, as the industry goes into survival mode.
When Seplat chairman Ambrosie Bryant Chukwueloka ‘ABC’ Orjiako rang the closing bell on the London Stock Exchange in April 2014, the Nigerian oil and gas business was riding high. The benchmark Brent crude oil price was a healthy $107 per barrel and Nigeria’s economic rebasing had doubled the size of its official GDP, thrusting the country onto the radar of global investors.
Seplat’s $500m initial public offering – a dual listing on the LSE and Nigerian Stock Exchange – was the first of its kind, and was heavily oversubscribed.
Today, Seplat CEO Austin Avuru is blunt about the industry’s prospects, as a collapse in global oil prices – which have slumped to below $60 per barrel – combined with the political uncertainty caused by a controversial delay to Nigeria’s general election weighs heavily on cashflow and investor sentiment.
“Generally, it’s about survival in 2015,” he says. “We think that whoever survives in 2015 will be there for the long run.”
The company, which began producing in 2010, is one of the larger and better capitalised of the new wave of domestic Nigerian oil and gas businesses, but Avuru is battening down the hatches for a difficult ride. Capital expenditure will have to halve, and the company will boil down its operational costs.
At the end of last year, as prices began to slide, Seplat went on a roadshow to reassure investors that it was stable. When its full-year results come out at the end of March it will do so again “to let everybody understand that we can ride these waves,” Avuru says.
As one of the few Nigerian domestic oil and gas companies listed overseas on a major exchange, Seplat shares are a bellwether for international confidence in the industry. From their peak of 266.9p ($4.1) in June 2013, they bottomed out at 102.3p in December. They have since recovered slightly, to 155p by mid-February 2015.
Avuru is philosophical. “In this part of the world, it doesn’t matter what happens, we will have uncertainty,” he says. “There will always be natural gas for use by industries and power. There will always be crude oil for refining. Whatever the case, we will be here to navigate through the difficulties.”
Since the start of the decade, Nigeria’s oil and gas sector has being undergoing a fundamental shift in its structure and ownership. In part driven by the government’s stated aim to indigenise the industry and in part by the changing strategy of international oil companies (IOCs), Nigerian onshore oil and gas assets have been moving into the hands of a cohort of new players – such as Seplat.
Many have bought into so-called ‘marginal’ fields; assets that were already producing, or had a history of production. These have been made available by departing IOCs, who almost universally are looking to move away from difficult onshore assets and towards the deep offshore deposits where they have a competitive advantage.
In Nigeria this move has been hastened by regulation – some of that deliberate, some of that less so. Cognisant of the value to the economy being taken offshore, successive governments in the country have been vocal about increasing locals’ share of assets and the support infrastructure around the industry.
Domestic players have been given greater access to blocks and contracts as they become available, while local content regulations dictate that Nigerian-owned businesses must have a prominent role in supplying the majors.
Beyond this, however, oil company executives say that they are being pushed away by the ongoing uncertainty over a long-delayed piece of legislation that is supposed to redefine the financial terms of the contract between the government and the industry.
IOCs have lobbied hard against the Petroleum Industry Bill (PIB) – which has been stuck in the wheels of Nigerian politics since 2008 – as it proposes to increase the taxes and levies on the oil majors. In August 2013 the Oil Producers Trade Section, a lobby group of large oil companies, including Shell, ExxonMobil, Total, Chevron and ENI, claimed that the cost of the bill would run to $185bn over the first 10 years, and that production would fall by 20%.
Local companies have taken advantage of the vacuum left by the IOCs to buy up assets, often backed by financing from local banks.
In 2010, the total value of deals in Nigeria’s upstream industry was $660m, according to data from IHS, Inc. In 2014, the upstream industry recorded nearly $7.5bn worth of deals, including the $2.6bn divestment of assets by ENI to a group of Nigerian companies, including the Talevaras Group and Tempo Energy.
Because the majority of these deals were arranged privately, the exact terms have not been made public. Survival in this low oil price environment will depend on a number of factors relating to the structure and the cost of the debt that these companies have taken on, including the baseline price of oil that the companies and their creditors assumed in their financial planning; the productivity of their existing assets; and the diversification of their portfolios into gas and power infrastructure.
“Low oil prices are more difficult for independents than for the majors, because the majors are largely debt free not only debt-free, they’re probably carrying significant cash reserves. The independents are quite heavily leveraged, and in the low oil price scenario, the big panic is more about cashflow than P&L,” Avuru says.
“You need to have sufficient cashflow to support your leverage as well as your work programme. That’s where strategic planning comes in. It’s about keeping an eye on the cashflow enough to support … the minimum work programme that allows you to survive, with enough cash on the table to service your debt.”
This could result in a shakeout, as companies unable to service their debt struggle to meet their obligations, according to Rolake Akinkugbe, head of energy and natural resources at FBN Capital
“The challenges are for companies that are heavily indebted, who borrowed heavily to acquire assets. They now face potential repayment problems,” Akinkugbe says.
“Those who are unable to fund their operations and assets and work problems internally, and have to borrow, may face really stark choices. Either we sell to an investor or we dilute equity significantly. People might have to give up more equity than they would otherwise have been willing to in the boom times.”
This is something that Nigerian companies have often been loath to do, she says, but if prices do not recover in the longer term, they may have no choice.
“If this low price environment is protracted, if there’s no reversal in the downward trend, then you could actually see some of these companies fold up. Hopefully that won’t be the case,” she says.
“I think the most likely scenario in the short term is that a lot of these players will look to restructure their debt, and part of that restructuring may involve selling some equity.”
Banks pull back
Restructuring that debt may be difficult. Nigerian banks invested heavily in the first round of deals, but may struggle to participate in future refinancing in the current environment. The Central Bank of Nigeria limits banks’ exposure to the oil and gas industry to 20% of their total loan book, which many are already close to breaching.
To add to the banks’ difficulties, the naira has fallen well outside its official range of 160-176 to the dollar, despite the CBN’s rearguard action. In one day in early February, the central bank sold $401m of its foreign exchange reserve at N198 to the dollar in an attempt to backstop the currency, but for several days in February the currency traded beyond N200 to the dollar. Nigerian banks are heavily exposed to the discrepancy between the official and unofficial currency rates.
This could widen the gulf between the bigger domestic players and the new upstarts, as companies with strong track records, good corporate governance and producing assets can look to international markets.
“Even in this current environment, if you’re a good company with a good story, strong corporate governance, you can still raise funds internationally,” Akinkugbe says. “But even that window is not totally open, and it’s not necessarily open for everybody. You have to have a really good corporate credit story and strong management. But we know that Nigerian companies are in a position to attract capital, particularly those who have been able to launch bonds or list on stock markets from outside of the country.”
This could create an opportunity for better-financed players to snap up distressed assets. Afren, a relatively small Nigerian producer with a small portfolio outside of the country, is widely believed to be up for sale, after two credit rating agencies warned that the company could default. According to Reuters, the company had around $1.15bn in gross debt in September last year, and has admitted to facing a liquidity shortage.
Seplat had been in public talks over a purchase of the company, but Afren pulled out of the negotiations in February. Asked to comment on consolidation in the industry, Seplat’s Avuru says simply: “Any acquisition that we’re taking part in should reflect the oil price.”
This consolidation could ultimately be beneficial to the industry, in the same way that the Nigerian banking sector emerged far stronger and more competitive from two successive rounds of consolidations, which saw weak and failing institutions rolled into more successful ones.
“It may be that you end up with a smaller group of more stable, more secure operators working together as a result of this. It will definitely drive M&A activity,” says Tim Newbold, a director at advisory firm Africapractice in Lagos. “There are definitely some who are in trouble. That’s without doubt.”
How the current price crash affects overall production is uncertain. Nigerian oil output has been victim to security and infrastructure failings over the past decade, as well as the regulatory uncertainty that has ridden on the back of political turmoil.
The delay to the Nigerian presidential elections –ostensibly due to an inability to distribute voter cards in the restive north east of the country – has revived investors’ concerns about the long-term direction of Nigerian politics, and raised the spectre of a return to militancy in the Niger Delta. This, too, could trim the outlook for the sector.
“I had an optimistic case for the Nigerian oil and gas sector before the oil price crashed,” Newbold says. “I thought you could potentially see the indigenous sector driving production growth onshore, the IOCs focusing on building up their deep offshore assets, and Nigeria producing at a higher level than it’s produced in a long time…
“That is now unlikely, and the wider political context makes it very uncertain. Much depends on where the oil price goes and the legislative agenda of the next government.”
Gas: a rare bright spot
Amidst the negativity of falling prices and political uncertainty, there is a rare bright spot for the hydrocarbons industry. While oil makes up the majority of the country’s exports, its large gas reserves have been underexploited.
The government, under its ‘Gas Master Plan’, has prioritised and incentivised the creation of gas infrastructure in Nigeria, with a view to using the resource to solve the country’s perennial undersupply of power.
The 2013 privatisation of power generation allowed has brought private sector investors into the infrastructure business – and created an end market for gas producers.A liberalised pricing regime allows suppliers to negotiate their prices, and to generate guaranteed revenues throughout the international market turmoil.
Growth in the gas business should “cushion the blow”, says Bolaji Osunsanya, CEO of Oando Gas and Power and president of the Nigeria Gas Association. “Gas has shown to be a bit more stable, a bit more local and more easily planned around.”
Osunsanya warns, however, that the industry may find itself squeezed as the government struggles to keep up with its commitments to invest in infrastructure and gas joint ventures.
Around 80% of Nigeria’s government revenues come from the hydrocarbon sector. The slump in prices has blown a huge hole in the budget, meaning that the government, too, will need to reassess its capital expenditure.
“The only concern we have now is that … in this new pricing regime, government will be impaired significantly, and will not be able to make their own quota in terms of investment,” Osunsanya says, adding that he believes that this will hasten the shift towards a more private sector-led model of financing for gas infrastructure.
“I see [public private partnership] models,” he says: Without a doubt there is a need to invest in this infrastructure… I think what will change is the nature, the shape and form of the investments. I think it will move away from government to more capitalised private investors.
“Without a doubt the current political transition puts a natural lag. Nobody likes to commit such huge investments at the break of a transition. But more importantly, I think the fundamentals of the business are in place.”