Nigeria & Oil Price Volatility
Nigeria is the largest oil producer in Africa and the sixthlargest oil-producing country in the world. Although the oil and gas sector accounts for a modest 10% (approx.) of GDP...
Introduction Nigeria is the largest oil producer in Africa and the sixth-largest oil-producing country in the world. Although the oil and gas sector accounts for a modest 10% (approx.) of GDP, the upstream oil industry accounts for more than 90% of the country’s exports and 80% of the government’s revenue.
The geopolitical situation between Saudi Arabia and Russia for market share in the oil and gas sector together with the COVID-19 global pandemic have hit the Nigerian oil and gas industry hard. With travel and economic activity restricted across the world, particularly in China (the largest crude oil importer), global demand for oil has plummeted.
Economic Impact On April 20th 2020, the WTI, the benchmark for US crude prices, turned negative for the first time in market history, falling $40 a barrel below zero. There is a historic oil glut, and storage facilities across the world are rapidly filling. In Nigeria, oil tankers have been stranded at sea loaded with unsold crude.
The reduction in demand has forced the Federal Government of Nigeria to revise its budget benchmark price for oil from $57 per barrel to $30 per barrel. This means a reduction in estimated revenue from the oil and gas sector falling by approximately 50% from over $30 billion to approximately $15 billion. Furthermore, this does not include Nigeria’s share of OPEC production cuts, which will reduce government revenue even further.
These cuts will inevitably have a significant impact on government investment and spending plans. Key infrastructure and energy projects will likely be delayed and/or abandoned. This may lead to the introduction of new laws and regulations including increased taxes on foreign investors as government seek to make up some of the lost revenue.
Market Impact The oil majors such as BP, Chevron, Total and independent oil companies have already begun to review their capital expenditure and operational costs. A number of them have scaled back on exploration and production activities, and new project approvals have been delayed in an effort to preserve long term value and protect dividends.
On March 23rd 2020, Shell Oil announced plans to reduce operating costs from $7 billion to $4 billion over the coming 12 months and to reduce spending to $20 billion or below, from a planned level of $25 billion. On April 23rd 2020, Norway’s Equinor became the first major oil company to cut its dividend following existing plans to reduce capital spending and exploration activities as well as cut costs by $3 billion to preserve cash. On April 30th 2020, Shell also announced a reduced dividend for the first time since the 1940s.
In Nigeria, the current price volatility is likely to lead to delayed or suspended final investment decisions, particularly investment in exploration and development leading to new production. Exxon, Shell and Total’s Nigerian deepwater offshore projects are likely to be significantly delayed as they will be unprofitable with Brent Crude below $60 a barrel. Furthermore, the still awaited passing of the Petroleum Industry Bill creates an additional layer of uncertainty for investors.
What Does the Future Hold?
Several players are trying to divest assets which are not considered to be of strategic priority to boost balance sheets. Others are trying to avoid the high cost of production in the current environment of low crude prices. In Nigeria, ExxonMobil is divesting its upstream assets. Total is also looking for a buyer for its 12.5% stake in OML 118 (offshore) and Chevron is divesting its equity interest in eight onshore and offshore blocks.
What remains unclear is whether this is, for some buyers, the right time to buy and expand existing portfolios or whether asset prices will decrease further, thus increasing returns to investors who wait for the market to bottom out. Weak companies will inevitably succumb to market pressures and smaller players will need to become more cost-efficient, quickly, if they are going to avoid insolvency. We will likely see increased consolidation in the sector and an uptick in merger and acquisition activity as the market continues to show signs of distress. However, what is interesting in this crisis is that we cannot predict with any certainty, who the market participants will be and what the buyer landscape will look like.
In terms of investment capital and financing options, the market will likely see a move away from traditional bank financing to new sources of funds including private equity-backed structures. Other than acquisition capital, companies will also need to refinance or reschedule existing facilities as it will become increasingly more difficult to service debt obligations if revenues continue to fall.
Opportunities in the Nigerian Oil and Gas Sector
Natural Gas Nigeria has substantial natural gas reserves. Given the lack of a gas infrastructure, approximately 75% of associated gas is flared and 12% re-injected. As a clean fuel, there is strong investor interest in gas-to-power projects, domestically, regionally and internationally. This is a great opportunity for Nigeria to refocus and become a major gas producer and exporter of LNG, together with Egypt and Mozambique. This will require integrated national strategic planning on the part of the Federal Government as part of a pan-African strategy. This has the potential to revolutionise the sector, the country, and the continent as a whole.
Diversification Oil and gas companies have an opportunity to transition and diversify their businesses towards greener and more sustainable energy sources. As the ESG agenda becomes increasingly more important to shareholders, companies will have to demonstrate responsible sourcing. This may impact margins and price expectations.
This time of pandemic is also a reminder, and an opportunity, for Nigeria and other African countries that rely heavily on natural resources to diversify their economies.
Renewables There is also an opportunity to accelerate the energy transition. Nigeria’s Rural Electrification Agency, through a partnership with the African Development Bank, has recently announced plans to provide medical and healthcare centres with solar mini-grid solutions. All On, the off-grid company established by Shell in Nigeria, has also provided an emergency relief fund for healthcare facilities fighting COVID-19. Investment in storage solutions, including stand-alone battery storage, will also add capacity and increase access to energy for the most vulnerable, particularly in rural communities.
While some new investments are being made in off-grid and mini-grid solutions, the entry point for some renewable technologies remains high. Low oil prices may also mean that companies are not sufficiently incentivised to invest in renewables. In this current low oil price environment, it, therefore, becomes increasingly important for governments to move away from extensive subsidies for fossil fuels. In Nigeria, government subsidies have meant that electricity tariffs are not cost-reflective. Distribution companies there have argued that the existing tariff structure does not guarantee a return on investment and have, therefore, in some cases, rejected power. The cost of power generation, transmission, and distribution must be accurately reflected in tariffs to attract private investment in the sector and to allow renewables to compete for investment.
Technology
Investment in technology and innovation in the oil and gas sector will also create opportunities. Digitalisation and robotics have great potential for safer operations, increased productivity and cost savings and this must be fully embraced if assets are to maintain value and not become obsolete. This will provide great opportunities for producers as well as for other intermediaries in the industry. Private equity will look for optimised operations with technologyfocused solutions. Refining capacity must also be increased in Nigeria to reduce dependence on the import of refined petroleum products.
Conclusion Despite the challenges, there are significant opportunities in the African oil and gas sector given the vast reserves on the continent. Furthermore, the cost of lifting oil in Africa is low compared to other parts of the world and this may also impact how Africa’s oil-producing countries weather the oil price volatility and the COVID-19 storm.
Producers and supply chains will have to adapt to the ‘new normal’. Survival will depend on business resilience. To thrive, businesses should create natural hedges while preparing for the next downturn.
• This piece was adapted for business a.m. from a research report prepared by this author