Are Nigeria’s new oil fields another waste of time?

Our article last week questioned Nigeria’s status as Africa’s oil giant, and the last sentence was particularly scathing. It essentially said, “Nigeria is in the depths of the trenches, competing against Angola and Libya for the weightless title of “Africa’s oil giant”.” I wince every time I read it, but it had to be said.
 

However, the government and the country’s national oil company, the Nigerian National Petroleum Corporation (NNPC), still have a few tricks up their sleeve to revive the oil sector. On the 28th of June, the Nigerian Upstream Petroleum Regulatory Commission (NUPRC) announced that petroleum prospecting licences for 57 marginal fields would be awarded to 161 successful companies after a bidding process that started in 2020. These licences will allow indigenous oil companies to explore (search for) and produce crude oil from these fields.

For context, marginal fields are smaller onshore or shallow water oil blocks left undeveloped and abandoned by international oil companies (IOCs) because of their relatively low production potential. Marginal fields, which produce 2,000 to 10,000 barrels per day, are too small to make economic sense for IOCs that produce millions of barrels from blocks across the world. However, they’re just right for local Nigerian companies that want to enter the oil market. Indigenous oil companies like Seplat and Nestoil, now household names in Nigeria, began their foray into the Nigerian oil industry with marginal oil fields.

When the news broke, I was in the middle of writing last week’s article and our deputy editor, Adesola, asked if the marginal oil field licences were a game-changer for Nigeria’s bleak oil and gas industry. Given that the issuance aims to increase Nigeria’s dwindling oil production, it’s a question worth answering.

To give a comprehensive answer, we’ll need to take a step back to understand the dynamics of marginal oil fields by looking at how successful past licence awards have been. We’ll also need to assess the recent licence award in the context of the current and future states of the global and local oil economies. By the time we’re done, we should have all the tools we need to answer Adesola’s question.

 

Marginal oil fields and survivorship bias

Survivorship bias happens when we focus on the success story and ignore those that failed. A typical example is when a college dropout like Mark Zuckerberg becomes a billionaire, and we think his story is the rule when it’s just the exception.

For every Seplat that emerged from obscurity thanks to marginal oil field awards, two other companies did not. But, we don’t know the names of those companies, so we focus on Seplat and conclude that marginal oil field awards are the best route for indigenous oil companies. This is survivorship bias.

Since 1999, 30 marginal fields have been awarded: two in 1999, twenty-four in 2003, one each in 2006 and 2007 and two in 2010. However, according to the NUPRC, only 17 are currently producing crude. Furthermore, out of 24 licences awarded to 31 companies (including Seplat) in 2003, as of 2013, only nine of those companies were still producing oil—1 in 3 odds.

The major reason for their failure was financing. We’ve said this in previous articles. Oil production is a financially tasking, definite high-risk, potentially high-reward endeavour. It requires initial investments ranging from $15 million to over $180 million. There’s also no guarantee that the oil found will be in commercial quantities for investors to recoup their funds.

Back in 2003, just four years after Nigeria became a democratic country, financing from international organisations wasn’t exactly flowing in. Also, Nigerian banks didn’t have the required capital as most banks had capital bases of less than $10 million. Marginal field operators who succeeded relied on foreign technical partners with the money and expertise to develop the fields.

A lot has changed since 2003. The good news is that Nigerian banks have more robust capital bases to support the oil and gas sector, which already accounts for 23%  of loans issued to the private sector as of December 2021. Oil prices are also high at about $100/barrel and could stay high till 2023. However, there’s some bad news—we might be approaching an economic downturn, oil prices could still decline before the end of the year (nobody really knows), and foreign investors have ESG concerns. We also can’t ignore Nigeria’s peculiar operational issues of theft, vandalism and production shut-downs.

This is a lot to take in but let’s start with the financing issues before we tackle the operational issues.

It’s all about the money

The global economic outlook is gloomy and difficult to predict (a combination investors aren’t crazy about) and this has implications for companies looking to raise financing, whether from foreign or local financing.

Some experts are convinced that we’re heading toward a recession given that US inflation is at record levels, prompting the US Fed to raise interest rates. These moves in the US have investors spooked, and the global stock markets are reflective of this. The US S&P 500 is down 20% year-to-date, while the UK’s FTSE 100 is down 4% year-to-date. Yields on short-dated fixed income instruments are also higher than yields on longer-dated instruments. This indicates that investors are demanding higher returns now as they factor in the risk of a recession. Even oil markets have been sensitive to the recession speculation, with prices dipping below $100/barrel this week for the first time since April.

However, labour markets in the US are still pretty strong. Unemployment is at 3.9% which is relatively high for the US (God when?) but much lower than the 7% and 10% during the 2008 and 1981 recessions. This has other people convinced that if there’ll be a recession, it will blow over pretty quickly. Still, fundamentals in the oil market haven’t changed—there’s still excess demand amidst a supply crunch. A recession would lower demand and reduce prices, but that hasn’t happened yet. It’s still just speculation so far. Interestingly, one investor who’s doubling down and buying the oil price dip is Warren Buffet, who purchased $500 million worth of shares in Occidental Petroleum, making him the largest shareholder with a stock value worth almost $10 billion.

What does this have to do with marginal oil field operators in Nigeria? Everything especially for foreign investors. Remember that exploring and producing from these marginal fields requires capital. Marginal oil field operators will need to raise financing amidst the uncertainty in the global financial market. Unfortunately, when the US sneezes, the world catches a cold. So as foreign investors dial back on risky investments in favour of safer bets while they monitor the state of the market, this reduces the pool of capital available. Furthermore, Nigeria’s oil industry isn’t exactly a safe bet for an investor. Warren Buffet might be daring enough to invest hundreds of millions of dollars in an established US oil company. But the number of investors willing to invest in a Nigerian company taking its first stab at oil production won’t be as robust for a few reasons.

We’ve already established that the threat of a recession is enough to spook investors. Increasingly, investors also have ESG (environmental, social and governance) concerns that seem biased against Africa. While the threat of climate change is very real and increasing every day, Africans with less bargaining power bear the brunt of it. For instance, the European Central Bank previously announced that it would stop funding fossil fuel projects by the end of 2021 but faced with an energy crisis, Europe has turned around to classify natural gas as a green fuel. So, raising financing from the international market will be difficult, and thanks to the recession risk and Nigeria’s operating risks (which we will break down later), rates will be high.

For Ayodeju Dawodu, a director at BancTrust & Co, a UK-based investment firm focused on emerging markets, the best bet for marginal field operators to raise financing is Tier 1 Nigerian banks. In his expert opinion, Nigerian banks don’t have the same ESG constraints as foreign lenders because sustainability isn’t yet at the forefront for local banks. He also believes that Tier 1 banks (First Bank, UBA, GTB, Access, Zenith) have the headroom and foreign exchange liquidity to give loans to marginal field operators. Remember we said that in 2003 Nigerian banks weren’t a major part of the financing conversation for marginal field operators due to their $10 million capital bases? Well, things have changed since then. For instance, Access Bank had a Tier 1 capital base of ₦928 billion (about $2 billion at official rates) as of December 2021.

However, given the global economic outlook, interest rates won’t be cheap, and the terms won’t be so favourable. First, Nigerian banks are stressed. Capital adequacy ratios represent how much capital banks must have in their reserves to cushion losses and protect from insolvency. The CBN’s minimum requirement for banks with international operations is 15%. 

While First Bank is pretty close to the threshold at 16% and GTCO and Access’ CARs reduced year-on-year, Nigerian banks’ CARs are good and demonstrate that they can withstand an economic shock (like a global recession or an oil price plunge). However, we have to pay attention to their non-performing loans.

For instance, First Bank’s relatively low CAR is a result of non-performing loans. As Abayomi, our banking analyst puts it “despite First Bank’s non-performing loans (NPLs) declining from 23% of total loans in 2017 to 6% in Q1 2022, the bank has had to forego ₦565 billion in loan-loss provisioning over the past five years to deal with its age-old asset quality issues (bad loans)”. It also doesn’t help that 15% of First Bank’s NPLs were to oil and gas companies.

Furthermore, global and local interest rates are higher. Central banks have their tightened monetary policy stance in response to inflation. Even the CBN increased interest rates in May this year, from 11.5% to 13%—it's the first hike in six years.

According to Dawodu, marginal field operators’ success with local banks will ultimately depend on the banks’ risk appetites and relationships. “Vandalism, theft and production shortages make Nigeria’s oil and gas sector risky, but people like Tony Elumelu (TNOG) and Aliko Dangote can get financing because they have relationships with banks”.

Essentially, raising financing won’t be a walk in the park even in 2022. But, there are also operational issues to consider.

Operational issues

It’s impossible to have a conversation on Nigeria’s oil sector without the words “vandalism” or “theft” popping up.

Our Seplat story showed that the company’s 58.6% increase in Q1 revenues was predominantly due to higher oil prices. In Q1 2022, Seplat’s major producing assets, OMLs 4, 38 and 41, which accounted for 69.5% of their Q1 2021 production, recorded an 8% decrease from Q1 2021. This was due to higher than planned downtimes on the Trans Forcados System. Pipelines have planned downtimes which are required for maintenance purposes at specific periods. However, vandalism and leaks caused this downtime to be 18% higher than planned in Q1 2022.  In addition, Seplat’s Ubima block only produced 337 bpd in Q1 2021 and recorded zero production in Q1 2022. The company stated that Ubima in Rivers state is a high operating cost environment due to vandalism and theft, which require significant capital expenditure to find safer evacuation routes.

Dealing with Nigeria’s turbulent operating environment is expensive—not only do companies lose out on real revenue due to stolen products, but there’s also the opportunity cost of higher than planned downtimes.

So far, we’ve discovered that the odds of success for marginal field operators aren’t great, raising financing won’t be easy, and ease of doing business in Nigeria’s oil sector is non-existent. So, what’s our verdict? Could marginal oil fields be a gamechanger?

Gamechanger or not?

Looking back now, the answer to this question was really at the beginning of this article. By definition, marginal oil fields don’t produce much. As of 2014, over ten years after the 2003 award, marginal oil fields contributed less than 3% of Nigeria’s oil production.

“Marginal oil fields don’t produce much, so their ability to contribute to Nigeria’s production is limited. It’s really just a launchpad for Nigerian operators to get experience and buy larger assets in the future,” said Ayodeji Dowado, director at Banctrust & Co.

Seplat (the best indigenous oil company by a mile), which started in 2003 as a marginal field operator, now produces about 30,000 bpd, roughly 2% of Nigeria’s average daily production. While the company’s acquisition of Exxon Mobil’s onshore Nigerian company will increase their production by almost 200%, what’s clear is that it takes years, maybe even decades, for marginal field operators to raise financing and contribute significantly to Nigeria’s oil production. Also, looking at Seplat, it’s clear that building a great company in Nigeria is no walk in the park. Besides financing, it also requires an efficient business model, strong corporate governance and the ability to adapt to changes in the energy sector and the global economy.

Awarding licences for marginal oil fields is a good move from the Nigerian government to increase local participation in the oil industry. But, according to NUPRC data, Nigeria’s production has declined from 1.8 million bpd back in 2019 to 1.024 million bpd in May 2022.

So, no, marginal oil field licences are not nearly enough to be called a game-changer for the industry.