Despite the rise in liquidity and a growing pipeline, local lenders remain cautious after the last oil price fall left Nigerian banks badly burnt, writes Sarah Rundell.
At the end of last year, Total’s giant Egina floating production storage and offloading (FPSO) vessel, three football pitches long, resembling a floating city, started pumping oil from her connected subsea wells 200km off the Niger Delta. Forecast to account for 10% of Nigeria’s future oil production, Egina is one of a handful of projects coming to fruition that suggests Africa’s oil sector is on the up.
The sector has been in the doldrums over the last few years following oil’s collapse in 2014 to less than half the US$100-plus a barrel it reached in the heady years between 2010 and 2014. Unable to finance costly offshore exploration and development to boost mature existing production, African output, led by Nigeria, Angola and Ghana, dropped back from above 10 million barrels per day (b/d) to 8 million b/d in 2017. Now, as oil prices start to inch higher, it is sparking renewed interest from operators as well as a new cohort of lenders.
The pipeline is beginning to look healthier. In Ghana, ExxonMobil and Aker Energy signed new contracts last year, and the Ghanaian government has promised more blocks for competitive bidding this year through a mix of open tenders and direct negotiations. It has also pledged more onshore exploration and vowed to develop the Western Region into a regional petroleum hub with integrated ports and refineries.
It’s no coincidence that the stronger pipeline comes alongside Ghana’s rosier economic outlook, evident in the IMF predicting it will be the fastest-growing economy in the world this year, says Wale Soyingbe, head of trade finance for Sub-Sahara Africa at Citi. “Highly capital-intensive sectors such as oil and gas are funded in Ghana primarily through foreign direct investment, and in 2018 Ghana saw quite a marked increase in FDI inflows,” he says. Positive signs of the country’s ability to borrow include its recent US$3bn eurobond which attracted bids more than six times the amount issued, he adds.
Elsewhere, the Nigerian government is poised to divest more stakes and issue the next marginal field round once it confirms new cabinet appointments. In emerging Senegal, Total has signed initial exploration and production sharing initiatives. Higher oil prices could kickstart investment in Angola, where production declined through 2018 to fall below 1.5 million b/d per day, 20% below its July 2015 peak of 1.8 million b/d, according to the Oxford Institute of Energy Studies.
Traders provide new sources of liquidity
There is no shortage of liquidity outside equity and balance sheet financing to fund new projects as they come onstream. Although the big banks have grown highly selective about which deals they do in a flight to quality and caution linked to compliance, other providers have rushed to fill the gap.
Reserve based lending (RBL) deals are still the main source of finance for Africa-focused independents looking to raise debt. Appetite from specialist RBL banks with sophisticated in-house engineers and independent reserves reporting capabilities to inform the borrowing base and protect banks if the oil price declines, is strong. “The appetite of banks for classic RBLs has returned with the passage of time and on the back of stronger oil prices. Banks are particularly on the lookout for sensible assets,” says Mukund Dhar, energy partner at White & Case in London. He notes in another trend that vendor financing often provides additional liquidity for smaller players like indigenous oil and gas companies, juniors and sometimes private equity-backed players in connection with acquisitions.
However, the biggest source of new liquidity is coming from traders and commodity houses in return for tied offtake agreements stretching into the future. Trader-fronted finance spans junior or mezzanine facilities, and even arranging classic bank debt transactions, with traders taking positions closer to conventional senior lenders than ever used to be the case. “Major global commodity traders need a supply to trade against and financing is a proven way to lock in that supply,” says Tom Longmuir, Paris-based counsel at Allen & Overy. He notes how banks in some funding structures have drawn confidence from the presence of a trader in the financing, viewing it as a “strong mitigant” against operational issues and local risk. One of which includes the ability of producers to meet their production requirements should oil prices fall, says Citi’s Soyingbe. “The preference is for transactions where the number of delivered barrels is fixed,” he adds.
And it isn’t just traders offering offtake finance to guarantee their own supply. The trading arms of large oil and gas companies are also lending money to finance upstream oil and gas that their own parent company isn’t necessarily involved in, observes Dhar. It’s a trend set to continue as large traders team up with local players to form consortia to bid for assets, particularly in Nigeria, predicts Longmuir. “Commodity traders bring financial firepower to the table and they are doing this to secure the offtake. We are seeing a broader range of players in upstream financing than ever before.”
Nigerian banks still cautious
Commodity trader-led finance is a welcome addition to the liquidity mix for indigenous Nigerian producers who have struggled to access local bank finance for a while. The problem is rooted in the seeds of the last crisis, when Nigeria’s local banks rushed to finance indigenous operators’ acquisitions of international oil company (IOC) assets and got stranded with non-performing loans when the oil price fell.
“The impact of sharp price declines which led to restructuring and term extension of deals is still high in the memories of most financiers,” says Soyingbe. In a reflection of their lukewarm enthusiasm, many aren’t even offering basic letters of credit (LCs), says Ngozi Okonkwo, chief legal officer at Oando, an African energy company. “Local banks find it difficult to finance LCs for trade, and companies have to resort to foreign banks. Local banks definitely don’t have the capacity to fund upstream projects.”
It’s an important point because many of Nigeria’s local players like Oando and Seplat want to take advantage of government tax incentives and expand their operations, building out riskier, capital intensive offshore projects. “The petroleum profit tax for a deep offshore asset is 50%. Onshore it is 65.75% for the first five years, then it rises to 85%,” says Okonkwo. That said, she does note that waivers under local content legislation are commonplace to allow project developers to bypass local bank finance if it’s hard to come by. “If the finance isn’t available from local banks then waivers under the act are easy to get and borrowers go to foreign banks. There isn’t an aggressive insistence that players use local banks because everyone knows it can be difficult.”
Nigeria’s onshore risks remain
Okonkwo notes that banks’ muted interest also rests in security concerns: Nigerian operators’ ability to access finance is severely crimped by the challenges they face safeguarding onshore pipelines. “Many onshore projects have struggled to tap finance because operators can’t guarantee the pipeline integrity. Existing operators are trying to bury pipelines further, but the thieves have become very sophisticated,” she says.
Oando recently abandoned its interest in a refinery project because it couldn’t safeguard the pipelines, she adds. Nigeria’s four refineries have barely functioned in the past five years, due mainly to sabotage of pipelines carrying crude to the plants. “There was a lot of interest in refinery space up until December last year, but it’s all stopped because the commercials didn’t work,” Okonkwo says.
Despite their cautionary approach, there are lots of examples where the commercials do work for local banks. They are sought-after funding partners by IOCs for their knowledge of the local market and regulatory landscape in a role boosted by local content rules. The same rules are starting to fan growth in Nigeria and Ghana’s insurance sector, notes Neha Khosla, partner at Norton Rose Fulbright. “In the past we have found that insurance requirements were almost entirely met by global insurers and reinsurers. Now we are seeing local insurers’ content going up in underwriting and reinsurances in Nigeria and Ghana,” she says.
A handful of local banks structure RBL deals, like Stanbic IBTC’s refinancing of its existing RBL facility for Eland Oil & Gas last year. Elsewhere, the US$14bn Dangote refinery, hailed as a gamechanger when it comes online in 2021 for its anticipated impact on Nigeria’s current crude exports and refined product imports, has been heavily backed by local banks led by Nigeria’s Guaranty Trust Bank.
“Nigerian banks play an important and significant role in major infrastructure projects like the Dangote refinery,” says Andreas Voss, chief country representative, Nigeria, and head of trade finance for financial institutions in Sub-Saharan Africa at Deutsche Bank. Banking reforms will also provide a boost to the capabilities of the region’s lenders, notes Soyingbe. “The Central Bank for West African States (BCEAO) has recently completed a wave of FX regulatory reforms allowing banks to source FX via the central bank to settle oil LCs or open account payments within 48 hours of a request submitted to the central bank.”
In another initiative, Nigeria’s central bank is also trying to shore up banks against oil exposure. Its March 2019 guidelines on stress testing requests that banks test their positions off the back of a fall in the oil price for the first time. “Bearing in mind the significance of oil and gas and related exposures to the Nigerian economy and the balance sheets of local banks, management should consider the impact of a sharp decrease in global oil price, with consequential impact on the rest of the economy,” it says.
A good pipeline and liquidity don’t necessarily equate to a financing bonanza. The impact of the global trade war and slowing growth, plus oil price volatility which makes it difficult to set a price deck that balances risk averse lenders and borrowers’ desire to raise more money, could halt progress. Some experts even suggest climate change holds long-term implications for oil financing. Many banks have walked away from coal-fired power financing and coal mining projects. It doesn’t take much imagination to extrapolate from what is going on in the coal sector to see a possible impact on the oil sector over the medium to long-term too, says Dhar. “The same arguments could be made here.”
Yet if the current liquidity is anything to go by, should conventional sources of finance dry up in the future, unconventional sources will quickly fill the gap. “Demand is slowing, but still growing in India, China and Africa and industrialisation has always been linked to increased consumption of oil,” Dhar concludes.