The initial post-Gaddafi elation has given way to anxiety, as Libya’s economy struggles to function. Its vast oil reserves are at the centre of an internal tug-of-war that has made even the hardiest investors wary. Elizabeth Stephens and Adam Nash of JLT Specialty report.
Since the demise of the eccentric Colonel Muammar Gaddafi, Libya has struggled to translate the euphoria of ‘liberation’ into real political progress and economic development. Elections were successfully held in July 2012, but the General National Congress which they brought to power and the government which it subsequently appointed have since wielded power in little more than a nominal capacity. The central authorities’ perceived lack of legitimacy and limited military capability have enabled the militias, with their regional, tribal and religious affiliations, to exercise de facto control over large swathes of the country. The inability of the central government to disband and incorporate these innumerable armed units has had dire consequences for an economy which is almost solely dependent on oil revenues.
The political violence risk that stems from Libya’s rule-by-militia and lack of central authority has been the single-biggest deterrent to investors. Even among international oil companies (IOCs), which have a traditionally high tolerance of risk, efforts have been made to scale back commitments or even exit the country, as a combination of civil unrest and terrorism has seen oil production levels dwindle.
And in the prolonged absence of a constitution, the weakness of the central government in Tripoli and the emboldening of regional groups have also created anxieties about contract certainty and legal and regulatory risk. It has become clear that the struggle for Libya’s future by no means ended with the overthrow of the ancient regime and in many ways, for foreign investors, the business environment has become more challenging than it was under Gaddafi.
The oil sector
In the initial elation that followed victory over the Gaddafi regime, Libya’s oil sector recovered quickly. With much of the oil infrastructure left remarkably unscathed when the conflict came to end, by late-2012 output was successfully ramped up to 1.37 million barrels a day, just short of pre-war levels. This renaissance, however, has been short-lived and as the interim authorities have failed to deliver on key political objectives amidst a deteriorating security environment, production has once again plummeted. Indeed, with political dissatisfaction soaring, the hydrocarbon sector has been reduced to collateral in the overlapping disputes between autonomous political actors and the central government.
In October 2013 the Western Mellitah export terminal and the Sahara oil field which it serves were crippled by protest movements organised by non-Arab minority groups demanding cultural and linguistic rights. These protests reignited in February of this year and are contributing to lost revenue of around US$130mn a day.
A similar situation in the country’s east has seen a number of key oil terminals blocked by a powerful rebel militia demanding autonomy for the Eastern Cyrenaica region. The blockade has been ongoing since last summer as the self-appointed Political Bureau of Cyrenaica, led by Ibrahim Jadhran with the support of a 17,000 strong pro-autonomy militia, has sought to pressure the government into devolving authority by starving it of oil revenues.
Right across Libya’s coastline and most persistently at the eastern ports of Es Sider, Ras Lanuf and Zeuitina, exports have been blocked and production at the connected oilfields disrupted as a consequence. The impact is severe with the government drawing-down on reserves to meet the shortfalls in revenue caused by the stoppages. By the end of 2013 the government will have drawn-down US$13bn in reserves out of a total of US$119bn. Costs in December alone were U$5bn, an unsustainable figure that would halve reserves by the end of 2014.
Major IOCs such as ConocoPhillips, Eni and Marathon have suffered losses as a result of the oilfields at which they operate being cut-off from the international market. The situation has forced many oilfields to wind down production and miss targets; at last year’s nadir production fell as low as 200,000 barrels per day (bpd) and in the first few months of 2014, output has continued to struggle below the 400,000 mark. In turn, traders and off-takers have been left empty-handed as tankers have been prevented from loading at hijacked ports after the Libyan government issued a threat of aggressive action being taken by its navy or legal proceedings being filed against offending entities. Tripoli claims that purchasing oil from rebel-held facilities would constitute a breach of Libyan sovereignty.
IOCs are registering the effects of the stoppages on their cash flows, which in the medium-term may undermine shareholder enthusiasm for the Libyan oil sector. Some IOCs are actively seeking buyers for their Libyan assets. More concerning though, is the impact on Libya’s balance of payments. If output persists much below 500,000 bpd for a significant portion of 2014, the government will be forced to continue drawing on its reserves to meet the shortfalls in revenue inflicted by the stoppages. The level of drawdown is clearly unsustainable.
All of this sets up a series of potential inflection points heading toward the middle of 2014. The potential for a new government in Libya after elections late in Q2 could restart progress toward a negotiation with federalist militias in the east in Q3. In light of this, Jedhran will more than likely stall negotiations until a new cabinet and congress are appointed. But if these new actors adopt the same position as their predecessors, who held that the conjoined issues of political devolution and oil revenue-sharing were essentially constitutional issues, the deadlock could continue for much of the year ahead.
Neither a full failed state scenario nor a completely stable recovery has ever been probable near-term outcomes. For now, production will effectively be capped at the 600,000 bpd available from Western Libya, precluding a sharply bearish market outcome, with an average of more like 400,000 bpd to 500,000 bpd based on intermittent outages, but the current export level is still likely to rise slightly.
Legal and regulatory uncertainty
Under the current setup, the central government-run National Oil Corporation (NOC) acts as ministry, regulatory agency and joint venture partner for the entire hydrocarbons sector. However, with the country’s legal and regulatory environment still in a state of transition and in the context of popular demands for political devolution and even federalism, there is some concern over the ability of the fragile central government to maintain this level of centralisation.
The Political Bureau of Cyrenaica’s decision to announce the establishment of an independent oil company and central bank, coupled with a recent incident in which the Libyan Navy was forced to fire warning shots at a Maltese oil tanker attempting to dock and the rebel-controlled port of Es Sider, has intensified investor uncertainty.
In early March, Jedran’s attempts at an unauthorised sale of oil from the rebel controlled post of Es Sider, via a North Korean-flagged tanker, Morning Glory, presented the ultimate challenge to the government. Parliament authorised soldiers and militiamen loyal to Tripoli to move against eastern separatists and seize three oil terminals under their control.
Jedran has been maneuvering for months to sell oil stored in containers along the coast, although offtakers have not been forthcoming. Despite threats by the government of military action, the Morning Glory broke its cordon and reached international waters.
The incident provided the trigger for the ousting of Prime Minister Ali Zeidan, with his inability to control the country’s vast oil supplies tipping the balance against him. The dismissal of Zeidan’s government, after 16 months in power, could lead to further instability.
Incidents such as this, combined with the lack of legitimacy and interim nature of central institutions, undoubtedly undermine contract certainty and raise questions over the long-term validity of contracts. It has even led some commentators to draw comparisons with Iraq where the ambiguous parameters of Kurdish regional autonomy have often left IOCs in doubt over the validity of concessions signed with the Kurdistan Regional Government.
In reality, the likelihood of the Cyrenaica region following a similar path is slim. The Cyrenaica autonomy movement does not have a strong organic base and genuine support for a federal style of government is weak. More accurately, the movement is driven by Jedhran’s opportunism and he is likely using demands for federalism as a bargaining tactic to secure more modest goals, such as revenue sharing. The 20-20-20 distribution of seats between the country’s three main regions – Fezzan, Cyrenaica and Tripolitania – in the Constituent Assembly, which has been tasked with drafting Libya’s new constitution, suggests that there will be a strong impetus towards greater regional power. While this may be a positive step to easing popular tensions, it could also complicate the country’s legal environment.
Despite the challenges, agreement will ultimately be reached over the sale of Libyan oil, which will create the opportunity for the development of the country’s infrastructure. There are already signs of an upturn in investment in utilities including telecoms, power, desalination plants, transport and other infrastructure and this will gather momentum as the long-term political system becomes clear. Irrespective of whether Tripoli exerts central control over the country or, more likely, a federal system of government is developed, foreign investment and expertise will be required.
Strong relationships with local politicians and communities will be of prime importance as infrastructure development gets underway. Those companies who take the time to understand the nuances of risk and reward associated with particular assets and investments will secure the most sustainable returns.