African oil & gas sectors adapt to lower prices

After two difficult years of spending cuts, layoffs and project delays, oil and gas companies are finally beginning to adapt to the slump in world oil prices. Analysis published by the energy consultancy Wood Mackenzie in July found that 56 companies reviewed would be able to generate a free cash flow at oil prices above $50 per barrel. Just two years ago, most of those firms relied on an oil price of $90 per barrel.

Adapting to this change in fortunes has not been easy. Most companies have had to make deep cuts, amounting to as much as 49% of spending on exploration and production, or $230bn, compared to 2014 levels, according to the Wood Mackenzie study. Although these cuts have made companies more resilient, investors are feeling nervous about where they spend their money and are placing ever greater importance on the cost efficiency of projects.

This shifting dynamic has a particular bearing on Africa’s upstream sector. After a boom in exploration and production activity in the late 2000s and early 2010s, companies are now looking at investments in the region with much greater scrutiny, says Chris Bredenhann, a partner at PwC in Cape Town.

A study by Bredenhann’s team published in August 2016 found that, despite the sharp fall in the oil price, Africa remains an attractive prospect. The study found that the continent produced eight of the top 20 discoveries globally in 2015, and nine out of the top 20 in the first eight months of 2016.

These include major discoveries such as the “supergiant” Zohr gas field off Egypt, containing 30 trillion cubic feet of gas, and Kosmos Energy’s discovery of 11–15 trillion cubic feet of gas off Mauritania. “The difference now”, Bredenhann says, “is that companies are approaching investments with a much more critical view.”

Falling investment

In a region where weak infrastructure and uncertain regulatory environments weigh heavily on the economics of oil and gas projects, the change in the global price environment has made investors warier of capital-intensive and technically complex developments in politically shaky frontier markets. An exploration licensing round in Uganda earlier this year, for example, failed to gain any interest from major international oil companies, attracting only junior players with little previous experience.

Where investment has continued is in those projects that were already close to completion, says Cobus de Hart, an economist with South Africa’s NKC African Economics. Delays to investment tend to have been concentrated in those projects at an early stage of development that still require significant capital investment, he says.

East Africa is emblematic of this experience. Once the jewel in Africa’s crown, it drew a frenzy of investment in exploration in the late 2000s and early 2010s, extending from Mozambique in the south to the volatile waters off Somalia in the north. But since the oil price has fallen, activity has slowed markedly as investors pause to consider the profitability of developing their discoveries. According to the Oslo-based consulting firm Rystad Energy estimates, capital spending on East African oil and gas projects fell from $4.6bn in 2012 to $2.5bn in 2015.

Reforms are needed

Analysts have widely attributed this slowdown to the immaturity of oil and regulations in much of the region. Tanzania and Kenya have both been slow to finalise the legal and fiscal terms governing the sector, while Uganda only issued production licences for oil fields managed by Britain’s Tullow Oil and France’s Total in August after years of negotiation.

With big questions around the price of oil, investors remain hesitant to take gambles in politically uncertain frontier markets. The same is also true in Africa’s two largest oil producers, Angola and Nigeria.

Gail Anderson, a sub-Saharan Africa upstream analyst at Wood Mackenzie, says these two markets are exceptional in the region in terms of the level of political risk they carry, combined with the enormous expenditure required to develop their offshore deep-water fields, where much of the interest from international companies has been in recent years.

In Nigeria, a surge in militant attacks on oil pipelines in the Niger Delta have led to falls in production of up to 700,000 barrels per day since the beginning of the year, allowing Angola to resume its mantle as Africa’s largest producer. Problems have been exacerbated by complex regulations requiring foreign investors to use local companies and staff, which are blamed for driving up the cost of doing business in Nigeria.

In early October, the president of the Nigerian Senate announced that the country’s long-awaited Petroleum Industry Bill, which should overhaul the entire legal and fiscal framework of the sector, would be fast-tracked. Given the history of delays, investors may meet such assurances with scepticism.

In Angola, legislation requiring international oil companies to rely on local firms for services and goods, combined with a lack of local capacity and resources, have significantly driven up the cost of doing business, says Anderson. The combination of high uncertainty and the high cost of doing business means many companies will need to think hard about where further cost cutting can be implemented.

“In both countries companies need to build efficiencies into the project design to make long-term cost savings,” Anderson says. “It’s about rethinking these projects so they’re cheaper from day one and that’s really challenging industry.”

These issues are unlikely to go away anytime soon. Most analysts remain cautious in their outlook, estimating the oil price will continue to hover around $50–60 per barrel in 2017 and remain below $80 in 2018. Still, Bredenhann notes that as companies continue to adapt to this “new normal”, Africa will remain an attractive prospect, given its plentiful resources and companies’ need to replenish their portfolio. “Reserve replacement is still the name of the game,” he says.

Charles Pembroke