Risk and reward of Nigeria’s 2020 marginal field rounds

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Big changes are occurring in the world of oil with renewables fast placing its foothold in the global energy market.

Bernard Looney CEO of British Petroleum, one of the world’s leading oil firms, explained in August how his company plans to invest more in low-carbon businesses—and reduce oil and gas production by 40% within the decade.

Looney’s explanation signals the shift in major oil companies, who are now scaling down on oil exploration and embracing investments in renewables.

Ironically, there is still excitement in the Nigerian oil and gas industry at the mention of crude oil production.

Case in point is the marginal fields bidding round announcement made by the Department of Petroleum Industry (DPR) recently.

These bidding rounds are expected to revive production of oil in fields that have been abandoned for at least ten years from the date of first discovery. Asides being abandoned, a marginal field can also be deemed so if the President says so, going by the DPR guidelines.

Many of these fields are, however, often abandoned by top exploration companies who consider them not profitable enough for development.

Getting a marginal field
Any company that has an Oil Prospecting Licence (OPL) can legally search for oil and operate on an oil field in Nigeria. An OPL is the first ticket to finding useful oil fields. But to enter the oil production stage, such a company would need an Oil Mining Licence (OML).

It is these licences that the government decides to revoke when oil exploration and production is abandoned on the fields. This license is then resold; hence the concept of marginal fields and its bidding rounds.

The government usually revokes and resells the licenses to increase its revenue and so that the “abandoned” OMLs can be developed.

Additionally, marginal fields have proven to be vital to Nigeria’s upstream local content development strategy. Previous licensing rounds produced some notable indigenous stakeholders in the industry such as Seplat Petroleum, Belema Oil , and Shoreline Energy.

Why now?
The DPR described the 2020 marginal field bidding rounds as coming at a time when the country is at a “precarious economic situation”.

The country is facing a challenging financial situation worsened by the pandemic and unstable oil prices; which makes the implementation of the 2020 budget a “herculean task.”

So, it can be deduced that revenue generation by the federal government is a core motivation for the first marginal field bidding rounds in 18 years. If successfully held, it would help to reduce the country’s 2020 ₦2.2 trillion budget deficit.

The government is hopeful that the entire bidding process would yield a revenue of $5.7 billion—around ₦2.2 trillion.

The DPR is also doing something different in this year’s bidding rounds to improve revenue levels. It is introducing a signature bonus (an amount of money paid by bid winners on their marginal fields) that varies for each of the 57 fields planned for auction.

This was prompted by an oversight during the 2003 rounds when a flat signature bonus was applied to all fields. It happened that owners of Assaramatoru field and Umusadege fields paid the same signature bonus rate even though there was a huge difference in their production levels.

Assaramatoru barely produced 1,000 barrels per day whilst Umusadege was awash with around 20,000 barrels per day consistently for over five years. With more due diligence, the government could have gained a significant amount of money from a higher signature bonus charged to Umusadege.

To avoid a repeat, DPR alongside its consultant had, in the last three years, been evaluating all the fields and allotting a commensurate commercial value to each.

While the revenue prospects look good, there are warning signals.

The red lights
There is the court case.

In July, the Federal High Court, Lagos had issued a restraining order to stop the selling, auctioning or acceptance of bids for some fields.

Although the DPR has succeeded in getting the restraining order lifted, the 11 repossessed fields may still carry litigation risks.

Should the court rule against the favour of the government, the total number of fields to be auctioned will reduce and the government’s revenue projection would also fall. If they win, there is still the chance of the matter being re-contested on appeal and taking a number of years before resolution occurs.

Investors will need to ensure as part of their due diligence that there is no litigation hanging over fields that are of interest to them.

Other caution lights in the process include the volatility of the foreign exchange market as investors will need to pay some of the fees and licences with United States Dollars (USD).

Then there is the restriction of transfer of interest after the field has been awarded. If any interested bidder of the marginal field—who have to be Nigerian—win, only a maximum of 49% ownership can be transferred. And must be with the consent of the Minister of Petroleum Resources. Investors that are interested in seeking international financiers must be aware of this, as it could hamper their chances of getting funds for immediate exploration.

Also how viable are these fields? Provided that bid winners scale through these hurdles, the question of their capability to commence immediate operations is rife.

After the 2003 licensing rounds where the government sold a total of 24 marginal fields to 31 companies, very few were productive. A report by BudgIT explained that 67% of marginal fields allocated in the 2003 licensing round did not produce a barrel of oil ten years later.

Although the 2020 bidders would go through a 12 stage process, none of the steps disclose that investors will have the opportunity to physically inspect the fields. Besides, Covid-19 restrictions still hampers the ability of investors to conduct this due diligence.

Rather the bidders who pass the pre-qualification stage will be relying on existing data that they have not personally verified. Whilst, the existing data is subject to scrutiny, it is important for these fields to be also inspected independently to avoid the level of redundancy witnessed in 2003.

Verification of data will also ensure that only viable fields are auctioned and better position investors to commence immediate production.

Closely associated with the issue of valuation of the fields is the uncertain global oil price. Earlier in the year, the price of oil took a spectacular dive due to Covid-19 reducing global demand and the flooding of the market by Saudi Arabia and Russia.

According to IEA Oil Market Report, the global oil demand fell by 16.4 mb/d in the second quarter of 2020 and the U.S. Energy Information Administration in its Short-Term Energy Outlook stated that existing inventory levels, OPEC surplus production and uncertainties regarding the trajectory of oil demand will limit an increase in crude oil price in the third quarter of 2020.

The oil price uncertainty and fluctuations may lead intending investors to base their valuations on pricing models that can become unrealistic in the near term which can disrupt plans of developing such fields.

Similarly, many local companies have been hard hit by the effects of Covid-19 and the ensuing significant decline in oil prices, so they may not have sufficient cash flows or be able to raise money from both local and international banks.

No rewards without risks
The announcement of the 2020 marginal field bidding process has brought excitement but there is a need for caution.

The 2003 process has, however, provided the opportunity to learn, improve and ensure that the winners of this bidding round are companies that have the technical and financial capacity to operate the fields.

Investment in oil and gas is a risky venture. However, risks must be proportionate else an investment will be the equivalent of a Russian roulette.

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