Information available revealed, big time players
in the Oil and Gas industry such as Wale Tinubu, Ben Peters, Tonye Cole, ABC
Orjiakor, Igho Sanomi and others face untold massive risks in their scramble
for ownership of oil wells.
Here are the details
‘Over the past few months, news has filtered
intermittently of the divestment of Royal Dutch Shell of some of its onshore
oil blocks [OML 18, 24, 25 & 29; OML is Oil Mining License/Lease] for
reasons ranging from change in strategy to focus offshore and on gas, to making
steps to eventually exit its Nigerian operations. Whatever the reason, $5bn in
cash is sufficient enough. The largest asset OML 29 is reported to fetch Shell
$2.562bn (or over N500bn, depending on what exchange rate you are able to
convert at). The various winners of the assets must have estimated the value
using discounted cash flow method, the mother concept of all of finance, which
states that the value of $1,000 today is more than the value of $1,000
tomorrow.
Say for instance, the interest on savings in
Banco Savvy is 10% daily, if I received $1,000 today, I would dash to put my
money in Banco Savvy and wait till tomorrow to collect my $100 (10% of $1,000)
and my original amount of $1,000 totalling $1,100 [$1000 + 10% of $1,000]. This
$1,100 is referred to as the future (tomorrow’s) value of $1,000 (present or
today’s value). This is known as compounding. The opposite of compounding (similar
to reversing a car) is called discounting, bringing tomorrow’s money to today.
If a payment of $1,000 was due tomorrow and I decided to make payment today,
using simple algebra from our compounding process where [$1,000 + 10% of 1,000
equals $1,100] we have Y + 10% of Y equals $1,000; y + 0.1y = 1,000 and since y
is common, we can calculate y as $909.09.
This discounting process, is what the buyers used
to value the blocks by calculating their projected revenues from owning the oil
blocks over a period, typically 5 years because in any case, except you are the
Alpha & Omega, or even just the Omega, you cannot really predict what can
happen in more than 5 years. The problem is, this oil block valuations were
done when the prices of oil were above $100, and the bidders calculated their
revenues perhaps using $75 as conservative estimates, with current oil prices
below $50, it means the projected revenue has fallen by more than 30% and
logically the valuation would fall by about that same amount. The fancy name
for this is called a sensitivity analysis. The total divestment is reported to
fetch Shell about $5bn and most of the agreements have already been signed, and
with the exception of Crestar, who did not receive Ministers Consent as
explained here; if and when the deals are concluded, Shell
would have won the lottery.
Adding the Oando-Conoco deal, the past few months
have witnessed increased participation of local content in the upstream sector,
which would be a major achievement of the President Goodluck/Diezani
Allison-Madueke administration; or if you are on the flipside, a failure on the
government to provide adequate security/environment which led to the strategic
exit of IOCs from Nigeria. In any case, about $4.662bn would go into the
coffers of the IOCs and a good portion of the funding would come from Nigerian
banks in form of debt to the buyers of these assets. Typically, these kind of
deals are funded 70:30 debt to equity ratio, although Oando would have us
believe it funded Conoco 50:50 as explained by this article. Maybe true in theory, in practice, what
would happen is that out of the additional $800bn equity to be funded by Oando,
would have borrowed between $320 – 450m to fund its equity portion. Or take Mr.
Benedict Peters’ Aiteo Consortium that bid $2.562bn for OML29 and $2bn debt,
being 70% of the total funding of $2.898bn, members of the Consortium borrowed
between $252 – 400m would have been borrowed to fund their equity portions. A
rough estimate of the total debt for these transactions is about $3.75bn (being
75% of the bid values), the bulk of which would have come from Nigerian banks.
One of the highlights of Professor Soludo’s rejoinder, in 2005, a syndication
of $300m would probably have been done by maybe 20 banks, but in the
post-consolidation era, $300m was a single ticket size in the Dangote Oil
Refinery deal. Nigerian banks are now syndicating billions of dollars.
Conservative estimates of local banks exposure to the upstream sector from
these deals is well over $2bn.
‘With the current oil price regime, these deals
have become sour. As highlighted earlier, repayments, from projected cash flow
of the oil blocks have now been reduced, meaning the ability of the oil blocks
to repay the debts has been constrained. It would take more than a
transformation agenda for the bidders to meet their obligations and covenants
under the respective loan agreements. (Un)fortunately, Nigeria is one of those
environments where the legal system is not well developed, so borrowers can
easily force lenders to restructure their loan. A rather strange occurrence
where even before the first year anniversary of these loans, a technical
default is envisaged and a restructure is necessary to avoid it.
Ideally, sale agreements of this kind should
contain a Material Adverse Clause. Essentially, an agreement that enables the
buyer or acquirer in a merger/acquisition to refuse to complete the acquisition
if the target (in this case oil blocks) suffer a change. Perhaps a reduction in
valuation of the blocks based on current pricing constitutes a MAC and bidders
should be able to renegotiate or walk away from the deal. While we cannot
confirm if such a clause exists, sources say the buyers forfeit 10% of the
acquisition costs if they decided not to complete the deal. Similar to playing Baba
Ijebu, the buyers have a choice between cutting their loses of 10% of the asset
value, repaying off the acquisition finance and avoid overpaying for an asset;
this would be the better option if you had a crystal ball and were certain that
current oil prices are sticky and expected to persist in the medium to long
term. This scenario is lose-lose for both parties; Shell has committed
extensively to exiting its onshore operations, already commenced strategic
layoff of hundreds of staff and seriously eyeing the $4bn+ cash pay-out. It
might be the buyers’ market.
But the chart of oil prices over the past 30 years
suggest this is likened to “an airplane that was cruising and suddenly meets an
unexpected and unprecedented turbulence” forcing it to fly low for certain
periods, and that oil should possibly rise to $70. This turbulence is primarily
caused by the interplay of supply and demand:
- America and its shale oil. From being one of the largest importers of crude oil, America is now producing circa 9m bopd in direct competition with Saudi Arabia.
- Saudi Arabia and the Gulf refusal to cut production and sacrifice market share.
- Even though there has been crisis in Libya and Iran, their combined production of about 4m barrels has not been affected.
There is more oil in the market than people are
demanding for; and from Economics 101, when supply exceeds demand, prices will
fall.
America’s shale is however very expensive to
produce and while there is no consensus break-even price of shale, it is
estimated to hover somewhere between $53 – 70 per barrel although it has been
difficult to find any two estimates that remotely agree. And yes, there are
plenty plenty estimates as seen here. If the break-even price is correct, then current
prices are unsustainable for many, about 30%, US shale producing firms. But
because Americans are smart, many of these US E&P firms hedged their
production.
Hedging is like insurance, where you pay your
insurance company a premium, say 3% annually of the value of your asset and any
damage or loss is covered by the insurance company. So, many of these US firms
bought “oil insurance” from “Oil-surance” firms. Where a US firm would have
paid a premium, to hedge its production at say $75 and now that prices are at
under $50, the Oil-surance company pays the US firm the $25 difference on its
production; multiply that by 1 million barrels daily; multiply that by 320 days
per annum. And you are looking at $8billion in insurance payments in a year.
The problem is Oil insurance firms who can make these payments do not exist.
This insurance is done by very smart bankers at Goldman Sachs, UBS and Co, who
use complex pricing models to determine the value of premium to be paid by US
firms to buy oil insurance at certain prices. Again, back to our oil price
chart, except you have a crystal ball, you really cannot tell the absolute
direction of oil prices. So why would these intelligent bankers agree to take
the opposite side of these hedge contracts? Well, like Baba Ijebu, like Las
Vegas, like Wall Street. Same game, different name.
Fortunately, most of these hedge contracts would
begin to expire from the third quarter of 2015, and your guess is as good as
mine on the number of hedging banks that will be willing and able to take the
opposite side of the hedge contracts. Then the wind will blow, and the bottom
of the hen will be seen. And many US shale firms may file for bankruptcy. Perhaps
about 50% of America’s current production would be affected, perhaps more or
less. It does not a necessary signal of good news for a drop in supplies. If
about 4m bopd would be affected, Saudi Arabia currently has sufficient capacity
to fill the void in the event of a shale bust.
The bidders therefore have to evaluate the choice
of forging ahead with the deals given the uncertain/unclear future about where
oil price will be. For any of the loans at a five year tenor (which is the
maximum I reckon most Nigerian banks would lend), an extension to 7 or 10 years
with sculpted principal repayments might allow the buyer repay the facility.
One would have to double check if there is any Nigerian bank with funding for
up to 7-years, especially dollar funding. Worst case scenarios, many of these
new local entrants would default on the acquisition facility and leave the
exposed banks in not so great financial conditions, imagine a bank with $300m
exposure having to write off 50% or $150m or N30bn. With no intentions of
pre-empting the banks, there is/are of course many ways of avoiding this
default and having to impair their loan book, is to simply renew these loans.
The banks with heavy exposure to the local players in the upstream sector are
First Bank, Fidelity; pause, you know what? This would be shorter if I listed
the banks with least exposure. Heritage, Unity, Enterprise, Mainstreet,
Keystone and Jaiz Bank are the banks with least or no exposure.
On a larger scale for oil cursed Dutch diseased
countries like Nigeria, Venezuela, et al, the days of oil at anything close to
$100 might very far into the future. Goldman Sachs forecasts it 3-. 6- and
12-month price of crude to be $42, $43 and $70. UBS estimates are in tandem
with IMF forecast of $56 towards the end of the year. We might not be seeing as
many trains and international airport remodeling in the future.’
...Gbemi Niyi (the hobbing post)
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