For many, 2020 will definitely be a year to remember…unfortunately not in a fond manner.
In the first quarter of the year we have seen free falling crude oil prices, stranded crude cargoes of some of the most sought after crude grades, negative prices for crude futures, global economic shut down; factories, schools, businesses, refineries are cutting production of gasoline, diesel and jet fuel and there simply is no telling where the bottom of the hole is.
Granted, the energy industry is no stranger to price crashes usually due to geopolitical instability and price wars between oil producing countries as was the case with the recent Russia & Saudi Arabia dynamic wherein Saudi Arabia and Russia were increasing oil production to regain market share from American oil companies that increased production and exports in recent years.
Now add a novel highly infectious virus that wipes away nearly of 30% of world energy demand and has literally brought the world to a standstill and there you have the makings of a perfect storm. The world is awash with too much crude at a time when global lockdowns on driving, flying and industrial activity have all but eliminated the need for crude oil.
According to the International Energy Agency, as much as 20 million barrels a day, of oil demand may be lost as the global economy grinds to a near halt. To put this figure in context, that is approximately equivalent to eliminating the entire crude oil consumption of the United States, the world's biggest oil consuming country.
On the 9th of April 2020, the OPEC+ made the announcement of a 9.7m barrels per day cut which is unprecedented in OPEC history. This only stirred a further nosedive in crude prices because although significant, the cut falls far short of what is needed to bring oil production in line with demand and the supply and demand imbalance is being amplified by a lack of storage to enable stockpiling (which in itself is flawed by its inevitably finite nature).
Challenges faced by Nigerian Energy sector
Spot price for Brent Crude is currently hovering around $20 per barrel, even at this; the fall in demand has left close to 20 million barrels of crude oil floating without any destination. This has forced the county to apply discounts across all its crude grades ranging from $1.50 to $7.50 per barrel meaning an effective price of as low as $12 per barrel.
Unlike International Oil Companies IOCs operating in the country, whose average cost of producing is about $22 a barrel, Independents need around $35 to $40 a barrel to break even. As a result, oil and gas companies are aggressively cutting costs starting with big ticket capex items and eventually human capital whether through layoffs, paycuts or a combination. Besides the direct challenges that this gap between the selling price and cost of production poses, there are other far reaching effects such as:
Possibility of a banking sector crisis – Nigeria's independents are responsible for about 20% of the Nigeria's average daily production, yet they account for approximately 90% of the $8 billion debts owed by oil producing companies in Nigeria and most this is owed to local banks. Many local banks were just beginning to recover from the dire effects of the 2016 price crash which saw the end of some banks and necessitated CBN intervention to limit banks' exposure to the sector. With current prices, many independents will find it difficult to cover their debt obligations thus significantly increasing the risk of default if loans are not restructured. A full blown banking sector crisis may be looming if this price trend persists
Inflation – Nigeria depends on the proceeds of its crude sales for approximately 90% of its foreign exchange earnings, the price collapse means a drastic drop in fx earnings. This in turn has caused a corresponding spike in the naira to dollar exchange rate and with so much uncertainty around the crude oil prices the market is still highly volatile. Many consumer goods available locally are either directly imported or are in some way dollar dependent meaning a rise in prices of goods. The National Bureau of Statics reported March 2020 inflation rate as 12.26%, from 11.98% in January. The combination of inflation and rising unemployment could lead to a deep recession.
Slowdown of Economic & Infrastructure development – The drop in crude oil revenue for the nation (with little diversified income) would leave a huge funding gap for proposed government projects which was to be financed with an initial budget price of $57 to the barrel.
Setback of Local content drive – once operators look to slash budgets, they start by cutting capital projects being offered by the service companies. The local service companies risk folding up since they do not have the same kind of margins and ability to absorb price cuts like their international counterparts mainly because they rely on the international service companies for many of their projects and don't own most of their equipment.
If the Covid 19 worldwide lock down persists thereby keeping the downward pressure on demand, how long can we go on like this? Being that the forces of demand and supply control market prices to the largest extent, isn't prudent to shut in wells and allow demand grow? There are many problems with that logical but simplistic view such as
The myriad of problems this poses is not without its solutions but requires critical thinking and high level coordination amongst producing countries. It cannot be a Nigeria only solution for it to have the desired effect. However if we do get to no storage/no offtaker territory, we may be left with no choice.
Survival is the name of the game
As I previously said, the industry is no stranger to price volatility, within the last decade (2010-2019) oil price averaged $80 with a low of $34 and high of $125. The crude oil prices would surely rebound but when and to what levels would be anybody's best guess. As Niels Bohr's said “Prediction is very difficult, especially if it's about the future” so rather than obsessing about a future we cannot predict it is important to first “survive the crisis” and adapt to the current times.
Aggressively cut capex costs – any cost that is not necessary to sustain production or to ensure the health and safety of lives, environment and property should not be on the agenda and contracts for even the essential service should be renegotiated to reflect current realties. To this effect, NNPC has mandated producers “to take immediate steps to reduce our operating costs, budgets and re-negotiate our contracts downward by 40% in the face of this adverse situation.”
Technology – Technology has enabled us to rethink the ways in which we perform certain activities during this crisis, we must continually explore the use of technology to drive down operational costs and augment human capital to increase efficiency
Human capital - Leverage your resources to work across functional silos and multitask. Ensure that you encourage innovation and creativity in staff and find effect ways to monitor staff productivity while working from home.
Government Intervention – Being that energy supply is considered a matter of national interest, measures should be implemented at a national level to provide some relief to the local oil and gas industry from the adverse impact of COVID-19.
Are there any opportunities to be had?
Crises are often the perfect kindling for igniting change and no matter how dire it may seem. The struggle to survive amidst the crisis would bring about many M&A opportunities that if done right could lead to the emergence of stronger more robust companies that are able to operate more efficiently and effectively.
Furthermore, there would be opportunities of low cost asset acquisitions for those with access to financing/cash because of the current low valuation price which would especially benefit niche operators that specialize in low cost and efficient operations
It is important that we do not miss the underlying messages amidst the crisis and just return to “business as usual” Post covid 19. Some key takeaways would be:
Sustain low costs and efficient operations - Build a resilient portfolio that will be profitable at $20 and hedge a portion of your production when prices rebound as insurance against the next inevitable price slump.
Collaboration between Independent Operators – Since many Independents do not have the asset base or capital to enjoy the sort of economies of scale IOCs experience, collaboration would be needed. A consolidation of independent players pooling together resources and synchronizing capex programs to significantly drive down the capex.
Local service companies – With the support of the government, the local services companies need to come to together to expand their services and drive costs down. It is important that they reduce their dependency on international service companies and indigenize some of their supplies/services thereby lowering costs and reducing the forex pressure
Security challenges – security is major cost driver in every company's operating cost. Government should drive a single solution (as opposed to pockets of solutions from various operators) to reduce disturbances to operations from communities and help drive down both operating and financing costs. Some independents have employed methods that work and keep them close to “free of community challenges”. Government could look into upscaling an already existing tested model for the industry
Full Energy Value Chain - As a Nation, the immediate key is not more storage for stockpiling. First, we need to domesticate our crude use it to power the country and make that leap from an oil exporting country to the full value chain whereby we have a robust domestic market for our crude sales and supply of petroleum products
The first and only meaningful battle is against Covid 19, as an industry, we must come together and refocus our CSR efforts and health & safety policies to fight this battle and return to the vibrant industry we so sorely miss.
In the meantime while we're all staying at home and staying safe, it is important to remember; physical distancing not emotional distancing! take care of your mental health and physical health and if you need to reach out to someone, please do. We are all in this together and we would get through it together.
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