Low Oil Price: Opportunities In The Midst Of Challenges
By Pita Ochai
‘You never want a serious crisis to go to waste.” Barack Obama’s former chief of staff Rahm Emanuel used this familiar aphorism when discussing the 1973 oil shock, and it applies again now. But today’s crisis is the reverse – plunging rather than soaring prices. And of course what is a crisis for some is a mild inconvenience to others and an opportunity for still others.
The fall in the price of crude oil in the international market is sending economic and political shocks around the world. The hardest hits are countries whose economies depend largely on oil for appreciable percentage of their foreign exchange earnings. According to statistics, crude oil accounts for about 95 percent of Nigeria’s foreign exchange receipts.
The reality of possible crippling budget shortfalls also stares many oil exporting countries in the face as the priced commodity has hit its lowest price level in four years. The prices of crude oil have now fallen by more than seventy per cent since June 2015, when the commodity was being sold for $110 per barrel to less than $30 per barrel. Analysts have blamed weak global demand and booming U.S shale production as reason behind the price plunge and with the Organisation of Petroleum Exporting Countries (OPEC) reluctant about cutting output. Having carefully studied the market situation, the World Bank has predicted that the international crude prices may go as low as $20 per barrel.
The impact of the falling oil price has been seen in the dwindling oil bench mark for the national budget of Nigeria. In 2014, the budget was based on 78 dollars per barrel, in 2015 it was lowered by about 17 percent 65 dollars per barrel, but the 2016 budget seems to be the worst hit with a drop of 41.5 percent which is 38 dollars per barrel. While the sustained low oil price is having its toll on government revenue, oil companies are not also spared. Most companies have reacted by reducing cost through sack of workers, and reduced investment as there are less fund do that.
According to Raoul Restucci, Managing Director of majority state-owned Petroleum Development Oman (PDO), governments that are dependent on high oil prices to balance budgets will generally be concerned over the source and distribution of funds and emerging fiscal deficits, while executives of exploration and production companies will increase their efforts to enhance and drive business efficiency.
However to Restucci, there is a silver lining in falling prices. “Operators tend to revert to more rigorous activity-based pricing and escalate efforts towards contract optimisation and efficiency. The decline compels the industry to reassess the incremental value generated across every facet of expenditures, and often to reinvent itself where returns are inadequate. This helps the company become more robust, sustainable and efficient,” he said.
According to Restucci, many opportunities can emerge from the current oil prices that simply reaffirm the need to get the basics right. Leveraging operator and contractor resources, rebalancing the apportionment of risks and aligning procurement efforts are some of the practices that will, no doubt, be implemented more effectively across the industry to generate savings and sustain profitability and investment return goals at lower price levels.
Osaze Benson, an energy expert, told Orient Energy Review that the global drop in oil prices has analysts mulling over the shrinking profitability of the oil industry. But it is not all doom and gloom. On the contrary, companies may be in a stronger position today to negotiate better deals with host governments, compared with when prices were high. “Oil prices are the most obvious drivers of change in the relationship between the two key players: host governments—the owners of resources; and companies—the holders of capital and technology. The price level significantly determines the degree of bargaining power each party has at the negotiating table.
Typically, when the oil price is high, the government has the upper hand; when the price moves in the opposite direction, the pendulum swings in favour of the companies,” he said. Adding that even before the oil price started to weaken, some governments introduced drastic changes to improve their investment outlook, such moves further toughen competition between countries for international capital. It is, however, a question of time before the pendulum swings again.
Experience shows that periods of high oil prices are not always good news for the industry. On the contrary; they typically attract higher taxes, contract renegotiations, tougher regulations and, in extreme cases, expropriation and nationalization as host governments demand a bigger share of the additional returns.
These changes are seldom implemented easily or peacefully, and often result in lengthy litigation. As shown by London-based think tank Chatham House, the higher incidence of arbitrations in the oil sector correlates strongly with the commodity price boom. A contract signed when oil prices were $30/bl may well be viewed as simply too generous to the industry at $100/bl.
The period between 2002 and 2008 is a good illustration. Over that period, oil prices were rising steadily and more than 30 countries revised their petroleum taxation systems to increase their share of profits. From Angola to Argentina, China, Ecuador, India, Kazakhstasn, Libya, Nigeria, and the United States (Alaska), governments increased the tax rates oil companies pay.
Today’s low oil prices have pushed some governments to go in the opposite direction. This is most notable in countries which have been struggling to increase production and attract investment. Low oil prices will only exacerbate an already dire situation and therefore prompt anxious governments to implement drastic measures to stop conditions from worsening further.
For instance, energy giant BP and its oil and gas partner, RWE Dea, recently made headlines after signing a historic deal with the Egyptian government. The contract has been described by some critics as the “great Egyptian gas giveaway.” While such a statement is surely an exaggeration, it indicates the Egyptian authorities’ willingness to try different means, even completely new schemes, to improve the country’s challenging investment outlook. The agreement shifts away from a production-sharing model—long used by Egypt whereby companies are paid a share of production as compensation for their efforts—to a concessionary system where the companies own all the production and pay taxes in return.
The Managing Director, Total Exploration and Production Nigeria Limited, Mr. Nicholas Terraz has said the oil price fall is responsible for the challenging economic environment in Nigeria, and noted that the harsh environment required oil companies to adapt and quickly take actions, while identifying three critical factors for sustainability of the petroleum industry.
Terraz, who spoke at the recently-concluded 20th Offshore West Africa Conference (OWA), in Lagos, elaborated on the three critical factors that will be key for future development in the industry. He noted that safety, irrespective of all issues, cost efficiency in company operations and adequate petroleum laws and regulations which provide a robust framework that is conducive to investment and flexible enough for the varied economic climates linked to the price of oil, were all absolutely essential.
Terrez, further hinted that, “If we are able to achieve these conditions and put in place laws that create a win-win situation for all stakeholders, our countries would have laid a solid foundation for a sustainable future.” “This will also stabilise investors’ confidence, ensures attractiveness and respect of the contractual and fiscal terms, cost efficiency is critical in the current context. Irrespective of all these issues, high safety standards must not be compromised” he added.
In response to the decision by the Organisation of Petroleum Exporting Countries, (OPEC) not to cut production, oil prices plummeted. Prices may fall further, or may stage a modest rebound, but it seems clear that expectations of a new floor of $100 per barrel were misplaced. So what should producers, governments and consumers do in preparation for an extended period of weak prices?
Olisemeka Obeche, an energy economist said: Firstly, they should not think of current prices as “low”. Since the birth of the modern petroleum industry, the inflation-adjusted oil price has averaged above $70 for just 16 of 153 years. Prices in a range of $60 to $80 would be enough to keep oil competitive as energy source and industry profitability still strong. So if you are a government official, this fall should not come as a surprise. The wiser states have already been trimming their budgets; for others, the time of consequences is approaching. Cutting wasteful subsidies now makes even more sense – the required hike to reach market prices is less.
“If you are an executive in an oil company, remember that the industry has overreacted to such boom-and-bust cycles so often before – overspending during the early 1980s in expectation of relentlessly rising prices, gutting research and the workforce in the 1990s, then suffering for it from rising costs and skills shortages in the 2000s, before repeating the mistake during the financial crisis. Is it too much to hope for that this time may be different? Of course oil companies will seek to halt unprofitable projects and squeeze suppliers,” he said.
Obeche said this should also be an opportunity to invest in technology and in building a younger and better-skilled workforce. For the bolder chief executives, this is a chance to make acquisitions. The supermajor oil companies may seek to fix their problems by delivering growth; the smaller independents may consolidate to build the scale to compete.
The low oil price also creates opportunity in the downstream sector in some countries like Nigeria. For decades, the downstream sector has always sat in stark contrast to what had always been a thriving upstream oil and gas industry in the country. The downstream sector was very much the sick child of the Nigerian oil and gas industry, defined and plagued by chronic fuel scarcity. During such times of scarcity, the petrol stations across the country would be littered with never ending queues of cars while jerry-can carrying touts held court in the thriving black market, the price of petrol often selling at five times the going rate.
A large chunk of energy policy in Nigeria has always focused on the upstream sector, that may be with good reason – the breadwinner of the family with energy sales accounting for up to 80 percent of the Nigerian government’s revenue and 90 percent of the country’s export. In the first quarter of 2014 alone (obviously before the oil price plummetted), Nigeria realized N2.432 trillion in oil revenue compared to N299.2 billion realized from revenues from non-oil sector sources. This has meant that the current low oil prices has hit Nigeria hard because the government’s income is not diversified.
Between June 2014 and January 2015, oil prices fell by nearly 50 percent, and the oil price has remained low since then despite one or two upticks. Oil exporters are said to be receiving about 54 percent less than what they received in 2013.
The Managing Director, Chevron Nigeria Limited, Clay Neff said Nigeria had the opportunity to improve its competitive position in the global oil and gas industry.
He noted that in this current situation, the country should restore investors confidence by providing competition in the oil market, adding that the security of lives and properties, and control stability and speedy approval processes should also be institutionalised.
The Chevron chief said the country should address its Joint Venture (JV) funding challenges and pay the arrears, adding that Nigeria had an attractive resource base.
While the upstream has been hit very hard by the current oil price, the downstream in a lot of countries, has enjoyed a boost in revenue. The low oil price environment has meant that the cost of feedstock has also fallen materially. Could this be the blessing in disguise?
According to Idahosa Andrew, an independent fuel marketer, the root cause of the Nigerian downstream sector’s travails can be traced back to high crude oil prices (and the weak Naira). This made it more attractive to export crude for foreign exchange rather than supply the domestic market.
Further, high crude prices meant a higher cost of feedstock (which wasn’t even readily available because most, if not all of the crude was exported). This invariably meant that it was easier to import refined petroleum product than to refine the crude in Nigeria. Let’s not forget the eye watering amount of government subsidies made available to petroleum marketers for the import of refined product. With such a huge pay day available to importers of refined product, why go through the hassle of refining? As a result, Nigeria’s refineries were brought to a grinding halt, operating far below capacity if not dormant for extended periods of time due to prolonged states of disrepair.
Now with the decline in government revenue as a result of the plunge in oil prices, it was difficult for the government to pay subsidies due to oil marketers. The month long fuel scarcity in May 2015 was as a result of non-payment of subsidies by the government. The new government finally announced the removal of the fuel subsidy and fixed the pump price at N86.5. The truth is that the new government can do without paying out huge fuel subsidies which is rumoured to be in the region of N2 billion per day.
Another point is that the outlook for Nigeria’s downstream sector has been bleak for quite some time, prompting major players such as Oando to exit the downstream business all together. Oando in July 2015 announced to its investors and journalists that it would be divesting its downstream business to focus on its upstream and midstream business. Without a doubt the uncertainty in the sector has led to this point.
At a time when there is so much gloom about the sustainability of economic recovery and about the putative limits to monetary policy, the fall in the price has come as manna from Heaven for all those Western economies, and Japan, that were hit badly by the successive oil shocks of the 1970s.
The logical effect of the fall in oil prices means that the cost of feedstock for refining has also fallen. The decline in feedstock should hopefully signal to the downstream market to invest more in refining, whether or not the subsidy regime will continue. Nigeria cannot afford to pay these subsidies if the price of oil persists at this level). Therefore, making imports less attractive to oil marketers. The market should realize that it is just as lucrative (perhaps even more so) to supply crude to the domestic market for refining instead of exporting.
Nigeria, with over 180 million people, cannot not be said to be lacking in demand for refined products. Nigeria consumed 305 000 bpd of petroleum in 2014. The fact that there is a problem of illegal refining is testament to the fact that there is a market there (albeit a black market. low oil prices should signal investors to invest in the infrastructure required to provide the much needed supply to meet the demand for refined product.