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(By Oyeleke Banmeke)
For almost half of the last century, oil prices have oscillated between multiple boom and bust eras. Energy-hungry countries have cheered at low oil prices, while commodity-dependent economies have cringed at the mere thought of dwindling oil prices and its consequent dire socio-economic consequences. In Nigeria, we have been at the latter end of the spectrum too many times, and on each occasion, the diversification remedy rings out loud across the nation, from the layman on the street to the leader of Africa’s foremost oil producer. Half a century after its independence, Nigeria still relies on crude oil sales for about 80% of its revenues and 95% of its foreign exchange – no thanks to the volatile nature of oil prices, the march towards diversification are almost immediately jettisoned with any upswing in oil prices. pear
Several key factors contributed to the latest oil price decline which commenced in July 2014 – they can be simplified to the fundamentals of demand and supply, and geopolitical maneuvering. The global crude oil market is currently faced with aglut of crude oil (a drastic improvement in shale gas technology and the re-entry of Iran and possibly Libya into the supply market). Additional pressures from the economic slowdown in BRIC (Brazil, Russia, India and China) and an associated reduction in global oil demand have led to historic dip in oil prices. Also, the world’s largest producers of oil (USA, Russia and Saudi Arabia) are disinclined to cut back on supply due to pressures to finance their national budgets. In response, on November 27th 2014, the Organization of Petroleum Exporting Countries (OPEC) held its 166th annual general meeting in Vienna and made a historic decision to allow the global market determine the price of crude oil. This effectively meant that OPEC was abandoning its usual approach of protecting ‘price’ but choosing ‘market share’ protection. This ‘inaction’ from OPEC has also significantly contributed to the decline in crude prices to-date– the OPEC basket of crude has faced a downward trajectory and even hit lows of $29 in January 2016 from the highs of over $100 per barrel in mid-2014.
Notwithstanding the seemingly inauspicious times ahead for Nigeria, which loses significant revenues with every dollar fall in oil price, it clearly is an interesting time, laden with opportunity, for the country’s mono-product and import dependent economy. Although the country faces numerous challenges in the short-term, it can overcome these challenges with deft economic management. In reality, there are only three salient questions to be answered during a low oil price situation – (1) What should upstream oil and gas operators do to survive the low price landscape? (2) How do you strengthen the oil and gas industry? (3) How does the country shore up its revenue base and meet growing obligations? (The third question is best left to the economists with their diversification toga, which is by no means a short to medium term solution.)
Question 1: What should upstream oil and gas operators do to survive the low price landscape?
Globally, upstream oil and gas operators have responded to the dwindling crude prices through various cost-cutting measures, leading to production slow-downs, staff layoffs and delay or outright shelving of major investment projects. Conscious efforts need to be made to support cost reduction and improve / create a healthy cash flow position with a view to ultimately improving margins. It is noteworthy to mention that Nigeria has one of the highest oil production costs among other producing nations (production costs reflected in the chart below).
The operators will have to carefully reassess both planned and ongoing capital projects, eliminating non-value adding activities and generally revalidating the business case for these projects in light of current realities. Operators would also need to prioritize turnaround and preventative maintenance to increase equipment uptime and decrease costs of equipment repairs, service providers and contract labors. Across the industry, contractual agreements will be renegotiated (with core and non-core suppliers) with a view to driving costs down. The need to outsource non-core or select back-office functions will reverberate once again across the industry.
In this era of low oil prices, another cost reduction opportunity being explored by oil and gas operators is in the area of technology advancement, and investment in research & development to discover cost-effective operating techniques (e.g. standardization of exploration and production techniques). Digital will also play its role in this future energy landscape as data analytics, visualization tools and computational techniques continue to enable profitability in the energy business.
Question 2: How do you strengthen the Oil & Gas Industry?
This period offers a golden opportunity for Nigeriato embark on a much-needed comprehensive reform of its oil and gas sector – a critical sectorleft underdeveloped by successive administration. Five priority reforms are briefly discussed below;
- 1. Nigerian National Petroleum Corporation (NNPC) Restructuring: When NNPC sneezes, the entire nation catches a cold, unfortunately, this state-owned cash cow is plagued by a fever that could make it sneeze more often than not. As NNPC serves as the primary authority providing steer for Nigeria’s petroleum industry, curbing the internal excesses within the corporation is a critical requirement for industry-wide development. NNPC needs to be repositioned for operational efficiency, optimized returns and transparency and accountability. Also relevant is the proposed unbundling of the organization to create a new partially privatized and commercially focused National Oil Company (NOC). Brazil (Petrobras) and Malaysia (Petronas) have recorded success stories in creating commercially-focused and technically-competent NOCs.
- 2. Passage of the Petroleum Industry Bill: The PIB remains the single most important legislation that seeks to introduce transparency and accountability in the Nigerian petroleum industry as it proposes institutional restructuring, a new fiscal & policy framework and gas sector reforms.Still awaiting passage since the last administration, the current proposal is to re-present the PIB as a split bill – the anticipation is to ensure passage in tranches. The failure to ratify and promulgate the PIB has consistently wilted the flow of investments in the oil and gas sector. In the long term, such decline in investment will likely pose consequences such as loss of jobs, decline in replaceable reserves and further revenue decimation. Currently, Nigeria’s daily oil production rate is stalled at 2.1mmbbl/d but passing the PIB will attract the significant investments required for the industry to move closer to achieving the 4mmbbl/d production target by 2020. In recognition of these consequences, a push-through of the PIB is advised in order to curb the evident losses and unleash the positive multiplier effects in other sectors of the economy.
- 3. Local Content Development: Developing local capacity and bridging the technical / non-technical skills gaps in Nigeria’s oil and gas industry is a necessary development measure as it can yield economic benefits for the nation. Efforts must be geared to ensuring local players in the industry are well-positioned to play a more active role across the entire value chain (particularly the upstream sector). Bottlenecks such as funding constraints and technical skill gaps must be urgently addressed to ensure indigenous participation and contributions.The Government’s key priorities should be strengthening the local content requirements to safeguard the interests of local companies as well as investing further in building local capacity to ensure that greater revenue generated from the oil and gas industry is retained within the country.
- 4. Downstream Sector Deregulation: The recent fall in oil prices has served as a prompt to remove fuel subsidies, channeling Government expenditure to other aspects of socio-economic development. Furthermore, deregulation could lead to the creation of a vibrant and competitive downstream sector, ensuring investment flows in the downstream. The current policy of the administration is on ‘price modulation’ (subject to pump price reviews based on the international price of crude) and not deregulation – consequently, it will be interesting to see how the Government reacts when the price of crude significantly increases without any form of provision for fuel subsidies in the 2016 budget.
- 5. Gas Market Development: With an abundance of natural gas reserves, Nigeria is well-positioned for economic growth through gas sector development. To actualize the desired development in the gas market, policy reforms should be implemented to cater for commercial regulation of the gas market (including gas supply, pricing, infrastructure and transportation tariff).
The decline of crude oil prices not only shocked many industry analysts, but has also not yielded the expected effect on the global economic growth. It is assumed the price has bottomed out and the only way now is an upward trajectory – however, it is not yet eurekas oil prices have only just begun to recover and the current price is just slightly over the budgeted crude oil benchmark ($38 per barrel).It is unimaginable that oil prices will return to the mid-2014 highs of over $100 per barrel in the short term – according to the IEA, the world oil market would remain oversupplied for at least another year.
The short to medium term priority for the Government should be strengthening industry-wide transparency, accountability and institutions. Over the same time horizon, the oil and gas operators should continue to focus on measures to survive the current low oil prices in a sustainable manner as there is a limit to how far they (oil operators) can continue to cut costs (in order to improve margins and cash flow position) without ultimately adversely affecting its production and reserves base.
Oyeleke Banmeke, Senior Manager Resources Group, Accenture Nigeria, writes from Lagos
