The next focus for African oil producers

The ubiquitous influence of these disruptions has been felt with pain by oil-dependent African economies, which today require new investments. Ultimately, investments will resume for companies to maintain their reserves replacement ratio above 100%. However, the break-even price of future projects will be closely monitored by investors.

Oil-dependent African countries should position themselves as the preferred area for future investments. We recommend that these countries focus on three key areas to win the upcoming battle for new investments: (1) talented and committed human capital; (2) innovative and flexible petroleum contracts; (3) vibrant local service companies offering services at international standards.

RAPID DECREASE IN OIL PRICE WAS UNFORESEEN

The collapse of the oil price from historical highs in mid-2014 left several oil-dependent economies on the African continent with a heavy hangover that is still hard to shake off. From June 2014 to January 2015, the oil price retracted by nearly 60%. With less cash on hand, several oil-exporting countries were forced to either curtail or put a stop to injecting vital investments into social programs. Borrowing on the international market has also been actively pursued to minimize budget deficits.

When oil prices started to decline during the third quarter of 2014, OPEC mostly saw the US shale oil producers as a nuisance that needed to be driven out of the market. In an attempt to drive US shale oil producers out of business, OPEC pumped even more oil, despite evidence of a glut in the market.

OPEC'S BATTLE WITH US SHALE PRODUCERS

According to data published by the International Energy Agency (IEA) the OPEC average crude oil supply for Q2 2014 was 30.27 million bbl/day. About two years later, the OPEC average crude oil supply for Q3 2016 was 32.77 million bbl/day, about an 8% increase. It was clear that OPEC was seeking to maintain the oil price down to force higher-cost oil producers like US shale oil out of business. Unfortunately, this brutal battle for market share between OPEC and US shale oil producers did little to rebalance the oversupplied oil market, and instead exacerbated the glut problem, which was further complicated by the slowing Chinese economy.

Some shale oil producers in the US did go out of business, but the continued low oil prices were also painful to oil dependent economies due to significant revenues shortfall. In contrast, shale oil producers were becoming more efficient and resilient by pushing their break-even price lower. It was clear that the strategy to retain significant market share by driving shale oil producers out of business was not working as planned. By mid-2016 OPEC knew it had to abandon this strategy.

NEW STRATEGY NEEDED

Then came the new strategy to rebalance the oil market by reducing production. In late 2016, OPEC countries led by Saudi Arabia and non-OPEC countries led by Russia were able to hammer an agreement to reduce oil supply. OPEC countries agreed to remove 1.2 million bbl/day of oil from the market whereas non-OPEC countries agreed to remove 0.6 million bbl/day. In such agreements, compliance is always "the devil in the details." In January 2017 the agreement came into effect for a six-month period, and at mid-year 2017 compliance has surprisingly been successful.

IS OPEC'S NEW STRATEGY WORKING?

On May 25 2017, OPEC and non-OPEC countries met in Vienna to agree on an extension to their production cut for another nine months until March 2018. During the closing press conference, US shale oil producers were no longer viewed as "the bad competitor" that needed to be driven out of the market as it was now considered big enough to accommodate US shale oil production. The war for market share was over for now. Furthermore, in its March 2017 Oil Market Report, the IEA appeared optimistic about the glut in the oil market draining away. At least for now, the IEA has maintained its 2017 forecast for global oil demand growth at 1.3 million bbl/day. During the first quarter of 2017, International Oil Companies (IOC) reported record profits that was comparatively higher than the first quarter of 2016 given higher oil prices. With oil companies returning to a more profitable state, a hope for resumed investments has started to shine on oil dependent economies on the African continent that have been dancing under the rain since mid-2014.

SOME WORDS OF CAUTION

Going forward there remain unanswered questions about the next actions for OPEC. One obvious question is: what if the market glut is still around after the nine-month extension? The appetite for extending the production cut beyond March 2018 might be waning. On this point, we should have an early indication when OPEC meets again this year for its 173rd meeting on November 30 in Vienna.

Assuming that we have a scenario where the oil market glut is persistent after nine months of production cut extension and OPEC abandons its current rebalancing strategy, the oil price could tumble to below $40 per barrel very rapidly even if Saudi Arabia seems determined to prevent this scenario given its upcoming Aramco IPO. This doom-and-gloom scenario for 2018 hinges on two key actors of the supply-demand equation: the US shale oil producers as well as the Chinese and Indian demand.

US shale oil production remains very dynamic and is still moving toward record levels in 2017. This could mean trouble for the rebalancing strategy that OPEC is currently following. Additionally, a slowdown in demand from Asia two biggest crude oil importers (China and India) would contribute to nullifying the production cut being pursued by OPEC and non-OPEC countries. In this mix of uncertainties, we can also add the return of oil production from big deep water projects where companies are increasing their production efficiencies, hence, lowering the break-even price of deep water projects. Despite small signs that the oil market might be rebalancing the road ahead for companies in the industry and oil dependent economies is still full of pitfalls.

SHAPING THE FUTURE

The use of renewables has made a steady progress and will continue to do so. However, we believe that oil will continue to play a significant role in the world economy for years to come, and it will continue to be a key contributor to the GDP of oil-dependent African economies. The prolonged low oil prices have had a negative impact on investments which is a driving factor for companies to maintain their reserves replacement ratio above 100%. Therefore, investments into new production will ultimately resume. Nevertheless, investors will likely stay away from high-cost projects with a long payback period.

For oil-dependent African economies, it will no longer be enough to react to unanticipated events as it did in the past. The upcoming battle will be a battle for attracting investments, and it will be between two groups of producers: high cost versus low cost. To win this battle, countries will need to move from wait and react to shape their future.

We believe the energy sector is facing the type of disruption never seen before. We are undergoing disruptions in several spheres at the same time. To name a few, we are seeing a technological disruption with the breakthrough in shale oil production, data analytics, artificial intelligence and the Internet of Things; an environmental disruption with a renewed awareness for climate change and an efficient use of energy; a demographic disruption with changes in consumer behavior; a geopolitical disruption with tectonic changes in the political landscape and the birth of new alliances from North America to Europe, from the Middle East to Asia and from Africa to South America. Faced with these unprecedented disruptive forces the oil dependent African economies have no choice but to actively participate in the fundamental reinvention of the energy sector.

For African oil producers to win the investment battle, there are three areas requiring continuous attention, including:

• HUMAN CAPITAL - Most companies understand that finding, developing, and retaining talented employees is very difficult. Talented and committed people in a country are one of the key enablers for attracting investments. No credible investors would be willing to put money into an environment where recurring industrial actions are the norm. Take an example of five companies with the same type of assets to operate, it will always be the case that there will be a difference in performance across the board that is likely to be driven by the people they employ. People are the key contributors to the success of a business. We therefore believe that by continuously producing world class engineers, geologists (and many other disciplines) with the proper work ethics, the cost of doing business will also be positively impacted.

• PETROLEUM CONTRACTS - Petroleum contracts cannot be a zero-sum game. What is positive for the State should also be in the best interest of the investor. New innovative petroleum contracts are needed to stimulate investments. Great flexibility should be built into the contracts such that the signing parties are able to adapt them based on the prevailing economic context. These contracts should be underpinned by a good legal system which is independent and protect wealth and investment.

The petroleum laws or hydrocarbon codes passed by parliament should be designed to attract investments and protect the public interests. Therefore, the competing needs must be adequately balanced. With flexibility being key in a dynamic and changing investment environment, petroleum laws should not be written as if they were a Production Sharing Contract. Likewise, countries should refrain from incorporating detailed fiscal terms into petroleum laws as any amendment will require the approval of parliament.

• LOCAL CONTENT - A diverse and competitive presence of local companies in the entire chain to support the production of oil will contribute to bringing the cost of doing business down. This is where the State can greatly shape its future by creating the necessary conditions to enable the development of capabilities for local companies according to international standards. Sourcing companies outside the country to carry out basic field operations jobs can add up to the cost of doing business. In the battle for attracting investments, the ideal situation would be for the local service companies to provide the same quality of services as international contractors at a lower cost.

CLOSING WORDS

US shale oil producers have captured the highlights since 2014 and are one of the disruptive forces in the industry today by forcing conventional oil producers to re-examine their business model. What their breakthrough indicates is that investors will return if they are presented with projects that have a short payback period and a break-even price that can be driven down.

The lesson for oil-dependent African economies is to fundamentally reshape their business environment by creating an environment that lowers the payback period and break-even price of projects.

ABOUT THE AUTHOR

Serge Toulekima is an energy consultant with 25 years of experience. He is based in Perth, Australia, and is a member of the Australian Institute of Company Directors. He has working experience in Africa, Europe, Asia, and Australia, and is a graduate of Texas A&M University.