August 7, 2020

A comeback by new-look Big Oil

Diversification away from oil has been the agenda of every government in Nigeria for more than two decades. It has been a slow process and the COVID-19 pandemic has shown that the FGN is vulnerable to the same Achilles heel as previous administrations. Oil and gas still provide the greater part of both FGN revenue and merchandise export earnings. These realities have spawned an academic debate as to whether a crashing oil price leads to recession in Nigeria in the way night follows day.

According to one school of thought, the pandemic is a positive for the movement to halt/slow climate change and a negative for the fossil fuel industry. If the FGN bought whole-heartedly into this narrative, it would surely push far harder on diversification. The story in our view, however, is more complicated. Big Oil has been bruised by the pandemic, but it is not in retreat.

We are off the floor and have moved four months on from the point in early April when shippers of US WTI had to pay to be rid of their cargoes. The three giants in oil services (Baker Hughes, Halliburton and Schlumberger) have announced write-downs totaling US$45bn in the past 12 months. The majors have not been spared. Ahead of its results for Q2 2020, Royal Dutch Shell guided to a cut in the valuation of its assets of up to US$22bn. BP reported on 04 August, halved its dividend and confirmed write-downs of US$17.5bn. Within its objective of net zero emissions by 2050, it has now pledged to reduce its oil and gas production by 40 per cent in the coming decade.

These write-downs are exercises in kitchen-sinking in our view. Global demand for crude has picked up in recent weeks, led by China. Running at 100 million barrels per day (mbpd) in January, it hit a low of about 70mbpd in April. The Paris-based International Energy Agency currently forecasts 92mbpd this year and an average of 98mbpd in 2021.

The oil majors have become leaner, more selective in their spending on exploration and more aware of the thinking of institutional investors. The European operators are more aligned with ESG values than their US and state-owned Asian counterparts. As they all reposition themselves in COVID-19 life, frontier areas such as Kenya and Uganda are losers. Italy’s Eni, for example, is to focus on its existing production fields such as Angola (oil) and Egypt (gas).

The collapse in the crude price in March/April, engineered by Saudi and Russia, dealt a major blow that brought a sequence of write-downs and bankruptcies. There was a pick-up in production last month but, given the nature of the shale industry, the indicator to track is drilling numbers. More than 14,000 wells were drilled in the US in 2019 and the best estimate for this year is less than 7,000 wells.

For a marker for the industry’s broad direction, we should see whether Apache Corporation and Total decide to develop a very promising prospect in Suriname. Estimated reserves amount to 14 billion barrels of very light, high quality crude and 32 trillion cubic feet of natural gas. The production costs compare favourably with most jurisdictions and Exxon is already producing across the border in Guyana. Our hunch is that the operators will proceed.

Even if the FGN was to share our nuanced view of the industry in the years ahead, it should redouble its efforts at diversification: get Nigerians to meet their tax obligations, remove distorting tax exemptions, make surgical cuts in recurrent expenditure, invest in the infrastructure and overhaul domestic oil industry legislation.

 

Gregory Kronsten

Head Macroeconomic and Fixed Income Research, FBNQuest