Taking Stock of the Oil Price Drop
By Nyonga Fofang on March 24, 2016
Low oil prices are squeezing African producers and the beneficial effects on the continent’s largest importer, South Africa, are difficult to measure. Private equity investors could have much to gain, and exporters should take this opportunity to introduce transformative economic policies.
There was a time when it seemed everyone wanted in on the oil game – there wasn’t enough of the black stuff to go around. Every other African nation was signing concession agreements so wildcatters and explorers could drill the continent’s underexplored regions.
The ubiquitous commodity has its appeal, illustrated by the swagger of moneyed young Arabs purchasing London real estate, Russian billionaires taking over football clubs and well connected, cash rich Angolans buying up chunks of the Portuguese stock market. We have seen the transformation of African nations endowed with hydrocarbons wealth. Equatorial Guinea, for example, is a different country to a decade ago, sporting impressive infrastructure.
And then the music stopped. Oil prices dropped from $107 in June 2014 to below $28 per barrel of Brent crude in February 2015, the biggest price reduction in 12 years. The price per barrel is now hovering around $40.
Back Down to Earth
The crashing oil price has had a massive impact on many African oil producers. This extends to an array of oil services companies, suppliers and the builders of related infrastructure. In these challenging economic conditions and with reduced access to traditional funding, the risk of contractor and counterparty default increases.
Oil exports account for about 40-50 percent of GDP for countries like Gabon, Angola and the Republic of the Congo, and more than 80 percent for Equatorial Guinea and Nigeria. On a national level the effect is, and will continue to be, a significant reduction in the number of investment projects, difficulty in servicing public and private debt, and a pressing need to adjust public expenditure spending across the board. On the plus side, net importers of oil like South Africa and Ethiopia should gain from cheap oil.
Benefits for Private Equity
As the oil price fell, South Africa was in the early stages of an economic downturn due to the weak commodities export market (an effect of the slow-down in China); a year-long period of labor strikes, particularly in the mining sector; drought; and financial jitters following the change of three finance ministers in a single week. It is therefore tough to determine precisely the impact of low oil prices on the South African economy. Nevertheless, for South African private equity firms with an energy focus, we believe that a period of lower oil prices is definitely an opportunity to acquire and develop assets with attractive valuations.
Private equity funds are playing a growing role in funding mature oil production projects and high-impact exploration, and we anticipate significant activity in private equity investments across the continent as energy producers look to sell assets and bridge cash shortfalls. South Africa’s Public Investment Corporation, already an active investor in the sector through a $270-million investment in West Africa-focused oil group Camac Energy, will be one of those looking to capitalize on opportunities in this market downturn.
Overall, this period of low oil prices will call for transformative economic policies that would lessen dependence on the black gold for producing countries. A prolonged stretch of low oil prices may cause African governments to review the basis on which measures like cost recovery are established. In the short term, if lower prices delay payment to the state, this may lead to governments looking to amend pricing structures or the entire basis of the granting of rights in order to achieve a higher return. This has certainly been the case in countries such as Russia, which has in the past abandoned the use of production sharing contracts in favor of risk services agreements that deliver a higher return to the state. Some countries, such as Equatorial Guinea, have been using this period to conduct a proactive review of contracts and management of projects.
We don’t believe anyone can predict how long the current period of low prices will last. Oil importers and private equity investors can benefit from the current situation, and this can be an opportunity for producers to take stock of their energy sector organization and investment agreements. But investment decisions relating to projects where production is due to come online years later, and will be ongoing for decades, clearly should not be taken on the basis of current prices.