OIL BUSINESS AND BANK LOANS
As oil prices hit rock
bottom at the international market, Demola Ojo takes a look indigenous
operators’ massive exposure to the financial sector and concludes that
dire times lay ahead if
urgent steps are not taken quickly to save the
sector from imminent collapse
The COVID-19 outbreak has profound
implications for many sectors, and the oil and gas industry is no
exception. In fact, the prevailing mood in the oil and gas industry is
one of anxiety and concern.
Even before the pandemic disrupted
financial markets, upended supply chains, and crushed consumer demand
across the global economy, oil-industry leaders were not optimistic
about 2020. The industry was already on high alert, and executives
expressed pessimism across all geographies and price points.
But fast-forward a few months, and the
oil and gas outlook has gotten dramatically and suddenly bleaker with
the continuous shutdown of key economic centres in Europe, America, and
South-east Asia on the outbreak of the novel Coronavirus.
Indeed, the industry is now on red alert
as demand has plummeted and loans obligations of players in the
industry remained unpaid.
This unforeseeable humanitarian and
financial crises have rendered previously planned strategies for 2020
redundant, leaving oil and gas businesses exposed or rudderless as their
leaders confront a disorienting future and vulnerable workers worried.
For many in the oil and gas industry,
the glass is half empty. The mood among respondents to our executive
survey is sober across geographies and price points, and the pockets of
optimism seen last year have steadily evaporated.
The survey of the industry indicates
that players may have to shut down if the global lockdown persists and
government does nothing to help operators.
To this end there is need for the
industry to be rewired, especially as it is the mainstay of the Nigerian
economy as the major revenue earner for government. In other words,
there should be a conscious policy intervention, especially on the issue
of debt overhang arising from the global energy crisis and its impact
on indigenous Nigerian upstream oil and gas players.
Covid-19 Flashpoint for Disruptions in Oil Market
COVID-19 could spur the biggest economic
contraction since World War II, hitting every sector from finance to
manufacturing and to hospitality. Yet energy, because of its supply and
demand sensitive nature, is particularly vulnerable.
The average market capitalisation of oil
and gas companies on the Nigerian Stock Exchange dropped significantly
before the outbreak of COVID-19 and has witnessed much steeper decline
than that of the overall stock market in the first quarter of 2020.
Particularly, the bane of the downstream
section of the local industry has often been linked to failure of the
fiscal authorities to come up with market-driven reforms such as the
implementation of Petroleum Industry Governance Bill (PIGB), removal of
subsidies on petroleum resources, revamp of local refineries and
adoption of flexible exchange rate system.
For the upstream segment, the general
crash in global economic growth has contained demand just as competition
among oil reliant-economies has flooded the market with products
leading to falling prices.
Initially, when prices started to plunge
at the end of January 2020, EIA had forecast that Brent crude oil
prices (the equivalent of Nigeria’s Bonny Light) would average
$43/barrel in 2020, down from an average of $64/barrel in 2019. The
forecast had also gone on to predict that oil will average $37/barrel
during the second quarter and then rise to $42/barrel during the second
half of the year, but all that projections have fallen flat as Brent
crude, the equivalent of Nigeria’s Bonny Light, currently trades at $12
per barrel, well below industry expectations, forecast, planning and
production costs
Beyond this, there is also a horde of
unsold inventory given the shutdown of most global economies on the
heels of the COVID-19 pandemic. Given this scenario, liquidity of most
Indigenous oil concerns has already been severe as a result of the loss
of material cash flow due to the global energy crisis occasioned by the
coronavirus pandemic.
This disruption has a dire consequence
for the local players in Nigeria’s upstream and downstream oil and gas
industry, who are fighting to maintain operations and margins
Loan Exposure to Nigerian Banks
Nigeria’s banking sector is the second
largest in sub-Saharan Africa behind South Africa. Total assets were
worth over N40 trillion in September 2019. But with crash in oil prices
in the wake of COVID-19, small and mid-sized Nigerian banks may be
constrained to rebuild capital levels going forward as it would be
difficult for businesses to repay loans, including oil companies.
Presently, many indigenous oil and gas
producers in Nigeria are struggling to stay afloat, as prices of their
products have fallen below production costs. This is just as they are
failing to meet their debt obligations to deposit money banks. The
result is that their portion of non-performing loans in the banking
industry is threatening the soundness of the nation’s banking sector.
The oil and gas sector represented about
30 per cent of Nigerian banks’ gross loans at end-3Q19. Accordingly,
loan quality is highly correlated to oil prices, as seen during previous
oil price shocks in 2008-2009 and 2015-2016. Though impaired loans have
decreased since 2017 due to rising oil prices as well as recoveries and
write-offs, the current shock could lead to a significant increase. Any
closures of oil fields due to a collapse in global oil demand would
exacerbate the impact.
The biggest problem local upstream
operators face to today is the apparent mismatch between their loan
exposure and the significantly dwindled revenues due to the Coronavirus
pandemic. With sub $20 per barrel prices for crude, these companies are
in dire straits. Average cost of production per barrel in Nigeria is
about $30 per barrel due largely to high cost of operation and security
related expenses that are peculiar to the Nigerian environment. The
burden of managing community restiveness has been practically left to
these operators alone.
The Trans Forcados Pipelines and the
Nembe Creek Trunkline through which most of these operators evacuate
their crude are often the target of militant attacks leading to
incessant force majeures. However, the loan agreements with these
indigenous players were structured in a manner that does not provide for
force majeure. Interests on these loans continue to mount regardless of
the reality on ground. A chief executive of one of the indigenous
companies who spoke on the condition of anonymity said banks needed to
be more sensitive to the plight of their customers. He maintained that
moratorium on principal alone would not be sufficient as the operators
simply cannot pay the interests for now.
He called out the banks for striving to
make profit in an economy where the companies they are funding are going
under. According to him “banks need to put their skin in the game and
realise that this is a symbiotic business. All stakeholders must partake
in the shared losses at this time so that when the rebound occurs, we
equally share in it.’’
As at the beginning of the year,
tier-one banks were estimated to have had an oil exposure of over N4.33
trillion, meaning banks could be forced to make trillions in loan loss
provisions and impairments as bonny light oil prices have fallen from
around $66 at the start of the year to as low $12 per barrel.
The impact of current situation would
lead to weaker earnings in 2020 if the oil loans, especially the
upstream oil loans are fully provided for. In other words, banks may
have to declare losses at the end of the year despite modest results
released in Q1.
Reflecting its expectation that banks
will face material pressures from the weaker operating environment in
the coming months, Fitch recently downgraded three Nigerian banks’
Long-Term Issuer Default Ratings (IDRs) to ‘B’ from ‘B+’ and placed all
10 Nigerian banks’ Viability Ratings and IDRs on Rating Watch Negative.
It explained that the resilience of banks’ asset quality, profitability
and capital during the economic downturn would influence, among other
considerations, how it resolves the Rating Watches.
Meanwhile, reports have it that
commercial banks are set to begin the recovery of N6.125 trillion
borrowed by oil firms to braze themselves amidst the sector’s
recapitalisation fears. The banks have reportedly issued correspondences
to oil firms, marginal filed operators and downstream operators, as
debts in the sector, according to a 2018 CBN financial stability report,
showed that N1.235 trillion had been added to the sector’s debt profile
since 2016 when it stood at N4.89 trillion.
“Banks are beginning to takeover
collateral tied to the loans,” says a management staff of one the
marginal field oil firms as banks followed up on the correspondence sent
to his firm.
Mitigating Inherent Risks to the Economy Upstream Oil Industry to Banks
The current demand and price crisis in
the oil and gas sector, which started in February 2020, has gone on for
almost three months now with a lot of upstream oil industry players
already defaulting. Consequently, since global demand is not expected to
increase significantly in the near term, crude oil prices will remain
low throughout this second quarter, putting Nigeria banks at risk to oil
companies’ exposure once again.
Most commentators on the topic say
mitigation efforts on the inherent risks to the economy should look at
what was done or not done during the 2015 – 2017 price crash since the
same scenario is playing out once more, noting that non-involvement of
government in the oil industry exposure of 2015 – 2017 had huge impact
on both the companies and the economy.
They canvassed that a moratorium on debt
repayments should be worked out between banks and oil-producing
companies in Nigeria to cushion the effects.
On the part of oil majors, they should
adopt leverage and hedging strategies against lower prices, which would
determine their chances of survival as well as the size of the hit to
their lenders.
The determining factor, according some
analysts, would be whether or not producers hedged when oil was above
$60 and that a number of more conservatively managed firms would be
dragged into restructuring discussions with their lenders if the current
level is maintained beyond a couple of months.
“Depending on how long this thing lasts,
high-cost producers could suffer. If it lasts for a long period, then
they will be in trouble because most of them need the oil price to reach
above $40 per barrel to break even,” one of them said.
They recommend that oil companies should
appeal to their lenders that the current operating environment is a
case of force majeure, which could buy them time.
They strongly advocate the involvement
of both fiscal and monetary authorities to mitigate and contain the
crisis in the oil sector.
They however, noted that that volatility could bring its own opportunities for those who have avoided excessive borrowing.
“The oil price crash creates openings
for cash-rich and under-leveraged players to pick up ‘quality producing
or near-producing assets at a significantly lower price’ than
previously.”
Policy Intervention to Stave-Off Collapse of Indigenous Upstream Players
The government cannot sit on the
sidelines and watch the banks and the oil operators wade through the
current turmoil in the oil market. The fiscal and monetary authorities
should evaluate their non-involvement in the 2015 – 2017 crisis and come
out with relevant policies to sustain the oil companies throughout this
coronavirus-induced price crash as well as stave off a recurrence in
the future.
Monetary Policy Option
The Central Bank of Nigeria (CBN)
through the Bankers Committee should work out a moratorium on debt
repayments by local oil-producing companies as long as the coronavirus
lockdown lasts. This would create a win-win position for both the banks
and the oil companies without adversely affecting their operations.
There should also be a restructuring plan for the companies to exit the
bad-loans overhang, thereby creating buffers for recovery as the global
economy gradually opens up.
While banks focus on negotiating with
local oil companies to restructure their loans in line with current
realities, it is expected that all banks will migrate a significant
portion of oil companies’ exposure due within the next 12 months from
stage 1 to stage 2. That should be based on the IFRS 9 requirement on
expected credit loss because the probability of default variable has
increased and the small companies would most likely default.
These should be codified into a guiding
policy by the CBN, which could include regulations on single obligor
limits for oil industry operators.
Fiscal Policy Option
The fiscal policy option should include
bail-outs or tax concessions to indigenous oil producers in order to aid
recovery and help advance the government’s push for local content and a
connection of the upstream oil sector with the local economy going
forward. The fiscal option should also include removal of subsidy so
that the local downstream section to be market driven.
In the United States, President Donald
Trump has already hinted a bailout for U.S. oil companies that have been
hard hit by a recent historic dive in crude oil prices.
Trump tweeted his support for the
industry after crude oil futures prices dove into negative territory on
Monday for the first time ever, a signal that the drop in demand from
the pandemic-shuttered economies around the globe had outstripped the
production cuts from OPEC, Russia and the U.S. companies that have moved
to rapidly idle oilfield operations. The Nigerian government should
consider this as well.
Since plummeting demand is the source of
the problem, so to create demand the Federal Government should revamp
local refineries to promote local demand for crude.
Conclusion
A prolonged lockdown, low demand and
crash in oil prices would not only affect the oil firms, but government,
the banks and the general economy. The financial health of energy
companies based in Nigeria and their efforts to service their debts is
extremely vital to the banking industry and government earnings.
Just as the drop in crude oil prices is
expected to breach federal government’s 2020 projected revenues, the
commercial banks are not exempted from this effect because there could
be an extension of moratorium periods and loan repayments and a
significant drop in new debt to oil companies as Nigerian banks seek to
proactively prevent a 2015 oil crisis déjà vu. This would surely lead to
a fall in the interest and non-Interest income banks have projected to
earn from oil companies.
The financial approach used by Nigeria’s
local oil companies against lower oil prices would affect their chances
of making it through and negatively affect their financial lenders.
The fiscal and monetary authorities should intervene to save the local oil industry, which is the mainstay of the economy.
Once the dust settles on the current
crisis, the oil and gas industry would face a rebound albeit slowly and
government should intervene for the industry to come back to pre-2014
market conditions.
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