Since the discovery of oil in Nigeria, the nation’s oil industry has been dominated by major international oil companies such as Shell, Chevron and Exxon. These companies provided the huge capital required to unlock Nigeria’s oil resources. In many ways, this has turned out quite well for Nigeria because these multinationals were able to bring to bear their wide international networks and technological capabilities to deliver on world class projects within Nigeria.
On the other hand, these were companies that by their very structure and diversity of assets are able to deploy capital quite easily across their portfolio essentially prioritised based on “the best player plays” principle; projects with the highest margins get attention and funding.
In the last decade, the oil and gas industry has experienced seismic shifts brought about by tight oil development in the US. This has led to major changes for Nigeria including movement of development capital away from projects in Nigeria to projects in tight oil basins primarily in the US.
What has happened to Nigeria’s oil industry in the recent past?
In the last 25 years, on average, one in three barrels produced in Nigeria has been shipped to the US (Energy Information Administration, 2019). And over its production history, Nigerian crude has enjoyed the status of a well-known sweet crude, rich in valuable crude oil product components, enabling this crude to command a price premium.
In the last decade, tight oil production from the US has edged out much of the oil produced in Nigeria that was typically exported to the US, forcing crude producers in Nigeria to search for other markets besides the US. This level of displacement of Nigerian crude was very effective because the tight oil revolution in the US over the last decade has produced crude oil of similar quality. Another event that has reduced the competitiveness of Nigeria’s crude oil in the global market is the re-introduction of US crude into the global oil market after the lifting of the US crude oil export embargo in 2016. As a result, the US tight oil revolution does not just reduce export of Nigeria’s crude to the US, but causes Nigeria’s light sweet crude to compete with US crude for what new markets Nigeria struggles to find.
In this fierce struggle for ready crude oil markets, the bargaining position of sellers will be helped or hampered by the availability of the required ships as well as commercially reasonable shipping insurance terms among other factors. The multinationals and their crude trading arms, ultimately will successfully sell crude exports from Nigeria, albeit at some price discount, which is ultimately reflected in lower royalties, production taxes and corporate income tax revenue to the federal government.
Additional challenge facing crude production from Nigeria is the need to continue to attract capital for more exploration and development of fields. Continuous technological and efficiency improvements in tight oil production that reduce development cost in the US erode some of the competitiveness of conventional oil production in Nigeria. For example, lower cost of production in the US tight oil basins such as the Permian continue to attract attention of multinational companies away from other higher cost, longer cycle projects outside the US.
This change in focus to the US is seen in the level of divestiture of non-US and in some cases non-shale US assets by US companies, and increased consolidation of assets within the US tight oil basins. Some US operators have been able to drive down the cost of production to levels that were previously the exclusive privilege of low-cost OPEC producers in the Middle East or in Nigeria.
Some operators place breakeven costs for their operations in the mid-$20 per barrel range while others still report levels as high as the mid-$60/bbl. range (Oil and Gas Journal, 2019).
The way forward
A few factors still keep Nigeria and most of OPEC producers competitive and as viable sources of future production. The key attraction of tight oil production is the speed of development, the rich ecosystem of technical skills teeming in the tight oil basins, which allow for rapid efficiency improvements and knowledge transfer, quick turn-around times and pay-out for wells.
Granted that these positives exist, tight oil still remains quite capital intensive and not all companies own premium acreage in the richest basins like the Permian, nor the scale to take advantage of such acreage positions. Additionally, margins could be razor-thin, especially as WTI prices continue to hover around the $50/bbl. range. This non-uniform lowering production cost advantage is evident in the wide range of breakeven cost reported by producers.
This implies that, while rapid execution allows independents to ride the waves of high price swings, unless prices stay consistently above $65 to $75/bbl., a long-term strategy, often preferred by stable multinationals will continue to require conventional resources located in commercially stable locales. And for small independents the quick decline rates in tight oil will continue to keep most in need of cash to maintain operations, insure constant edgy attention to the management of volatile times, including the tight-rope walk of balancing the benefits of price-hedging and the inefficiencies and associated value erosion from increasing financial operations.
Additionally, private equity firms, and banks also see the level of capital required for tight oil development and are insisting on more discipline from operators. While in the past, awash with debt capital from an excited financial sector during high oil price periods, companies could pursue aggressive development in the tight oil basins, currently, there is ever growing push to improve efficiencies, drive down cost and keep debt levels low.
Lower debt levels imply that companies can only expand if they generate cash from operations to do so, thereby curtailing their capabilities to match their appetite for expansion. We also observe lots of mergers in the last few years, as better capitalised firms strive for efficiencies through scaled-up operations. Size enables some firms to take advantage of better produced water management programs or transportation contracts to deliver their crude to refiners. Additionally, the bigger these firms are, the better the bargains they can extract from oil servicing firms, such as in drilling and completions operations.
With consistent efforts towards cost competitiveness of the Nigerian barrel, Nigeria will be closer to shielding its industry from the price swings that edge out capital investment within Nigeria’s oil industry
This constant need for expansion capital and the tight economics of tight oil places Nigeria and other OPEC members in a place with some options. Nigeria could incentive efficiencies in operations to continue to move the Nigerian barrel lower on the cost curve. Efficiency gains occur as knowledge is shared through joint operations/ventures. Direct investments in upstream infrastructures or incentivising such investments could be game-changing for the nation in reducing development costs.
How many locally-owned ultra-modern drilling rigs exist in the country, with directional drilling capabilities? Within the right commercial framework, multiple operators could pull together the required work portfolio to justify such spend. Efficiencies could also be derived through supply chain improvements. Much has been said already about the Petroleum Industry Bill and the potentials therein for Nigeria to improve its fiscal regime (I hope to discuss my take on that in a separate article in the future).
With consistent efforts towards cost competitiveness of the Nigerian barrel, Nigeria will be closer to shielding its industry from the price swings that edge out capital investment within Nigeria’s oil industry.
In the last 4 years, the federal government of Nigeria has experienced severe reduction in oil revenue following the fall in oil prices since 2014. This is not for any policy errors the nation has engaged in. Like many other Petro-states, the Nigerian political scene is littered with lucky and unlucky presidents. Some are lucky because, without their control, sometimes despite policy missteps, many things lined up in their favour, chiefly among which is the price of oil. Very few leaders of Petro-states have been able to effect policy moves that reduced the impact of low oil price periods.
Good leaders of course are able to set the foundations and reset the economic sails to ensure future tides don’t bludgeon the national economy this badly.
MADUABUCHI PASCAL UMEKWE
Dr Umekwe writes from the US and he can be reached on pascalonline7@gmail.com
