Oluchi Chibuzor writes on the implication of the reduction in the amount of crude oil marginal fields operators can produce on the businesses of the operators
The international crude oil market has faced notable challenges in 2020. As at January, no one knew the debilitating impact Covid-19 would have on the energy market. The year began like any other without the slightest inkling on the chain of events that has left crude oil producers reeling.
Just as was the case in 2019, Russia and Saudi Arabia, two of the world’s leading crude oil producers continued petroleum industry their oil and gas related war of attrition within the year.
It commenced on March 8 2020 when Saudi Arabia started discounting the price of its crude in response to Russia’s refusal to reduce crude oil production in order to stabilize prices. Specifically, Saudi Arabia announced price discounts of $6 to $8 per barrel to customers in Europe, Asia and the United States of America.
The unexpected price slash by Saudi Arabia caused a free fall in prices of crude oil on March 8 with the Brent crude falling by 30 per cent, the largest drop since the Gulf War. Similarly, the West Texas Intermediate (WTI), another grade of crude oil used as a benchmark in oil pricing, fell by 20 per cent.
The spiral effect continued the next day, March 9 2020, as stock markets worldwide recorded significant losses as a result of the price war and fears over the COVID-19 pandemic.
The Russian Ruble declined by seven per cent to a 4-year low against the dollar.
However, the crude oil prices and stock markets began to recover a few days afterwards. On March 10 2020, Saudi Arabia announced that it would increase its production volume from 9.7 million barrels per day to 12.3 million barrels.
The oil market remained depressed for the rest of March and early April before Russia and Saudi Arabia reached a truce on April 9, and agreed to oil production cuts.
Notwithstanding the production cuts by Russia and Saudi Arabia, the price of WTI fell into negative territory on April 20 – the first time in history due to low demand and insufficient storage.
According to Reuters, the WTI plunged to minus $38 per barrel while Brent crude oil price dropped to $18 per barrel. This situation was made worse by the coronavirus pandemic, which was spreading like wildfire across the globe, forcing many factories to shut down while several countries closed their borders to contain the spread.
OPEC Intervention and Production Cuts
Following the truce by Russia and Saudi Arabia, the organisation of Petroleum Exporting Countries (OPEC) announced that its members and ally, Russia, had agreed to crude oil production cuts that would take 10 million barrels off the market in order to help stabilise the market and shore up prices.
In a statement released after the meeting, OPEC stated that measures were, “agreed by all the OPEC and non-OPEC oil producing countries with the exception of Mexico, and as a result, the agreement is conditional on the consent of Mexico.”
Interestingly, OPEC blamed the coronavirus pandemic alone for the volatility of the market. According to Secretary General of OPEC, Mohammed Barkindo, “Covid-19 is an unseen beast that seems to be impacting everything in its path. For the oil market, it has completely up-ended market supply and demand fundamentals”.
Although the OPEC production cut which resulted in quota allocation to member states has helped create stability in the oil market, it is bad news for countries that depend on crude oil sales for a significant income. Nigeria is a case in point.
Implications of Production Cuts on Nigeria.
Before the oil market was routed by the Russia-Saudi Arabia faceoff, Nigeria had set a production target of 2.18 million barrels of oil per day.
In fact, on October 8 2019, President Muhammadu Buhari submitted the federal government’s budget proposal for 2020 entitled, “Budget of Sustaining Growth and Job Creation” before a joint sitting of the National Assembly. Aside the record N10.33 trillion ($33.8 billion) budget with an estimated revenue target of N8.15 trillion ($27.4b), the budget was premised on a projected crude oil price of $57 per barrel and an estimated 2.18 million barrels per day.
That projection has been obliterated considering the current realities of the crude oil market. Against the backdrop of the OPEC production cuts and continuing volatility of the market, the federal government was compelled to make a downward revision of its crude oil production volume estimates.
The OPEC production quota has pegged Nigeria’s production to 1.4 million barrels per day. This has thrown up new economic realities for Nigeria including a reduction of the 2020 budget by over N300 billion ($980.3 million) to a new budget of N10.8 trillion ($30 billion). It has also resulted in the Naira being devalued by the Central Bank of Nigeria (CBN) to help deal with the forex crisis.
Some oil industry analysts have queried the production quota of 1.4 million.
Energy analyst at Sofidam Capital, Charles Akinbobola, said Nigeria could have gotten a better deal.
“This does not look like a good deal for Nigeria, we should have negotiated for a 23 per cent cut on production of 2.3 million barrels per day, not 1.83 million barrels per day, ”he said.
Consequently, the Nigerian National Petroleum Corporation (NNPC) through its Crude Oil Marketing Department (COMD) allocated certain percentages of production cuts to oil companies operating in Nigeria in order to achieve compliance with the OPEC crude oil production quota for Nigeria.
A Case for Marginal Field Operators
To this end, analysts believe there is a need to interrogate NNPC’s production quota allocation to marginal field operators considering the fact that they contribute just about two per cent to Nigeria’s daily production of crude oil.
The production quota allocation to marginal field operators is already having a telling effect on their operations and these companies may become insolvent if the government fails to take drastic measures.
The current low price of crude oil has significantly constrained the revenues of marginal field operators.
Aside this, most of the marginal fields are highly leveraged and as result are not able to meet debt service, with a significant risk of bankruptcy.
Bankruptcy will result in more job losses at a time Nigeria is grappling with record levels of unemployment.
On August 24, the National Bureau of Statistics (NBS) released a report, which showed that 27.1 per cent of Nigerians are unemployed. The NBS data further reveals that Nigeria’s economy contracted by 6.10 per cent in the second quarter of 2020 with a possibility of further contraction, which will throw the economy into a second recession in four years.
Against this backdrop, the federal government should critically consider not cutting the production volume of marginal field operators in order to protect the sector and employment of Nigerians.
According to the DPR guidelines on marginal fields, the main objectives of Nigeria’s marginal field programme is to grow production and capacity of local producers, diversify resources and investment flow. It is also meant to promote technology transfer and common usage of assets to ensure optimum use of available capacities. Nigeria runs the risk of erasing the progress made so far in marginal fields if the cuts are not halted – and immediately.
According to the 2020 oil and gas industry outlook, “the oil and gas industry was already in flux prior to the spread of COVID-19. Five years of low oil prices have sapped upstream investment, LNG markets have been oversupplied, and the energy transition has taken off.”
The conclusion of the report is that the sharp decline in fuel and power demand has hit an already stressed industry, creating new challenges. The industry will not fully recover until COVID-19 has been successfully contained in most countries, either with the development of a vaccine or the implementation of a widespread test-and-trace program. Even as the number of new cases has been reduced in the hardest-hit countries in Asia and Europe, its spread is increasing in the Americas.
Furthermore, the report indicates that while the largest driver of the current price collapse may be COVID-19, fuel switching could dictate the recovery. Power demand fell almost 20 percent in March in several European countries, and despite the recent economic thaw across the continent, for many, demand remains 5 to 10 per cent below expected levels.
Recovery will likely require not only for the number of new COVID-19 cases to drop substantially but also for economic activity to return to its pre-virus levels. That includes GDP growth as well as other oil and gas–relevant indicators, including industrial activity levels; transport demand; and demand for goods like cars, appliances, and other consumer products. While driving has picked back up in the United States and elsewhere, public transit and flying remain at a fraction of the January levels.
Understanding Marginal Fields
Marginal fields are those discoveries made by oil majors that were undeveloped either because of distance from the existing production facility, low reserves (in view of the majors) or likely low production volumes as a result of flow assurance issues.
Industry watchers believe that though marginal fields in Nigeria have average economic life of between eight and 15 years and can produce between 4,000boepd to 30,000boepd per field, they give local players the best opportunity to participate in the oil and gas sector, develop expertise and grow local content.
“But operators have not always been prolific producers. A total of 30 marginal field licences have been awarded since the policy was introduced and only around 30 percent of the fields have reached commercial production. Marginal field production only makes up 3.05 percent of crude oil output between 2015 and 2016, “said industry analyst.
Meanwhile, according to DPR, the marginal field companies produced about 2.14 per cent of the nation’s total production in 2018. The depletion rate was about 2.7 percent, with a life index of 36.83 years and a national reserves portfolio of 1.61 percent. The reserves hold a potential for production that lies within the medium-term range.
“From our experience advising on several marginal field issues and transactions, we are of the reasoned view that wrong technical and financial partnership is one of the key ingredients for the failure observed in the operations of many of the licensees that have performed below expectations,” Ayodele Oni, analyst at Bloomfield law firm said.
Instructively, Nigeria has not also held marginal field bid rounds since 2003. Twenty-four fields were awarded to 32 companies, some of them two to a field, in 2003.
In the midst of the coronavirus pandemic, the federal government is experiencing a cash crunch. It has reviewed the budget and cut out needless expenditure. Nigeria’s credit ratings have been downgraded and the naira has been devalued. In view of social distancing guidelines, any licensing round could be held digitally but that will open the process to accusations of irregularities as many will be unable to participate.