Cheap oil prices mean pain for exploration firms

BY MICHAEL DUNCAN

The future of oil and gas companies remains indeterminate in the face of declining global prices of crude oil, which have seen a barrel now trade at less than $50 (Sh4,500), the lowest in the last six years.

The crisis, according to reports by analysts in the energy sector, has been occasioned by accelerated production by the United States from its shale resources and a general decline in the demand for oil.

And Saudi Arabia, the largest oil producer within the Organisation of Petroleum Exporting countries (Opec) has refused to heed a call by other members of the association to cut its daily production to deal with the glut. As a result, major oil and gas exploration companies have announced plans to deal with the effects of the supply glut, varying from reductions in exploration budgets, re-alignements of their strategies to focus on the resources where discoveries of substantial amounts have been declared, and even considered mergers.

In an update of its operations released this month, Tullow Oil Plc of the United Kingdom announced a further reduction of its global exploration budget to $200 million (Sh18.3 billion). Last year, Tullow undertook a similar action that saw its exploration budget slashed to $300 million (Sh27.5 billion) to counter the effects of falling prices of crude. 

In addition, the firm has said that it will focus primarily on the East Africa region where the company has discovered oil in substantial amounts to warrant spending in production, which leaves Kenya untouched in the firm’s plan to reduce exploration activity in its assets around the world.

“The reduced exploration programme will predominately focus on a number of high impact, low cost exploration opportunities in East Africa,” Tullow chief executive Aidan Heavey said last month.

It is also expected to advise on the number of job cuts that will be undertaken to tame the company’s administration costs to help it adapt to the new size of operations.

Tullow, together with its partner, Africa Oil Corporation of Canada, are responsible for most of the oil discoveries in Kenya. The firms have found oil deposits in their exploration acreages within the Lokichar Basin and, lately, in the Kerio Valley basin.

The amount of oil discovered so far within the Lokichar basin is above 600 million barrels which the industry considers the minimum quantity to warrant production. 

Africa Oil has also announced a plan to cut its spending in the face of weak crude prices, saying that it will focus on high-impact prospects that can be developed at low cost.

“We will be focusing our evaluation on identifying a prospect in that basin with a high chance of a robust trap and better quality reservoirs. We are well positioned to weather the current downturn in oil prices with no debt – primarily through discretionary spending and low operating and development costs. Our goal in 2015 is to keep the project moving forward while being financially conservative until oil prices show signs of recovery,” said Africa Oil president and chief executive officer Keith Hill.

Yet another oil and gas exploration company has hinted that it may exit the Kenyan market should a planned sell-out go according to plan. Swala Energy, an Australian company which is a partner of Tullow Oil on block 12B within the Nyanza basin has already appointed a financial adviser to oversee the process of a merger or complete sale of the company.

In a notice to the Australian Securities Exchange, which comes shortly after the company put on hold a plan to raise money that was partly to finance its operations in Kenya due to market uncertainties brought about by the downward trend in crude prices, Swala said that the move was undertaken to secure a long-term value for its shareholders.

The suspended cash call would have seen Swala raise Sh378 million. Outside Kenya, the company has exploration licences in Tanzania and Zambia. Last December, it secured Sh202.5 million from New York-based Magna Equities to finance exploration activity in Kenya and Tanzania.

According to a recent announcement by Swala, FirstEnergy of the United Kingdom will advise on the best process for the merger of complete sale. This comes at a time when the exploration firm, together with its partner was expected to drill the first well on block 12B in the second half of this year.

“Swala’s board of directors has appointed FirstEnergy to manage a process with a view of reviewing the company’s options to maximise the long-term value of the company’s potential, including a potential merger or sale of the company,” reads a letter by the firm to the Australian Securities Exchange.

 

Africa’s share of the global crude reserves is estimated to be just 9.6 per cent, ranking it third in the world region-wise.

Even as the East Africa region is recently emerging as an oil and gas hub due to the commercially viable discoveries of oil and gas in Uganda, Tanzania, Mozambique and recently Kenya, West Africa account for much of the continent’s crude production.

Intra-sector conflict

Sterling Capital Limited says in its latest sector outlook report that discoveries of oil and gas in the country are bound to attract foreign direct investments. However, apart from the effect of the weak prices of crude, it cites conflicts between oil and gas companies as a potential future risk to exploration activity in the country.

“Declining crude oil prices and conflicts with area residents demonstrating over discrimination in terms of employment pose as major potential future risks,” reads the research note.

Demonstrations by locals are evident in Kenya with such cases having been reported in Turkana, at some point even stalling Tullow’s operations.

Analysts attribute the agitation to lack of a law on local content that compels locally operating international oil and gas companies to incorporate local skills and services to a specified extent. The country can borrow lessons on local content regulation from other African countries with established guidelines on local content to mitigate possible unrest from communities living around exploration projects.

In Ghana, for instance, the country’s Petroleum (local content and local participation) Regulations 2013 are meant to “promote the maximisation of value-addition and job creation through the use of local expertise, goods and services, businesses and financing in the petroleum industry value chain and their retention in the country.”

In addition, oil and gas companies are also faced with a new taxation regime since the re-introduction of the capital gains tax which took effect at the beginning of this year.

Capital gains tax was suspended in 1978 to accelerate growth of the real estate sector and capital markets, but it was re-introduced by the Cabinet Secretary for the National Treasury last year as a measure to shore up government revenue from taxes.

The tax is targeted at gains made from sale of exploration rights for companies within the extractive industry at the rate of 30 per cent for resident companies, and 37.5 per cent of the net gains for non-resident companies.

Deloitte, a consultancy firm, has warned that implementation of the tax on oil and gas transactions could discourage investments in the sector.

“The drawback with the fiscal regime which has the potential to derail the momentum building is the unclear tax policy position on farm down transactions. Not all such transactions generate windfall profits as some pundits presently appear to opine,” says Deloitte in its latest report on Kenya’s petroleum fiscal regime.

Farm down transactions are those that involve a sale of part or all of an exploration company’s interest in a block to another firm. A majority of the large oil and gas companies depend on such transactions to acquire exploration acreages originally owned by the smaller firms, as they avoid taking the initial risk.

Farm down transactions are common on acreages where there are proven leads for presence of either oil or gas deposits and often the small firms that have discovered these patterns do not have enough capital to proceed with drilling and eventually production.

 

In mitigation, the Kenya Oil and Gas Association (Koga), an industry lobby, is in talks with the government to push for an amendment to reduce the capital gains tax on transactions involving oil and gas companies. 

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