The Politics of Oil and the African Experience
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When large gas quantities within Barnet Shale (one of the largest gas fields in north America) were discovered under DFW International Airport by Oklahoma Chesapeake Energy, those familiar with economic development did not pop champagne. Even the cities of Dallas and Fort Worth, owners of the airport, did not see a dime of the revenue or lease signing bonus. It was agreed that instead of going to salaries and wages, all monies from such operation had to go towards capital improvement of the airport. The initial signing bonus kicked in more than $100m to the airport capital funds. This is one reason why DFW International Airport (with about 600 approved wells, with only few drilled) is one of the most liquid airports in the world. It gets annual revenue.
If this discovery had been in Africa, the President or Prime Minister would have put their hands in the till, hosting parties and popping champagne. For the record, Nigeria accounts for about 60% of the total oil spills in the world. Imagine the environmental issues accruing from these spills and how long it will take for the oil leave the surface of the earth – centuries! Even with that, the country has not stopped the celebration.
Let’s remove the emotive aspects and look at money and how, in economics, it attracts itself as opposed to science where opposites attract. Whether dealing with oil or real estate, one thing is common to investment that requires heavy capital outlay – expectation of return of and return on invested capital.
In the case of oil, the process starts with exploration to see what is in the ground, and access is granted (in the case of US) by lease from the landowner via mineral rights leases – individual property rights under fee simple rights. In developing nations (where minerals are often a national right) the government grants oil companies the rights without considering individual property. For most Africans, land is owned on communal basis and some of those that claim ownership to it hardly have recorded documents attesting to such ownership.
When the exploration rights are granted, the oil companies often spend their money looking and may not find something of commercial quantity. The quantity has to support the invested capital while the projected revenue has to cover return on and return of invested capital.
Let’s say there is a commercial quantity of oil or gas. The announcement is made and the home government is ‘excited.’ There is frenzy and everyone now ‘Thanks God’ because they are instantly rich and do not have to work anymore. Alignment politics kick in. The PM or president starts appointing an oil minister. The finance minister does not want to be left out. National assembly folks start to gerrymander on loose and lousy regulations to compel the president to grease their palms before any major deal is done – corruption overrides and overrules. Now, the oil company that has risked its corporate capital is faced with local sentiments and demands that have nothing to do with return on and return of capital.
Let me now illustrate with a simple oil production arithmetic that applies to commodity
1. Exploration Cost – $500,000,000
It may take years of looking and doing all sorts of geophysical and geo-science analyses to determine where the oil is and how best to drill, vertical or horizontal. This money, once committed, starts to accrue interest payment whether the exploring company self-borrowed from its resources or from a third party. Often it is OPM – other people’s money scenario in which case, interest payment kicks in and this carries lots of risk because if there is no ‘find’ or if the ‘find’ is not sufficient, payment still accrues. On interest only payment schedule assuming 10%, which is low, one exposed at $500,000,000 has to come up with $50,000,000 in annual payment before production starts.
2. Production Cost – $100,000 per well – 50 wells to drill
The well cost has skyrocketed because there are many drilling opportunities. Therefore, available skills are charging premium. Whether the well is inland or off shore makes a lot of difference as the terrain is an additional factor considered in drilling.
3. Total Exploration/Production – $1,000,000,000
At a $1b capital outlay before production, that is a high financial exposure that most companies are jittery about as it is a major carry on their balance sheet.
4. Expected Daily Barrels – 50,000
Ghana does not produce 50,000 barrel daily and most individual wells hardly produce 1,000 barrels daily. But let’s assume Black-gold as in Ghana is a gusher.
5. Well Life – 7 yrs
Analysts use 7 years for well production life, because in that period, the pressure is high and the oil flow may not need mechanical inducement to make it flow. As the years go by, production drops/decreases and some engineering has to be provided to aid flow at this time. The well may get sluggish. At this time, the crude is heavy with slug and may be capped or abandoned.
6. Price/Barrel – $100/barrel
The price of the commodity is key because if it is not right, the company loses money. Oil price fluctuation is a nightmare for oil investors. A dollar less than the price quoted at production time may be devastating, creating difficulty for a company to stay afloat.
With the above, let’s now do the numbers. The two main issues here are RETURN ON – interest payment and RETURN OF, payment to retire principal capital. In the former, it is interest only. With the latter; it is amortization of the total debt for a $1,000,000,000 over 7 years [well life] at say a favorable effective rate of 7% because the company has great corporate bond rating that qualifies her to borrow at such rate. Note that in the case of real estate, one may elect interest only payment because in 7 years, the asset may have appreciated. Such is not the case with an oil well because it is a depreciating asset – the volume drops as production proceeds. Its initial investment is therefore set on amortizing schedule.
Now the numbers: the annual payment due to retire $1,000,000,000 in 7 years is $185,553,220. The total revenue expected from production assuming there is no interruption is $1,825,000,000. Now let’s see how the numbers are crunched to make payments to stakeholders - the host nation and foreign interest. Note that oil is considered to be an unearned income because there is nothing anyone did for oil to be in their backyard, therefore, the attitude to it is different than when one is engaged in a sector such as agriculture or manufacturing that demands actual engagement.
Most oil companies operating in Africa pay royalties because African nations have not invested in the exploration and production aspects of oil. Therefore, they settle for what is left after production and operation expenses are taken care of. In addition to retiring the debt, operation costs are killers, and they can run as high as 70% of the gross revenue. In this example, this is how it will flow:
Gross Revenue – $1,825,000,000
Operation Expenses at 70% – $1,277,500,000
Effective Revenue BT - $547,500,000
Debt Repayment – $185,553,220
Net Income –$361,946,780
Net Income Per Barrel – $19.83/barrel
This is where the rubber meets the road and the ratio of shares can be 50/50. Since African nations have not invested in the exploration and production but only wait for royalty payments, whatever they receive is marginal. Nigeria for instance makes between $5-10 per barrel because of the same reason. No Nigerian bank can afford to invest $1,000,000,000 from local sources. With a devalued currency, it is very unlikely - and even if they had the money – with choking interest rates, the companies would not borrow. Although Ghana’s currency enjoys exchange rate parity with the Dollar and Pound/Euro, for example, the high interest rate from local banks and its limited capacity makes it very unlikely that the local banks can finance such capital intensive projects.
The undue expectations that Africans place on revenue when oil is discovered have to be eliminated or minimised. National governments do not help matters when celebration precedes realities. Were they to explain these scenarios, maybe the appetite for undue expectations can be managed. Were the local financing community to invest in the production, they share in the Return On and Return Of invested capital. Interest payments on borrowed money is what creates wealth. So for a $1b principal amortized over 7 years, the total payment is $1,298,872,540 – $1,000,000,000 = $298,872,540, wealth created. This is due to the magic of financing.
Additionally, if in 7 years the well is a ‘gusher’ and no serious capital investment is required to keep the flow, the revenue basis increases and the nation has to enhance its share ratio. But it’s very unlikely in 7 years there will be no major capital re-investment.
The Middle East nations, unlike their African counterparts, have a stable local currency that is stronger than the Dollar/Pound/Euro. They are able to attract skill sets without attached money. Their currency advantages provides a basis for their share in the wealth because they are invested partners and have set aside a certain percentage of their revenue as a hedge and cushion to buy down interest rates. In the Middle East, borrowing is about 3%-5% compared to typical African nations at higher rates that average 30%. The above is basic without specifics but offers the typical approach investors in the oil sector take in looking at any opportunity. In the end, it is about the money is borrowed, paid back and re-invested.
If Africa’s leadership played down on the unrealistic expectations, the argument that the oil companies are taking advantage may reduce. No one will invest their money and just let it evaporate. There is a risk and reward culture/mentality to investment. Africa is never an invested capital partner but an expecting partner on royalty payment.
I used to feel for Africa but once I started digging into the politics of oil production, having read books such as ‘Prize’ and ‘Why We Hate Oil Companies’ by former US Shell Company, I minimized my criticisms.
Africa needs to be educated on the Business of Politics and Politics of Business in relation to commodity prices. Even though the continent supplies about a third of the raw materials the globe needs to run industries, it is not on the ‘soft’ aspects of product development which is money and its machinations – labor. No African nation has a sovereign wealth fund that is about a $1b, and even at that, the leadership want CASH in return instead of bartering their commodity for infrastructure. Cash is INELASTIC while Credit is ELASTIC. The fungibility of MONEY is enhanced by credit facility and a legal framework that backs its utility as a legal tender. Africa is lacking in credit facility and legal framework. Its cash base is often limited and marginal, inelastic and offering limiting conditions.
If anyone cares to know how Saudi made it big with its oil resources, they should avail themselves a copy of FDR Meets Ibn Saud by William A Eddy. A copy was given to me in 2005, by Friends of Saudi Arabia at the 60th anniversary of the meeting at Great Bitter Lake. King Saud, who had no formal education, was adamant on what he wanted from US as far as drilling for oil in the kingdom, was and is concerned. FDR was taken aback but given the interest, he yielded. There is value in well-crafted relationships on no-victor no-vanquish culture. At the time, no one from Saudi Arabia had a college education. But in 1945, most Nigerians already had interaction with the West and had produced educated persons on paper but lacking PHD – Passion Honesty/Hardwork and Dedication.
The ones that got educated went home acting like ‘White’ folks, wearing a wig in the case of lawyers and striving at all cost to be Knighted by the British Empire and when they are not able, they settle for stupid and silly ones granted by the Knight of Columbus or Christopher just so they have the title ‘Sir.’
The same opportunities that other people were offered were extended to Africa but given the attitude of laziness and lack of intellectual vigor, Africa settles for the lowest hanging fruits and least areas of resistance. Lace that with tribal wars and resentments within Africa and a crafty foreigner exploits the situation to their advantage. Africa enables what happens to her both by design and default.
The world is driven by fierce competition. One must come prepared to do battle. Coming to the table with emotions simply because one was once colonized or enslaved is an old story that offends dignity. We must stop whining, seek to understand and then come back prepared like the Scout – Always Prepared. Money is a magnet for itself, and until one has equity in a production opportunity, they do not count. Unearned resources such as oil, is a dog-eat-dog sector, and it’s never for the feeble and faint hearted.
If Saudis with minimal education could stand up to US and demand better deals even when OPEC was set up, why not Nigeria? Well, Nigeria has more educated folks than Saudi, but with a mentality set to undermine one’s own economic wellbeing, counter to what FDR said, what does one expect?
A Nigeria/Ghana Oil Minister is willing and able to sign away their country’s natural resources for mere $1m, in bribe with a promise to help their kids or family get admission to nice college overseas, and maybe buy a lousy house in a suburb of US or UK. They are marooned by the glamor of their roles but short on the heavy lifting to help level the playing field. A former Nigeria Oil Minister – Tam David West, went to jail under IBB, whether on trumped up charges or real ones, for accepting a wrist gold watch as a gift. Well, what does one expect from a starving morbid anatomy professor on shoe string salary, who suddenly had to deal with shark like persona one encounters in the oil sector. Regardless of his PhD, he lacked strength to negotiate and got marooned with mere token. Corruption is never all the story, but gullibility often makes even a well-educated one fall prey to traps. No excuse though.
By Ejike Okpa II
Dallas, Texas.