Emerging markets oil and gas: key issues in challenging times

It is an understatement to say that the combined effect of a global pandemic and collapse in oil demand has and will have an impact on the oil & gas sector.  Whilst many of the issues are macro in nature and outside of the control of the public or private sector, there are common points of concern for the industry in this troubling time which apply globally, but which are nevertheless of particular concern for those operating in some emerging African hydrocarbon-producing countries:

• Impact on Host Governments/States Income: many Host Governments/States are reliant on income from oil and gas production, with this income stream forming a large part of a country's GDP or underpinning a large part of its national budget.  Where this income becomes increasingly restricted, this could give rise to a heightening of the counterparty risk posed by state owned entities forming part of a joint venture as their liquidity is reduced and/or the funds that are available are diverted to support other funding requirements elsewhere in-country. 
• Sovereign Debt: with a restriction on income from oil and gas production, Host Governments/States have in the past looked to debt instruments to raise much-needed funds.  However, in a capital-constrained world and one in which the credit ratings of Host Governments/States are taking a hit, this is becoming a less likely source of capital, coupled with a need in many cases for such nations to seek restructuring or reduction of such external obligations.  As a result, companies should constantly monitor their state-owned entity counterparties to pre-empt potential defaults.
• Currency and FX Issues: in some jurisdictions there is a distinct lack of foreign currency reserves, and in others the local currency is being (or needs to be) devalued.  In an industry which is global in nature and where the US Dollar is the predominant currency used, the lack of foreign reserves can cause an issue for counterparties where, for example, payments (including debt service) are required in US Dollars and some or all of its revenues are in local currency.  A devaluation of the local currency (which in some cases has not yet aligned with market expectations) also poses issues for those holding US Dollars since US Dollar balances will not be converted when the rate is considered unreflective of the "true" value, thereby exacerbating the problem of a lack of foreign currency reserves.  As a result, parties should be mindful of any currency-related issues ahead of time, and engage with counterparties as soon as possible so as to seek to avoid any scenarios leading to contractual default.  
• Highly Leveraged Companies: in a low oil price environment companies which may be considered over-leveraged, even at $60/bbl, could be at risk of being unable to service their debt and, absent a restructuring of that debt, may be at risk of default and/or collapse.  From a practical perspective, servicing US Dollar debt in the absence of a sufficiently liquid US Dollar cashflow will present obvious challenges.  Whilst companies which are conservatively leveraged will likely be able to 'weather the storm' a little longer, it is inevitable that even conservatively managed companies will be dragged into restructuring discussions with lenders if the low oil price environment continues for a prolonged period. 
• Hedging: hedging will be a feature of many companies' operations, particularly those that are funded by international banks for which hedging was a key element of agreeing to provide a facility, and those companies may for the time being be protected from the decline in offtake pricing where they hedged at pre-crash pricing.  However, that protection will only last for as long as the hedge tenor and after that time - assuming we are still in a low oil price environment - those companies may experience cash flow problems.  In the short-term, however, those companies may be able to monetise these hedged positions to create additional short-term liquidity, although that can be a time-consuming process to navigate and may include lender consents. 
• External Financing: the expectation is that the flow of money into the sector from the equity capital markets will be stemmed, and access to debt capital markets may be equally as impacted (and if not impacted, then the commodity price fluctuation risk will be priced accordingly).  For those companies considering restructuring/diversifying their capital structure, the narrowing of solutions (or cost-effective solutions) may drive the need for more inventive restructurings.  
• Portfolio Mix: companies with a mixed portfolio across exploration, appraisal and development may be naturally hedged against the downturn where exploration and appraisal obligations can be deferred, and where the capital intensive phase of development has not yet begun and can either be cancelled or pushed out by a significant period.  However, those in a capital intensive phase where project costs have been committed/paid may have no room to manoeuvre and may be reliant on the goodwill of counterparties and key stakeholders when seeking to cancel or defer capex.
• Capex Deferral: companies will be cognisant of ongoing minimum work obligations and the impact of that spend in the current environment.  Early engagement with regulators on the ability to defer spend until a more sustainable price environment is advisable where companies consider this may be necessary so that the legal and commercial aspects of such deferral can be worked through.
• Supply Chain: businesses will be focusing on preserving the status quo/operating on a 'business as usual' basis for so long as is possible in the face of the myriad issues impacting operations – both in terms of the acquisition of goods and also services.  However, there will be elements of this that are outside of the control of the business and therefore the tight management of the supply chain and early engagement and intervention, from a contractual and practical perspective, will be important so that issues can be identified as early as possible and any negative impacts mitigated.  Where pinch-points are identified, parties may need to begin considering the commercial, legal and practical steps to shutting in production. 
• People: along with potential supply chain issues, companies will be concerned about the wellbeing of their people, and their ability to move freely.  For companies involved in operations in countries where expats are heavily relied upon, the logistics of clearing people into the country (often through quarantine) and then rotating manpower can prove a logistical nightmare.  In these circumstances a 'break from the norm' may be required to ensure that operations can continue.  For those that can work remotely, in some emerging markets companies will face the additional battle that to do so is not so easy, and internet access and a reliable power supply can prove problematic.
• Storage: various markets are experiencing pressure on storage capacity across a range of products and as a result this has the potential to impact on operations upstream of the storage.  Where this is likely to be an issue, parties will need to be mindful of the impact on operations of a lack of storage capacity, and the steps that will need to be taken contractually and operationally to deal with any issues.
• Licensing Rounds and Activity Levels: Host Governments/States keen to attract inward investment in the sector are likely to face reduced interest at this time or possibly speculative bids, and as a result planned bid rounds or out-of-round discussions may be deferred for a considerable period.  Where this is a concern for companies planning to enter processes or currently participating in processes or discussions, engagement with the relevant regulator as early as possible will help to avoid misspent time and resources.  Governments/States will also be witnessing a sharp slowdown in exploration and appraisal activities, with final investments decisions on greenfield and brownfield projects delayed or, worse still, cancelled. 
• Opportunities: some say that with uncertainty comes opportunity, and this may manifest itself in the following ways:
  
  • a lower oil price environment provides opportunities for cash-rich/underleveraged players to pick up quality assets at a significantly lower price than would have previously been the case, although above ground risks are likely to cause the same (or even heightened) concerns in emerging markets;
  • for countries which are net importers of hydrocarbon products, subject to storage availability, availability of foreign currency reserves and downstream offtake arrangements/demand, now might be a good time to acquire (and this may help to mitigate pressure on the economy elsewhere);
  • again subject to storage availability and transportation/processing capacity, hydrocarbon traders may seize the opportunity to lock in volumes on preferential terms;
  • downward pressure in the service and contractor sector generally may mean that companies are able to secure preferential terms for ongoing or upcoming capital intensive phases and generally achieve cost savings that may lead to trading advantages when production comes on line; and
  • companies can look to position themselves and/or optimise their operations so as to take advantage of a potential price spike.

Our teams are well placed to help navigate the issues above, as well as any others, so please do get in touch.