Oil In Global South Under The Gun

Oil and gas companies are paring back investments and slashing jobs, which is taking an enormous toll on oil-producing regions, particularly in North America.

But it is not just the north that is suffering. The Global South is also seeing investment dollars dry up as international exploration companies cut drilling plans, and in some cases, even cancel in-country plans all together. In fact, in many countries in Africa and South America with a burgeoning oil and gas sector, regulatory rules are a bit of a moving target. Worse yet, the necessary infrastructure - oil and gas pipelines, processing stations, even roads - are still developing, making drilling operations more difficult relative to well-trodden areas in North America.

Moreover, 2015 will likely be an historic year for the global oil and gas industry. Tens of thousands of jobs are starting to disappear and capital investment plans are being dramatically scaled back. That makes frontier areas for the industry - Africa and parts of South America in particular - first in line for cutbacks.

Take East Africa. The leading international oil and gas company in the region is Tullow Oil PLC (LON: TLW), which had a rough 2014. It blew some serious money drilling multiple wells in different parts of Africa, only to see them come up dry. In April 2014, Tullow drilled a deepwater well off the coast of Mauritania, which failed to find any oil or gas. That led to a $415 million write down in its Mauritania assets. The previous year, Tullow had a 25% stake in two dry wells drilled by operator Statoil (NYSE: STO) off the coast of Mozambique.

After other failed drilling expeditions in Ethiopia and Norway, Tullow began a campaign to sell off some assets to reduce expenses and raise cash. This was the first major warning sign for the region's oil dreams - and all of this occurred before the massive collapse in oil prices. After slashing spending and ridding itself of more speculative assets, Tullow decided to focus on its bread and butter - continuing to produce from the game changing Jubilee field and focusing on developing the TEN field in Ghana - and safer drilling projects in Kenya.

But the bust in oil prices inflicted a serious wound on Tullow, which announced its fourth quarter results this past week and scrapped its dividend program due to a worsening financial position. Most importantly for the future of African oil development, Tullow slashed its exploration budget by 80%, from $1 billion down to just $200 million. "On the exploration front, we're not giving up exploration, but you have to be sensible. And we're focusing our exploration programs around our existing producing assets or the very low cost areas like East Africa," Tullow CEO Aidan Heavey said on February 11 in a conference call with investors.

However, in the current pricing environment, East Africa is starting to see investment dry up. After leading the industry in Kenya, Uganda, and Ethiopia, Tullow is shrinking its ambitions in the region. Tullow said it would reduce its number of rigs in Kenya by three, with just one remaining. And despite being the only oil company to find significant volumes of oil in East Africa, it is pushing off final investment decisions until 2016, delaying first production until the end of the decade at the earliest.

Critically, before major volumes of oil can come online, pipeline infrastructure will need to be constructed, a lengthy process that has both engineering and financial challenges, but also political obstacles as well.

Even Tullow's TEN field, now the heart of the company's medium term value proposition, could face delays because of oil prices. Tullow based the project's economics on an assumption of oil at $80 per barrel. With prices well below those levels, some industry watchers are concerned the project timeline could slip. Tullow insists it is on track for first production in 2016.

East Africa had a lot of its hopes pinned on Tullow. With the British oil company's fortunes taking a turn for the worse, East Africa's oil ambitions are on hold.

South America

Across the Atlantic, another region in the Global South is expected to see a retreat in investment in oil and gas. Colombia, which became a darling for international investors in recent years, is starting to see some warning signs for its oil and gas sector as well.

Although there have not been official announcements, Bloomberg is reporting that ExxonMobil (NYSE: XOM), ConcoPhillips (NYSE: COP), and Royal Dutch Shell (NYSE: RDS.A) are all reconsidering their plans for shale development in Colombia.

While that will hardly register a blip on the share prices of the oil majors - Colombia was never expected to make up an enormous share of their portfolios - it is bad news for Colombia. It is also bad news for smaller companies operating there. Sintana Energy (CVE: SNN), a small Canadian company that had snatched up shale acreage with huge upside potential, positioned itself to profit from the rising interest in Colombia's Middle and Upper Magdalena shale formations. Sintana says it is sitting on 4 to 8 billion barrels of oil potential in the Middle Magdalena, and an additional 2.1 billion barrels in the Upper formation. Below is a diagram from a Sintana Energy investor presentation, depicting some of the interest in the area.

Sintana sought to farm out some of its operations to ExxonMobil. It achieved that goal when it completed a deal with ExxonMobil that would see the oil major drill the VMM-37 block. But with the collapse in oil prices, Sintana may not reap the rewards if ExxonMobil decides to back away from drilling. Sintanta had aimed for 2 wells to be drilled in 2015 and 2016, but that is now up in the air.

Low oil prices may have been the final nail in the coffin (for now) for Colombia's Middle and Upper Magdalena. A bad pricing environment merely compounds an already uncertain market. Oil companies have complained that the Colombian government has created a lot of uncertainty regarding regulations of hydraulic fracturing. "The lack of regulatory clarity and community fears over fracking are key issues," the Vice-President of Upstream Consulting at Wood Mackenzie told Bloomberg. "Since Exxon, Shell, Conoco are cutting budgets, it's likely that Colombia spending will fall. Companies in general are very disillusioned with the country."

Pacific Rubiales Energy Corp. (TSX: PRE), another small Canadian firm operating in South America, is also not performing well. It is suffering under growing debt, and the prospect that some of its productive leases may expire soon. It is cutting its exploration budget as its finances worsen.

Seeing the writing on the wall, the Colombian government is considering slashing royalty rates on producers that ramp up existing fields. It is unclear yet what this proposal will do for the industry.

Meanwhile, offshore development, which has longer development timeframes that are less sensitive to short-term moves in oil prices, remain a promising area. In July 2014, ExxonMobil along with Statoil and Respsol (BME: REP), obtained the rights to drill off the coast of Colombia. The three companies took near equal stakes in the COL4 Block, with Repsol taking the lead. The oil companies have conducted 2D seismic surveying of the offshore blocks, with 3D seismic surveying outstanding. Any significant volumes of oil coming from the Colombia basin remain several years away, but should prove a bit more resilient than onshore shale if the oil majors move forward.

Conclusion

Investors and energy analysts are focusing overwhelmingly on North America during the current oil bust, and for good reason. It is one of the most prolific areas for oil and gas development in the world, and could see a substantial cutback as oil prices remain weak.

But it is not just North America that is suffering. In fact, North America could bounce back quicker if oil prices rise. Frontier areas of exploration - underexplored areas in East Africa, and unconventional development in Colombia, in particular - are under the gun. These areas do not make headlines in the West, but they offered oil companies some of their most exciting growth prospects.

Now they are on the chopping block.