A Worrying New Trend For Oil Investors

Low oil prices are cutting into the balance sheets of oil companies all around the world. That presents difficult decisions for operators who must decide how to correct their falling revenues. New projects are being suspended or cancelled while assets are also sold off. Capital spending programs are shrinking and debt is rising. For the oil majors, dividend programs are safe for now, but that could change.

Meanwhile, another threat to international oil companies is emerging. In countries where firms are operating - countries that are woefully dependent on oil for their national economies - the business climate could be darkening.

The Niger Delta

Let's take Nigeria as an example. The OPEC member is the largest oil producer in Africa, a feat that is only possible because of the massive investments from the largest oil companies in the world. Royal Dutch Shell (NYSE: RDS.A), Chevron (NYSE: CVX), ExxonMobil (NYSE:XOM), and Eni (NYSE: ENI) have all been operating in the Niger Delta for years.

Nigeria is not an easy place to do business. Corruption and theft are pervasive. Shell has consistently seen its pipelines attacked. In August, Shell declared "force majeure" on two key pipelines - its Trans Niger Pipeline (TNP) and the Nembe Creek Trunkline (NCTL) - after they suffered from sabotage. The two pipelines were temporarily shut down for repairs. That is just one small example of some of the challenges facing the oil majors in Nigeria.

But, things could get trickier with low oil prices. The Nigerian government, starved of revenues because of the collapse of crude prices, is looking to raise more cash from the oil majors. The Nigerian National Petroleum Corporation (NNPC), a state-owned firm, said that it wants to renegotiate contracts that it has with the oil majors "to extract as much benefit as possible for Nigeria," the company said in a recent statement.

The new government of President Muhammadu Buhari wants to renegotiate the production sharing contracts between the oil companies and the government. It is hard to overstate the potential implications of such a move, as some deals have been in place for decades.

Nigeria Hit Hard

But given the fact that oil accounts for 70 percent of the government's budget, Buhari appears willing to take such a drastic step. The closely watched U.S. shale industry needs oil prices somewhere in the range of $45-$65 per barrel to breakeven, depending on the company and location. But the Nigerian government needs oil prices well in excess of $100 per barrel to breakeven. GDP growth has slowed to just 2.35 percent in the second quarter of this year compared to a 6.5 percent annual rate for the same period in 2014.

Moreover, the currency is under pressure. The naira hit an all-time low in February, after which the central bank has tried to maintain a stable exchange rate. However, after China's devaluation and another dip in oil prices since August, Nigeria's currency is under increasing stress. It may not be long before the central bank is forced to devalue.

Government Looking to Private Companies for Cash

The NNPC just took on $1.2 billion in loans from private banks to fund 36 drilling projects it works on in a joint venture with Chevron. Without funding of its own, the NNPC had to turn to private finance.

That is a short-term band aid. To fix the financial shortfall, the NNPC is setting its sights on oil companies for new sources of cash. It is unclear what an attempt to renegotiate production sharing contracts will have.

Nigeria's production sharing contract (PSC) was introduced in 1993, and they offered attractive fiscal and legal regimes. In 2000, when the government auctioned off offshore tracts, they tightened the terms. The government's take rises as oil prices rise, so they are hit hard when prices fall. There is also a sliding scale for taxes depending on the difficulty of oil projects. Deeper offshore projects - which account for much more of Nigeria's output than they used to - are subject to less tax. With oil prices falling, and more and more production concentrated offshore, the government sees an opportunity in a renegotiation of contracts.

Companies at Risk?

It is too soon to say how a change of the PSCs could affect companies operating in Nigeria. If the government is to take in more revenue, that would logically come out of the pockets of the oil majors. The most exposed is Shell, which has been operating in the country since 1937. Shell, through its joint venture with NNPC and other private sector partners, operates more than 50 oil fields, over 5,000 kilometers of pipeline, and two major export terminals. Shell also operates the Bonga field, the country's first deepwater discovery, which increased Nigeria's oil output by 10 percent when it came online in 2005. In total, Shell produces 739,000 barrels of oil equivalent per day in Nigeria.

A Willing Partner

The oil majors would rightly point out that corruption within the NNPC is arguably a worse problem. To be sure, that is something that Buhari's government is also trying to tackle. His successful election was largely driven by a public desire to address corruption. Buhari has purged an array of top officials at the NNPC, and a corruption scandal was also revealed, in which company officials were stealing $1 billion a month from the state.

To the extent that Buhari can successfully clean up the NNPC, the international oil industry will be pleased with a better operating environment. However, if contractual terms are changed, a lot of uncertainty will reign. At its worst, major changes could lead to legal disputes between companies and the Nigerian government.

There are a few reasons to think that the government's review of the production sharing contracts won't be that bad though. For one, the managing director of the NNPC, Dr. Ibe Kachikwu, is the former executive vice chairman of ExxonMobil Africa, and he was appointed by President Buhari to clean up the NNPC. Presumably, he has a good understanding of how important it is to keep Nigeria attractive for investment. Moreover, when he announced that the government would seek to renegotiate contracts, he also took care to say that he would not create an anti-investment climate.

At the same time, the government is under pressure to reduce tax for onshore fields. One possible scenario going forward is some reduction of onshore tax, to be offset with a tax hike for offshore fields.

Low Oil Prices

Policy changes in Nigeria could prove to be a financial blow to the oil majors operating there, but the damage is so far unclear. A long-stalled petroleum bill has cast a cloud of uncertainty over the industry for years, and the bill could again receive attention in the coming months, raising more questions and concerns for companies who are invested in Nigeria.

The brewing storm is indicative of the dual threat that multinational oil companies face in this low price environment. Oil companies are losing revenue with oil prices less than half of what they were a little over a year ago. But, with host countries bleeding cash as well, tax changes could be coming, to the detriment of the bottom lines of oil majors. Of course, this will play out in different ways. In the UK, for example, the government cut taxes to keep the oil industry healthy. In Nigeria, and perhaps other places that are losing revenues, the government could take the opposite approach. Investors should be aware of this emerging trend.