Financing oil in Africa
Traditional ‘business as usual’ financing methods will no longer be adequate to meet the unprecedented demands for capital to finance energy sector expansion in Africa and indeed around the world.
Due to the increased regulation of banks since 2008 and as the debate around climate change continues to heat up, more and more institutions and investment funds are dropping fossil fuels from their portfolios meaning fewer banks are willing to lend to oil or gas projects in Africa. This has resulted in more finance coming from private equity and from non-bank lenders, and more trade-based lending. Recent growth in African economies has also meant increased interest from investors in both debt and equity for African projects (not only oil and gas).
Africa is an oil rich nation, however, the continued growth across the continent is threatened by major development challenges, the most significant of which, is infrastructure. The World Bank estimates that a US$43 billion annual investment is required to fund the energy infrastructure in Africa.
Firstly, African countries face relatively high financing costs, reflecting investor’s perceptions of the high risk involved in holding assets, particularly in energy infrastructure, in the continent. Infrastructure is considered risky since it is illiquid, long-term, and can be vulnerable to changes in countries’ policy and regulatory environments. These factors make debt and equity for infrastructure projects in African countries more expensive than in developed countries. Energy infrastructure projects have high upfront construction costs (even more so in the case of sustainable ones). Given the exploration phase in an oil and gas project is the riskiest, the risk/reward ratio therefore needs to be as high as possible.
Infrastructure investment in sub-Saharan Africa is financed by the public sector, either through domestic government funding or external official development assistance (ODA), the private sector, and other “financier” countries, such as China. Multi- and bilateral organisations and development finance institutions (DFIs) like the World Bank and the African Development Bank also provide financing for energy infrastructure projects. These organisations play significant roles in attracting private-sector investment and can help mitigate risk in areas where political and economic instability may be viewed as hazardous.
Multilateral Development Banks (MDBs) and Development Finance Institutions (DFIs) also play a significant role in financing and de-risking the earlier stages of large infrastructure projects in Sub Saharan Africa and use blended finance instruments (such as concessional capital, guarantees and risk insurance, technical assistance funds, and design-stage grants) where needed to make the risk-return ratios more appealing and investable. An example of blended finance is the UK government recently partnering with five African countries to design a new project development facility focused on developing sustainable infrastructure projects across Africa that will ultimately be commercially investable.
COVID-19 impact on investment
African oil exporters are feeling the pressure after the crash in the oil price and fears of the Covid-19, as investors pull money from international bond markets. With low prices and excess supply pushing oil & gas balance sheets to the brink, raising traditional debt will remain difficult and may require restructuring. Oil companies will have to pursue alternative sources of funding like PE investors, direct lending funds, distressed debt funds and hedge funds to see out the downturn.
Further analysis from Wood Mackenzie suggests up to 33% of capex spending – roughly $10bn – could be wiped out across Africa’s upstream activities this year, as energy firms tighten the purse strings.
A few cash-rich players have pursued M&A strategies, including Total, which acquired Tullow Oil’s Ugandan assets and ExxonMobil, which struck an agreement with Algeria’s state-owned energy company Sonatrach.
In a low oil price environment, oil companies are having to formulate robust controls, tight cash management and good communication with investor and lenders as they compete for capital to be allocated to the energy sector over others within countries. As a result, high-cost and high-risk projects will be move down the priority list or be deferred. This was demonstrated in June when Senegal’s President Macky Sall announced that “Senegal has been forced to delay its first oil and gas projects by up to two years because of coronavirus”. Other countries may follow suit.
International Oil Companies (IOCs) like Eni and Total who have the largest presence in Africa, have already indicated 25% cuts to their investment in exploration and production projects in 2020. In Nigeria, Shell and Chevron Corp., are selling fields or putting them under strategic review as they scale back Nigerian operations.
National Oil Companies (NOCs) will also face similar challenges as IOC’s as they are heavily impacted by the credit quality of their sovereign. There may be limited government support meaning that secure lines of funding will be essential to weather the decline in demand.
A new dawn for investment
Closing the gap on Africa’s energy challenges presents major opportunities for investors. Just last week, Mozambique’s first ever onshore liquefied natural gas (LNG) project led by operator Total secured $20 billion financing. The project is expected to reach financial completion by the third quarter of 2020 with co-investors including Mozambique, Japan, Thailand, and India. This Final Investment Decision (FID) is the largest sanction ever in sub-Saharan Africa oil and gas and will be transformational for Mozambique. The deal demonstrates confidence and the investment potential for key African assets.
In 2020, companies will face new tests and challenges to optimise oil delivery whilst having to be cost effective, return cash to shareholders and invest for the future.
The pace of change is increasing on many fronts. It’s vital that African governments and their development partners put in place policies and investments that are appropriate with the continent’s massive and urgent energy needs. Governments will also need to assess the value of the investment in question and how it can improve overall market efficiency, stabilise nations and address societal challenges including poverty. We explore this theme further in our next blog.