The nature of the Oil and Gas industry in Nigeria makes it unattractive for commercial lenders to agree to finance such projects when they are embarked upon by smaller companies. Even when such financing is available, it comes with high interest rate for loan servicing such that default is not particularly uncommon.
Lending is even more uncommon when financing is for smaller companies, worse still when the smaller companies are vendors, sub-contractors, specialist consultants and service providers this may be because of the inherent risks involved and the possibility that their contracts are not bankable in the opinion of the lenders.
Regardless of the difficulty in securing loans oil and gas exploration projects have developed alternative means of finance through the use of Drilling Funds, Illustrative Agreements, Royalty Purchase, Sale Purchase Agreements, Production Sharing Contracts and company backed contractor funding.
Innovative Funding Initiative
Innovation is simply the use of creativity and witty inventions in solving problems; this creativity sometimes births assets that qualify for Intellectual Property protection. In this regard, it was recently reported that some Nigerian Banks have signed a Memorandum of Understanding (MoU) with Total E&P Nigeria Limited and Total Upstream Nigeria Limited for a $7.5 billion (Seven Billion Five Hundred Million Dollars) Nigerian Contractors’ Initiative. Under the arrangement, the accredited banks would specifically finance Total’s local contractors meanwhile there will be domiciliation of payments in the banks, thus giving Total and the Banks less risk and more control. (It seems Total and its lenders are optimizing risk by adopting flexible contracting strategies).
Non bankability of contracts is the unwillingness of banks to finance a project or a contract most often due the uneven distribution of risk and other factors. This is a challenge faced by Marginal Field Operators and smaller companies like vendors, sub-contractors, specialist consultants and other service providers.
What is a Bankable Contract?
In this writer’s opinion, a bankable contract can be defined as one where risk allocation between the contractor and the project company is acceptable to the lenders (Nigerian Banks). Lenders/banks all over the world focus on the ability (or the lack), of the contractor to claim additional costs and/or extensions of time as well as the security provided by the contractor for its performance.
Low comfort=High Equity Support
Where the lenders are uncomfortable with the level of risk, the greater the amount of equity supports the sponsors will have to provide.
Contracting Strategies in Oil and Gas?
The Oil and Gas Industry has evolved a series of contracting strategies to help it allocate tasks, responsibility and risk. Lenders have shown a preference for Engineering Procurement and Construction (EPC), Engineering Procurement and Construction Management (EPCM) as these contracts seem to have single point of responsibility, guaranteed completion date and clear division of obligations and liabilities, other more flexible variants include Lump Sum Turn Key Contracts (LSTK) and Convertible Contracts.
Possible Ways Lenders Assess Bankability?
Lenders may look for fixed completion date like in an EPC Contract, they look for a fixed completion price for the project, they like to see no or limited technology risk; output guarantees; liquidated damages for both delay and performance which is a standard feature in EPC Contracts; security from the contractor and/or its parent; large caps on liability and restrictions on the ability of the contractor to claim extensions of time and additional costs (ideally liquated d.
Merits of the Funding Initiative
The possible merits should include a sustainable Funding Relationship, safe compliance with Nigerian local content laws, bridging the funding gap for the company’s local contractors, effective management of the facility by the financiers and effective management by Oil and Gas Companies of its value chain, including suppliers and distributors.
Management and Supervision of Funds and Project
This arrangement inherently increases the capacity of both the lenders and the company to manage both the funds and the project in general more effectively.
Accessible Funding for Vendors and Suppliers.
The funding initiative makes it easier for the vendors, sub-contractors, specialist consultants and service providers to access funds from lender with the Oil and Gas Company’s involvement, erasing totally any doubts of excessive risk and other fears that banks harbour.
Compliance with Local Content Provisions
This unique funding initiative provides a safe method by which International Oil and Gas companies may comply with the Local Content provisions in Nigeria. Local content provisions make it mandatory for Nigerians to be involved to a certain degree in Oil and gas projects and stipulate training of local employees and the exercise of a preference for local contractors.
Taxing the proceeds of such a project might not be difficult as the transaction history would be easily accessible given the cash flow of the Oil and Gas companies, vendors, sub contractors, specialist consultants and service providers would all probably be domiciled with the bank/lenders.
Take down Lightening Rods for Disputes
Regardless of the amity between the Oil and Gas Company, the lenders and vendors, sub contractors, specialist consultants and service providers, the Oil and Gas company desires its work done, the lender will want the facility repaid on time while the vendors and others will want to be paid on time for the work done. It is this author’s observation that all these expectations, if not properly managed, can easily lead to disputes with some particular issues having a higher tendency to spawn conflict than others, it will be prudent to prevent contractual disputes and major claims as they automatically increase project cost. A good example is an “Ill-defined work scope /specification” this will probably snowball into a dispute as unclear work scope/specifications often drive up cost, with conflict arising over who will bear the extra cost. Discrepancies in piping & instrumentation diagrams (P&ID) may also increase project cost and lead to disputes.
Differing interpretations of standard contracting requirements such as Force Majeure terms; Limitation of liability and Liquidated damages may also result in a full fledged dispute.
Settlement of Disputes
Where disputes between the parties (Oil and Gas companies, vendors, sub contractors, specialist consultants and service providers) arise from the “Funding Initiative, the parties may settle same by mediation, negotiation, arbitration by an independent expert or, in the event there is no reconciliation, by litigation as a last resort.
Choice of Law
Parties may wish to choose the law that would govern the contracts and any disputes that may arise, seeing that the contract will be performed in Nigeria; Nigerian Law may just be the convenient option.
Contracting strategies will continue to evolve to cover the ever changing business environment with old arrangements being used in new ways to solve new problems involving old or new parties. It is this writer’s hope that the innovative funding initiative be fine tuned and sustained so that it can evolve into an industry standard beneficial to all. The information contained in this piece should help inform the Oil and Gas Company, its lenders and its vendors, sub-contractors, specialist consultants and service providers seek legal advice as to some possible issues prior to signing any contracts.
Olufola Wusu is a Commercial, Oil and Gas and I.P. Lawyer based in Lagos
Olufola Wusu Esq. © 2013
Olufola Wusu is noted for his “dynamic practice” and “commercial acumen”. He is praised for his “first-rate skills” in assisting clients…