Olufola Wusu

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The Minister of State for Petroleum Resources, Dr. Ibe Kachikwu, on Monday, July 31, 2017, while speaking at the opening ceremony of the Nigeria Annual International Conference and Exhibition organised by the Society of Petroleum Engineers in Lagos warned that the Federal Government will be compelled to halt oil production if the cost of production remains high, perhaps in a bid to enforce page 75 of the National Petroleum Policy which places Priority focus on low cost oil operations ($9-­10/bbl).

The minister said, “When you look at the cost of production in Nigeria, it remains blatantly high. Our cost per barrel today is about $27 per barrel for JV (joint venture) fields. In Saudi Arabia, it is about $9. So we are way apart in terms of cost that anything that happens will hit us very hard.

“…There is no way this country will produce oil at this sort of swelling prices that we see; there will be no margins left for this country.

“For me, you rather leave the oil in the ground than produce at a cost that doesn’t make sense. So, cost is going to be a very high driver. So that is certainly one area we are focusing on; we are working collaboratively with oil companies.

“But let’s make no mistake about it: If we cannot negotiate it down, we will compel it or we will stop the production; it does not make any sense.”

Nigerian Oil and Gas Production is carried out under four main contract types; Sole Risk, Marginal Fields, the Joint Venture Agreements and Production Sharing Contract, which governs offshore fields where the bulk of Nigeria’s production emanates from. Government’s role is interesting as it is both a player and a regulator in the industry.

There are six major International Oil Companies active in Nigeria:
1. Shell (SPDC)
2. ExxonMobil
3. Chevron
4. Total
5. ENI
6. Addax

There are a large number of indigenous operators in the Nigerian Oil and Gas Sector.

Stopping Oil Production?

Stopping production will drive up global oil price temporarily as supply will dip while demand remains constant, Nigeria won’t benefit from any marginal increase in price as it will have stopped production and may lose market share to emerging players like Iran.

Enforcement vs. Collaboration

Mr. Austin Avuru of Seplat was reported to have disagreed with Kachikwu, that issues of cost were a question of collaboration rather than a question of enforcement. His ideology may be similar to the paradigm held under globalization. Globalization had a theory that, markets mature to a point where they become self regulating, dispensing with the need for governmental policy intervention. However the subprime mortgage crisis in the United States which was a nationwide banking emergency, that contributed to the U.S. recession of December 2007 – June 2009 poured cold water on the theory of self regulating markets.

Policy Directions are long overdue!

In a free market economy, Government acts in a paternalistic role, giving policy direction to industry players, compliance is rewarded and non compliance is sanctioned. The issue of collaboration only comes up when industry players need help in complying with policy directions issued.

The National Petroleum Policy has given clear policy direction on cutting cost of oil production which the Honorable Minister seems poised to enforce.

What factors influence cost?

At page 57 of the National Petroleum Policy, the Nigerian government acknowledges the need to help produce a lower cost environment by:
a. Resolving the Niger Delta militancy issues
b. Reducing the general cost of doing business in Nigeria
c. Optimizing Contracting cycles

OPEC vs. Shale Producers
While OPEC attempts to control the price of Oil, it also needs to address two critical issues: the need to maintain prices at a reasonable level without losing market share to non-OPEC producers and the need to maintain unity and cohesion in the midst of geopolitical tensions and differences in domestic economic situations.

OPEC has tried to control Oil prices by attempting to regulate supply in order to influence price. OPEC strives with limited success to control “external factors and parties” in an attempt to control price with mixed results.

The easiest way to achieve this – short of a major exogenous shock to oil production — through a large increase in energy demand or a dramatic fall in its supply, perhaps remotely triggered by the heightened tensions between the United States and North Korea and their respective allies.
The alternative is better supply management. Here, OPEC members have essentially three types of approaches available, and each comes with implementation challenges.

1. OPEC can to try to set up and coordinate an alliance of OPEC and non-OPEC producers in order to regulate supply and price.

2. OPEC can try to strengthen its alliance with non-OPEC producers by pushing for stronger production cuts and more effective verification mechanisms.

3. OPEC can repeat its strategy of attempting to disrupt the current production of non-OPEC suppliers by over supplying Oil to the point where prices drop below the production cost of OPEC and non-OPEC producers like Shale Prodcuers, depriving non-OPEC Producers of cash flow to fund their operations.

Strategic Response; Shale Producers cut cost by Innovating (Hydraulic Fracturing)

OPEC had attempted to disrupt the current production of non-OPEC suppliers by over supplying Oil to the point where prices drop below the production cost of OPEC and non-OPEC producers, depriving non-OPEC Producers like Shale Producers of cash flow to fund their operations.
OPEC’s strategy to over supply crude oil to crash prices, had a crucial flaw, it under estimated the power of Shale Producers to control an internal factor; the price at which Shale Producers produce oil and gas.

How Shale producers drove down cost?

OPEC’s strategy ended up triggering off a “cost cutting war” among the Shale Producers leading to the fine tuning and commercial application of the Intellectual Property backed “Hydraulic Fracturing” process used by drilling companies to increase the amount of oil and gas that is produced from each well in unconventional plays. While OPEC was trying to cut supply, Shale Producers were able to cut their production costs by half!

Need to reduce the cost of producing Oil and Gas in Nigeria

Consistent losses + Government subventions = No job losses
The NNPC is one of the few oil companies in Nigeria that has not significantly downsized regardless of the drop in oil prices. It may have consistently declared stupendous losses yet it plans to expand its retail footprint across Nigeria.
The big question is; what are the possibilities if the Federal Government can no longer afford to subsidize the operations of the NNPC?
Another question is can the government which depends on income from the oil and gas industry; afford to give subventions to the entire oil and gas industry? Your guess is as good as mine.

Capex vs. Downsizing

Most oil and gas companies have severely cut their capex, as the oil prices drop some more, oil and gas companies both international oil companies “IOC’s” and indigenous companies may be forced to further cut capex and downsize.
Strategic Companies Innovate
Some argue that more strategic companies will keep their staff during the dip in oil prices with the knowledge that the oil price will rise again. That may be a valid argument but should it not be left to the oil and gas companies to decide how “adventurous” they want to be with their capital?

The IOC’s may have a war chest to withstand that kind of strain, it’s the indigenous companies I am worried about, they may not have the financial depth or the operational width to withstand a prolonged dip in oil prices. Perhaps this incident will trigger off a wave of cost cutting via innovation protected by Intellectual Property among the indigenous oil and gas companies…

IOC Strategy: Oil and Gas + IP = Sustainable profitability

Besides the IOC have both tangible and intangible assets to bank on, Shell is reported to have the most valuable brand in the oil and gas industry while ExxonMobil is reported to have collected more than US $129 million in 2011 from licensing its IP to third parties, and this number is increasing every year.
Innovation/Intellectual Property is crucial for sustainability; the IOCs can pledge their IP as collateral for fresh facilities.

Indigenous Oil and Gas Companies Strategy:

Oil and Gas – IP = Non-Sustainable profitability?
Meanwhile, our indigenous oil and gas companies may not have any oil and gas IP; they typically engage technical partners (who spend tons of cash on Intellectual Property to give them an edge) with great fan fare.

Some indigenous companies have been in existence for over 30 years but I am not sure we have many indigenous oil and gas companies who have “research and development departments” much less a cache of oil and gas IP.
Once the returns from their tangible assets i.e. oil rigs dwindle due to low prices they cease to be very profitable, worse still they barely have any intangible assets i.e. IP to leverage on. They end up waiting for oil prices to rise before they can return to profitability.

Indigenous companies need to borrow a leaf by cutting the cost of Oil production in line with the National Petroleum Policy, by applying innovative technologies and processes protected by Intellectual Property to cut the cost of producing cost of oil.

North Sea oil and gas companies’ strategy
Innovation/IP+ new markets = sustainable profitability

The UK government is supporting the oil and gas companies by encouraging them to invest in other markets like African countrues. Besides the UK government is encouraging the North Sea oil and gas companies to innovate and protect their innovation. This is based on the premise that innovation will help a company ride through trying times and boost its profitability even more when oil prices stabilize.

Mini case study: Innovation/IP + Oil and Gas= Sustainable Profitability

Qatar LNG is arguably the biggest LNG company with 20 trains, Nigeria LNG has 6 trains. Qatar LNG has developed indigenous LNG technology making it easier and cheaper for it to produce its LNG on a very large scale. Large scale production of LNG comes with the benefit of price flexibility, ability to meet demand and its immense LNG storage facility gives it increased security of supply. Recently QatarGas LNG was able to give prices rebates to win a contract worth $18 Billion from Pakistan.

QatarGas has huge technological advanced LNG vessels that enable it to deliver one single cargo to two different locations at a time. Most LNG companies can only deliver one single cargo to one location at a time.

Page 57 of the National Petroleum Policy provides for incentives to reward lower cost producers. To reduce the cost of oil production in compliance with the National Petroleum Policy and in a bid to benefit from the unnamed incentives, indigenous companies need to look for cheaper, better and faster ways which are often protected by Intellectual Property (Innovation) to produce oil and gas.
A good start for any oil and gas company seeking to reduce cost in compliance with the National Petroleum Policy is to identify what Intellectual Property Assets it has which can help it reduce cost…

Olufola Wusu is a Commercial, Oil and Gas and I.P. Lawyer based in Lagos

Olufola Wusu Esq. © 2017

Olufola Wusu is noted for his “dynamic practice” and “commercial acumen”. He is praised for his “first-rate skills” in assisting clients…