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ESG uncertainty continues to disrupt industry M&A

© Shutterstock / Roger Brown PhotoSeals in the front, rig in the back
Cape fur seals rest on a beach in Namibia with a oil rig in the background.. Shutterstock ID 1399480877

High energy prices have revived interest in Africa’s oil and gas, but financing remains painfully hard to secure, amid ESG uncertainty.

Energy has been in the spotlight in recent times as oil and gas prices have spiked, as sanctions on Russia build on economies reopening after the pandemic slowdown. Given Europe’s need for alternative sources, Africa seems well placed – but investment have yet to start flowing.

The European Union has set out an ambitious plan to eliminate its dependency on Russian gas by 2030. Countries that have previously driven talk around the energy transition have set out plans to fast track LNG supplies.

Germany, the Netherlands, Italy and others are reconsidering how they will secure the energy they need.

Fickle finance

While governments have rediscovered their enthusiasm for natural gas, financiers remain reticent. A lack of financial support has hamstrung new entrants to the energy space.

“ESG has had a massive impact. It’s extremely challenging to raise capital,” United Oil and Gas CEO Brian Larkin said. “We’re fully funded from cash flow but an acquisition that might need to bring in cash looks more challenging.”

Monitor Exploration CEO Andrew Shrager agreed saying that institutional investors’ focus on ESG and the energy transition made financing “very difficult” for independents.

“Investors are only prepared to back companies looking to buy production and who can say they’re doing something on the environmental front. That’s made it difficult to look at exploration,” Shrager said.

Energy needs

The case for Africa needing its own energy transition, with access to more energy and at the right pace, has often been made. Europe, now facing its own energy challenges, cannot afford to absent itself from this debate.

“This is still the biggest business in the world. There’s a need to invest, otherwise the collapse in supply will be even worse. Environmentalists may welcome the reduction in oil and gas but this would drive even greater problems – and put more power into the hands of those with supply,” Shrager continued.

“The EU has said it may classify gas as green, that would help unleash investments,” said Envoi technical manager Martin Riddle.

BlackRock CEO Larry Fink has often been named as driving investment away from oil and gas. In a March letter, though, he highlighted that the energy transition would “only work if it is fair and just”. The shift, he said, would not come in a straight line.

The investment manager went on to say BlackRock was committed to helping companies in the energy transition. “To ensure the continuity of affordable energy prices during the transition, fossil fuels like natural gas will be important as a transition fuel.”

On the up

Higher energy prices may go some way to securing new investments in the sector. This is driven by the longer term trend of demand recovering after the dark days of the pandemic, compounded by the short-term volatility of Russia invading Ukraine.

“What goes up quick can go down quick,” United’s Larkin said. Prices are hard to predict but a number of banks and advisors have suggested these will be higher for longer.

There are always difficulties around buyers and sellers agreeing to a price. “The only way is to be pragmatic in M&A,” Larkin said. Deals should be structured so “there’s no buyer or seller embarrassment”.

The way to achieve this is to have mechanisms in place to “ratchet up or down if the price improves or deteriorates”, Larkin said. “You have to have a practical buyer and practical seller. A ratchet mechanism protects both sides.”

The independents

One of the continuing trends is that of majors leaving mature – or more complicated – assets. Shell has sold down projects in Egypt, to Capricorn Energy, and a number of licences in Nigeria. BP is forming an independent joint venture in Angola with Eni, while holding talks on reducing its work in Algeria and Libya.

“There’s a lot of interest in projects in Africa, but it’s the same companies looking. The challenge is around raising the money – and that’s been an issue for quite a while. There’s not enough money and there’s not enough people who can vet opportunities properly,” Envoi’s Riddle said.

Savannah Energy and Seplat Energy are two companies that have managed to buck the trend, focused on West Africa.

“It’s still a buyers’ market. Companies that have production and cash flow, like Seplat and Savannah, have opportunities,” Riddle continued.

The majors have “left a lot of crumbs on the table”, United’s Larkin said. “There’s a lot of opportunities for small companies with track records, strong boards and capable executives. There’s so many opportunities right now – I’m the most excited I’ve ever been, particularly in Africa and South America.”

Larkin went on to say that exploration was seeing a return of sentiment. United, he said, takes a managed risk approach, where 90% of its investments go into production and 10% into exploration.

“As the production business grows we can take on more exploration risk. We understand that everyone wants production but it’s the cyclical nature of the business. There have been very few large discoveries in recent years.”

Deepwater delve

The majors’ plans will be closely watched, particularly in the deepwater. The last 12 months have seen some indications of a return to exploration, with Eni drilling the Baleine find in Cote d’Ivoire, while Shell and TotalEnergies scored discoveries offshore Namibia.

“In the deepwater, there’s a limited number of companies that can participate,” Envoi’s Riddle said. The days of minnows taking on the frontier and deepwater risk are unlikely to return in the foreseeable future.

The Venus and Graff discoveries in Namibia demonstrate what can still be found. A number of small companies in the offshore will be hoping that the Total and Shell finds have piqued interest in deep-pocketed potential partners.

“The finds are going to spark a lot of interest in the upstream of Namibia. I expect more M&A as the bigger companies come in to acquire assets from junior oil companies,” SNC Law Group managing partner Shakwa Nyambe said. “Namibia has a chance to be the next Guyana.”

Envoi’s Riddle said governments must act to ensure their offerings are sufficiently attractive to secure investments.

“Looking at licence round plans, some governments haven’t realised this is the final swan song. There’s one last wave of exploration and production, before investment in renewables will take over,” he said.

Showing some signs of potential exploration growth, Shell signed up new licences in Malaysia in March while BP added new acreage in Indonesia.

Selling down

The focus, for now, is on buying production in order to cash in on high prices. These opportunities are in short supply. One exception though is the majors, aiming to sell down mature assets – or those with too many operational challenges.

Shell has publicly set out a strategy of selling down its onshore assets in Nigeria, with the others following.

This exodus of big oil from the onshore has some worried. Nigeria’s PENGASSAN union recently issued a warning, calling for the government to do more.

Most companies buying assets from the majors “do not have and cannot attract” the cash required to invest in their assets. Buyers tend to run assets down, rather than investing in workovers or drilling new wells, PENGASSAN said.

The Nigerian government “must be worried [about] portfolio and briefcase investors in the oil and gas sector whose sole aim is to milk the field dry”, the union said. It warned that this would have the result of the oil sector becoming as dysfunctional as Nigeria’s power sector.

The government should “persuade and further incentivise” the big companies to stay in country and secure benefits from the recently passed Petroleum Industry Act (PIA).

Ensuring sufficient capacity is a challenge for Nigeria and beyond. Oil demand is likely to reach record levels this year and the war in Ukraine has highlighted a major vulnerability in Europe’s reliance on Russia.

There is scope for additional investment in Africa to meet this shortfall, but the frosty ESG climate must show some signs of thawing to allow this to flourish.

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