Dr. B.O. Oramah

1. Financing Local Content Vehicles in Africa’s Oil & Gas Sector: Some Lessons of Experience NOT AN OFFICIAL UNCTAD RECORD By Dr. B.O. Oramah Senior Director (Planning & Development Department) African Export-Import Bank (Afreximbank) Cairo, Egypt Paper Presented at the 11th African Oil & Gas, Trade & Finance ConferenceNairobi, Kenya - May 23-25, 2007

2. INTRODUCTION 1.1 Preamble • Africa’s Oil & Gas Sector (the “Sector”) still remains an enclave with limited linkages to other sectors of the economies of African Oil Producing nations. • That notwithstanding, the Sector constitutes the backbone of the economies of the African Oil Producing nations. • The Sector accounts for over a third of the total merchandise export revenues of the Continent.

3. Against this background, African Export-Import Bank (the “Bank” or “Afreximbank”) considers it as a Strategic Sector and supports activities within the Sector. • Afreximbank is therefore pleased to be invited to participate in this Conference and to share with delegates its experiences in the financing and promotion of Local Content in the Sector in Africa.

4. 1.2 AFREXIMBANK • Established in 1993 as a multilateral financial institution. • Shareholders include African governments, African private investors and non-African investors. • Authorized capital = US$750 million. • Mandated to finance intra- and extra-African trade. • Headquartered in Egypt with Branch offices in Abuja, Harare and Tunis. • Cumulative approvals since 1994/95 to 2006=USD10.2 billion

5. Afreximbank (www.afreximbank.com) has come a long way in bringing Structured Finance to Support African entities operating in the Upstream segment of the Sector. From 1998 to 2006, the Bank’s credit approvals in favour of the Sector amounted to about USD2 billion. • Prior to the introduction of Afreximbank’s Structured Oil Field Services Financing, Corporate Finance was the Instrument of Choice in Financing Operators in the Sector.

6. The consequence was that Oil Field Services remained under the control of Large Multinationals with very little local participation in the Sector. Financing of African operators seeking to develop Marginal Oil Fields was also considered unattractive by lenders. • Afreximbank’s activities in the Sector seems to be reviving the interest of International banks in the financing of Local firms operating in Africa’s Oil & Gas Sector.

7. 2. Africa’s Oil & Gas Sector 2.1 Activities in the Oil & Gas Sector Activities in the oil sector can be broadly categorized into: a) Upstream Activities: • Exploration; and • Production of crude. Oil Field Services support the above activities b) Downstream Activities: • Refining; and • Distribution and Sales.

8. 2.2 THE UPSTREAM SECTOR 2.2.1 Africa's Strengths • Africa is well endowed with oil and gas resources, and accounted for about 12.3% of global oil production and 10% of proven global oil reserves in 2005. • Africa also accounted for about 8% of proven global gas reserves in 2003. • Increasingly higher quantities of oil and gas reserves are being found in Africa's deep and ultra deep offshore areas, especially in west Africa. • Nearness to Key Markets. • Low Production Cost.

9. 2.2.2 Weaknesses • Volatile oil and gas prices; • Wars/ community disturbances; • Environmental problems; • In many countries, unclear rules and regulations regarding award of Concessions; • Over-dependence on foreign technology and skills; • Political instability; • Economic instability; and • Lack of Finance.

10. 2.2.3 Prognosis • Despite the weaknesses, activity in the Sector is expected to continue to grow driven by: • New technologies that have facilitated deep offshore activities; • Events in the Middle East that have accelerated geographic diversification and a surge in interest in Africa’s Oil fields; • Current high Oil prices and good near to medium-term market prospects;

11. Prolific nature of most basins; • Some policy support, e.g. Oil free zones in Nigeria, Equatorial Guinea and Angola; • Official support for the development of Marginal Fields; • Most activity in the near term, especially in West Africa, will be off-shore to avoid community problems and civil strifes and due to huge discoveries already made;

12. Given higher cost of off-shore activity, financing requirements will increase. • Movement to off-shore will require more logistics support increasing the importance of oil field services. • The increased need for local participation in Oil & Gas activities will expand in terms of allocating some major fields as well as some major oil service contracts to indigenous entrepreneurs.

13. Attacks on Foreigners in the Niger Delta has led to withdrawal of some foreign Oil Service Companies, e.g. Wilbros. If this trend continues, Local Content will accelerate especially given the emergence of competent local companies.

14. 3. LOCAL CONTENT: SOME ISSUES 3.1 Definitional Issues 3.1.1 A Nigerian Local Content Committee defines Local Content as: “…the quantum of composite value-added to, or created in, the Nigerian economy through a Utilization of Nigerian human and material resources and services in the exploration, development, exploitation, transportation and sale of Nigerian Crude Oil and Gas resources without compromising quality, health safety and environment”.

15. 3.1.2 Key Objective of Local Content Policy is to increase Local Value Added in Oil and Gas production and Sales, i.e. the Sum of: • Rent (R) • Wages (W) • Salaries (S) • Interest (I) • Profits (P)

16. 3.1.3 Thus: • Local Content Promotion does not necessarily mean Indigenization of Ownership of firms operating in the Sector • Local Content Policy is successful if: where n represents all firms in the Industry; and where LC = Local Content; TS= Total Spend; and t = time n n - Σ Σ (R +W +S +I +P ) (R +W +S +I +P ) L L L L L t L L L L L t-1>0 L=1 L=1 > LC LC ( ) ( ) TS TS t t-1

17. Measurement Issues need to be properly dealt with in Determining Local Content (LC) Targets e.g. how are goods supplied by a local company but imported classified? • LC is better measured at firm levels rather than focusing on Spends per Project.

18. 4. LOCAL CONTENT: Achievement and Targets 4.1 Successful Countries include • Norway • Venezuela • Malaysia • Brazil 4.2 In Africa, Nigeria appears to be the One Country Vigorously Pursuing this goal restricting certain activities to Local Firms e.g. • Certain Seismics • Front End Engineering Designs • Fabrication • Geological and geophysical studies • Fixed Platforms • FPSO Top-Sides construction, etc.

19. 4.3 The ultimate objective of LC policy is to break the enclave nature of oil activities 4.4 Successful countries have used a cluster approach to achieve this through promoting Domestic Supply Chains

20. 4.5 In the Oil and Gas Industry, Service Companies / suppliers account for 80% - 90% of cost of producing a barrel of oil. Billions of US$ can therefore be retained in the Continent if domestic Supply Chains Flourish.

21. 4.6 Michael Porter is regarded as the founder of the Cluster Approach in Economic Policy Decision-Making. Porter defines Industrial Clusters as: “Geographic Concentrations of Inter-connected Companies, specialized suppliers, service providers, firms in related industries and associated institutions e.g. universities, standards agencies and trade associations, in particular fields that compete but also cooperate”.

22. 4.7 Benefits of Clustering: • sharing of expertise • Complementarity in bidding for works • increased scale economies through specialization (e.g. through bulk purchase, joint marketing etc.) • Rapid spread of information and knowledge • Crucial support services are attracted, e.g. infrastructure, legal, financial etc.

23. 4.8 HOW CAN CLUSTERS EMERGE? Through: • gravitation towards a large leading sector, e.g. as in Houston and Aberdeen • public policy, e.g. as in Norway, Malaysia, Brazil and Venezuela. Local Industry Clusters account for 45% to 75% of the supplies and works in the O&G industries of these economies 4.9 Most successful Clusters have emerged through public policy.

24. 4.10 In Africa, Nigeria is a good case where public policy is attempting to create Industry Clusters and Supply Chains in the Oil and Gas sector through its Nigerian Content Policy.

25. 5. Financing The Oil And Gas Supply Chain 5.1 What Are Oil Field Services? 5.1.1 Restrictively seen as Logistic Services - Marine Services, Provision of Facilities, Maintenance Services 5.1.2 Definition expanded (as Oil Industry evolved) to include Engineering, Construction, fabrication, Drilling, and other activities.

26. Oil Services Market has enlarged as a result of: • Out-sourcing of most activities by Producers • Increasing importance of off - Shore Activities 5.1.3 Accordingly Typical Project is executed with variety of contracts involving Services and Supplies (See Fig. 1)

27. FIGURE 1OIL FIELD DEVELOPMENT PROJECTSHOWING TYPICAL SERVICE CONTRACTS INVOLVED Project Owners Project Construction Contract O&M Contract Spares And Materials Supply Contract Services Ownership interest Service Contracts awarded through JV Operator

28. 5.2 Typical Service Contracts are: • Those signed between Oil Producers (Oil Majors / Minors) and Major oil field services companies, for example; • Schlumberger • Halliburton • Baker Hughes, etcetera • Contracts between Major Oil Producers and Minor Oil Service Companies • Sub contracts between major service providers and minor Oil Service Providers.

29. 5.2.1 In Africa, most of the services shown in “Figure 1” are provided by Foreign Companies. 5.3 But Local Content Promotion in Oil Field Services Business is becoming a priority in some African Countries, such as: • Nigeria where target is up to 45% Nigerian by end of 2007. • Angola where goal appears to be 10%

30. 5.4 Goal is to capture huge amounts of money paid to Service Providers and integrate the Oil Sector with the Overall Economy through creating Industry Clusters with strong local content. 5.5 Financing is a major constraint in promoting domestic Supply Chains in the Oil and Gas (O&G) sector because of the characteristics of indigenous Oil Service Companies (OSC) listed below:

31. small size of capital (USD 1 million or less), except a few in Nigeria that have grown significantly in size • firms with limited experience in oil field services • have no, or limited borrowing track record • negative net current assets in cases where debt financings have occurred • corporate structure sometimes confusing

32. small players with annual revenues of less than USD5 million • usually require financing far in excess of equity capital • loan required usually of medium term nature as main use of loan is to acquire equipment for contract execution

33. 5.6 The Critical Issues in Financing Indigenous Companies Therefore Revolve Around How To Deal With: • Their Low capitalization • Limited experience • No borrowing track record and therefore no credible banking relationships • Their Highly specialized assets with limited secondary market. • The above factors mean that pure corporate Finance will be difficult • Resort to local bank financing is constrained by lack of medium term funding in many markets

34. 6. Afreximbank’s Experience: • The Bank had since 1998 been financing Local Content Vehicles (LCVs), especially in Nigeria and Angola. • Preponderance of funding have gone to: • Marine Services e.g. Leasing of Tug Boats, Barges, Anchor handling vessels etc. by LCVs to Oil Majors. • Drilling Services • Logistics Services • Engineer, Procure and Construct Contracts as well as Fabrication Works Financing have been limited.

35. 7. Some Case Studies 7.1 Financing Rig Acquisition for Performance of Drilling Contracts for an Oil Major.

38. FIGURE 2Deal Structure Lenders Account Banks Loan Repayment Security Trust Deed Loan Repayment Account Charge in favour of Security Trustee Security Trustee/ Collection Account Bank USD70 million Loan DSRA & DSA Payment of Contract Proceeds Assignment of all Contract Proceeds & Other Collaterals Security Trust Deed Payment of Contract Proceeds Oil Service Contract Oil Major for the Contract being Financed Drilling Contractor Contract Performance Contract Performance Oil Service Contracts Other Oil Majors DSRA – Debt Service Reserve Account DSA – Debt Service Account

39. Strengths of the Deal • Solid performance history of Drilling Company • Diversified pool of contracts and receivables • Oil service contract, long, binding and enforceable. • Clear Local Content policy and policy support • Strength of the contracting counter-parties i.e. Oil Majors • Rig Refurbishment contract with first rate name in the U.S.

40. 7.2 Financing Logistic Services Provider

41. 7.2 Financing Logistic Services Provider (Cont’d)

42. 7.2 Financing Logistic Services Provider (Cont’d)

43. FIGURE 3Deal Structure US$50 million working capital finance US$50 million for construction jetty & camp US$30 million equivalent in local currency, to refinance existing loans Oil Service Company Bank Syndicate Legal assignment of the right to receive all proceeds under service contracts All-risk Insurance Debt Service SPV Contracts Irrevocable instruction to pay into collection account: confirmed by oil companies Collection Account Consents Insurance Companies Payment Debt Service Account Central Bank Oil Companies

44. Strengths of Deal • Long, binding and enforceable contracts with Oil Majors. • Diversified pool of receivables. • Diversified pool of activities some with very low performance risk. • Although company is of mixed ownership (Foreign and African), it met the Local Content Policy definition. • Owners have long experience operating in Africa. • Activities critical to Oil Majors so strong Oil Majors support.

45. 7.3 Financing a Small Marine Services Provider

46. 7.3 Financing a Small Marine Services Provider (Cont’d)

47. Strengths of Deal • Experience of promoters and the company in providing Marine Services. • Long, Binding and Enforceable contracts. • Contingent Oil Service Contract mitigates performance risk. • Willingness of counterparty to acknowledge notice of assignment. • Asset- backed Structure. • Local content policy support. • Vessel Leasing has limited performance risk.

48. FIGURE 4Deal Structure Lending Banks Contingent Oil Service Company 5. Repayment of principal and interest 3. Disbursement 2. Assignment of Service Contract Proceeds Oil Majors Oil Service Contractor 1. Oil Service Contracts 4. Performance of Service Contracts

49. 8. Lessons • A variety of LCV’s can be financed if the ingredients are right, namely: - right contracts i.e. • long, binding and enforceable. • credible contract counterparties. • willingness of counterparties to acknowledge notice of assignment. (b) Company size need not be a constraint if deal is properly structured. (c) Asset-backed lending mixed with structural receivable- backed financing present good structure when the LCV is weak. Oil Service assets namely rigs, vessels etc., have of recent been appreciating in value and are in high demand.

50. 8. Lessons (Cont’d) (d) Emergence of NOCs as exploration and producing companies need not be a constraint to financing activities in the future. (e) International banks are getting wiser and entering the market • Afreximbank has not suffered any loss in LCV deals. A difficult deal was fully recovered from disposal of asset financed. • Introduction of Contingent Oil Service provider mitigates performance risk • Getting Oil Majors to acknowledge notice of assignment still a problem but legal opinion shows it doesn’t matter as long as Notice is served as experience supports this. • Build-in 30-90 day delays in repayment in your structure as big Oil Majors sometimes delay payments for works done.