NATURAL RESOURCES INSIGHTS | 30 JUNE 2020

Achieving high yields in a low yield environment

Camillo Atampurgre Author

Camillo Atampugre

Senior Banker - Natural Resources and Energy

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Africa remains an attractive market for international capital for oil projects and investments.

Africa remains an attractive region for international capital keen on funding upstream projects. There is increasing appetite from funds chasing yields and who are looking at the upstream sector in Africa on a selective basis.

Those investors who are able to understand and overcome some of the risks involved are able to demand significantly higher yields in a low yield environment.

Africa is home to substantial oil and gas discoveries, which require large capex to develop. This provides an opportunity for international capital, including banks such as Absa, to invest or provide capital.

While international oil companies have been rationalising mature legacy assets by exiting from some African countries, we have seen significant commitments to new mega-projects in other parts of the continent, for example in countries such as Mozambique, Angola and Senegal and Mauritania.

On the other hand, Asian national oil companies are also increasing their share of investments in the upstream as they continue to secure oil supplies to meet domestic energy requirements.

New capital demands

When it comes to new capital, this has been largely driven by private equity backed by Exploration and Production (E&P) vehicles and Global Trading houses. Private equity-backed vehicles have focused on mature producing assets divested by international oil companies, where they see a unique opportunity to create value by optimising recovery, cost cutting and resource additions.

Traders have also been driven by access to production, which they can use to leverage their trading infrastructure.

When we look along the capital structure, there is appetite from funds chasing yields and who are now looking at the upstream sector in Africa on a selective basis.

Those investors who are able to understand and overcome some of the above-ground risk are able to demand significantly higher yields in a low yield environment.

For the new hydrocarbon provinces, development finance institutions and export credit agencies are critical in securing project financing for the large-scale projects, such as those in Mozambique.

Development finance institutions and regional banks are also increasing their support to fund the upstream sector in Africa.

Meeting a financing gap

The global oil traders who have been very active in the upstream space have shown appetite along the capital structure by providing funding in exchange for production offtake. They have also demonstrated their flexibility to participate at the mezzanine level as well as arranging bank debt.

Although predominantly focused on liquids offtake, some traders are now interested in securing gas offtake to bolster their portfolios and to position for the energy transition.

Because the large global banks are highly selective about transactions and focus more on quality, the traders have moved in quickly to meet this financing gap.

We are therefore seeing that traders have increasingly become the new source of liquidity in the market with their funding tied to long-term offtake agreements.

In transactions where traders are present, the attractiveness of the deal is enhanced because banks are able to take additional comfort in partnering with a credible trader as an off-taker and funder in the deal.

However, a broad criterion for a majority of the traders is to fund developments where production is approximately 10kbopd or above or alternatively where there is clear sight to material production growth in the near term targeting the “10kbopd” production goal.

Various players are involved in the market

The entry of non-traditional providers of capital in the African upstream sector has been received positively from the perspective of regional banks.

However, for the mega upstream projects international banks continue to play a leading role in advising, structuring and arranging the funding and as such participants remain the traditional banks.

But for a number of transactions, which are material, but of less high profile in nature regional banks, traders and funds have combined forces to get transactions across the line.

In some instances, deals have been accompanied by vendor financing which from a traditional banking perspective provides a significant boost to the comfort levels required by credit teams.

So how can fund managers develop sustainable strategies for emerging markets’ hydrocarbon sector?

Sustainable investing has been rising significantly on the agenda of fund managers and in particular in the oil and gas space.

Many investors support schemes to improve transparency and disclosure with increasing demand for information about how oil and gas companies are responding to the environmental threat.

In Africa, the importance of Environmental, Social and Corporate Governance (ESG) has become important when it comes to banks providing funding for projects or clients. For fund managers, a sustainable strategy has to consider a number of factors, which will require the sector to evolve and improve their ESG strategy comprising of:

• Disclosure of impact on climate and clear policies to reduce carbon emissions
• Energy mix favouring gas assets/ projects – as a transition fuel
• Transparency and accountability around corporate governance and associated policies; and
• Ability to demonstrate the positive social impact of projects i.e. local content, community engagement.

In the African context, however, it is important to acknowledge the importance of the oil and gas sector to the economies of the producing countries, as a source of government tax revenue, which supports the fiscal budgets and access to hard foreign currency.

Therefore, a complete exit from investors in the resource extraction sector would be a disaster for the economies. However, the approach to sustainability and in particular ESG should be at the forefront of any investment decision.

That is why at Absa, the cornerstone of our credit decisions is to ensure that the project meets the requirement of the Equator Principles, which are a set of industry standards that are benchmarked for sustainability, social and environmental risks management for project finance.

Camillo Atampurgre Author
Camillo Atampugre

Senior Banker - Natural Resources and Energy

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