bongo beats his drum: oil nationalism & expropriatory risk in gabon

this week, gabon has officially stated that it would like to expropriate assets of three international oil companies (IOCs), one of which include addax–a company that makes up approximately one-third of sinopec’s international acreage. the expropriated production field in dispute–obangue–represents about 3% of sinopec’s portfolio, and if addax’s other two fields are taken away–tsiengui and koula–it would be another deep cut to addax’s operations, as these two fields contribute roughly 2-3% of the company’s earnings. in total i estimate gabon to be 5-6% of sinopec’s portfolio.

while most people view this looming dispute as an equity story, gabon, which is one of the few countries in the region that posts budget surpluses but it also dealing with declining oil outputs, there’s also a fixed income narrative. gabon has a $1 billion dollar eurobond due in 2017 that has traditionally been a safe bet for those in the african sovereign bond space, as it generally tracks global oil market dynamics. the three fields in question produce 40,000 barrels of oil per day, which translates to 20% of gabon’s total oil output and 16% of its export earnings ($1.6 billion). however, the country has been late on some of its payments recently, and some of its bondholders with whom i’ve spoken have raised surprising questions on its creditworthiness.

so what does this all mean for investors with gabon exposure? i’ll answer three sets of questions.

Q1: what will the outcome of the court case be for addax? what does this mean for future chinese investment in to gabon?

Q2: will this impact upcoming offshore bid rounds in gabon?

Q3: how does the power struggle in the bongo family feed in to expropriatory risk?

A1: china is not likely to win its case against gabon, and will have to increasingly comply with resource nationalist demands from the government. many companies have undergone government-led audits of their contracts in the past year. while addax is arguably the most high-profile of these reviews, canadian natural resources, as well as france’s maurel & prom and perenco have also been looked at. perenco was able to mitigate their expropriatory risk by accepting more onerous fiscal terms on a license that was set to expire. while many observers of china-africa relations see african countries as being squarely on #teamchina or #teamUSA, ali bongo’s gabon has shown that it does not favor west, east, or south. as such, the claim that chinese companies were unfairly targeted will likely fall on deaf ears in an arbitration court. moreover, the gabonese government has also pursued similar action against cmec for failing to develop mining assets in a timely manner (see previous posts).

gabon’s government–which is undergoing a huge infrastructure buildout in efforts to achieve middle-income country status–claims that addax purchased its acreage at a substantial discount when oil prices were low. now, as gabon’s fiscal surplus which was 7.5% in 2012, looks to be halved and some to between 2-3% of gdp because of exponential increases in government spending, it will be looking to plug this gap as much as possible. gabon suggests that addax (before it was a subsidiary of sinopec) purchased the production fields at a $780 million discount when oil prices were around $70. it now demands that it make up for the difference. while to many western observers this is a clear example of seller’s remorse, i think international regulatory bodies–the world bank, imf, icc court of arbitration, et. al–are beginning to side with resource-rich african countries in cases like this. they believe that african countries who may have inked deals that might have not maximized state revenues to the fullest extent are entitled to take another look at contracts, especially if they were signed by leaders who were corrupt autocrats. a similar case is underway in guinea’s simandou iron ore mine, where it looks increasingly likely that vale will have to pay for bsgr’s sins.

A2: no, but small and medium-cap oil companies looking to invest onshore and in shallow offshore will have to compete with the government parastatal. after delaying offshore bid rounds due to environmental concerns in the aftermath of macondo, and failed attempts at closed auctions, gabon is planning a semi-open bid round for its offshore acreage sometime this summer. the deep offshore acreage up for grabs has pre-salt geology, which if developed properly, could be a boon for gabon’s lagging revenues. the government recognizes this, and if perenco is any historical indicator, companies with a proven track record of developing this geology (which tend to be the larger IOCs), will (a) be successful in winning bids and (b) not face expropriatory risk, so long as the contract penned with the government accurately reflects where oil prices will be going over the lifetime of the awarded field.

furthermore, there is a growing trend in west and central african resoruce-rich countries to force more established companies from onshore acreage that is technologically easy to develop for hydrocarbon parastatals. i’ve seen this in conocophillips’ divestment from nigeria for oando, as well as the emergence of angolan oil companies (read, shell companies) onshore. put simply, a state-owned oil company can develop onshore and shallow acreage, while deepwater pre-salt plays cannot. for gabon to chase out the few companies who have the expertise to jumpstart a lagging oil industry.

moreover, while the country still has yet to pass a new oil bill–some investors may question why a company may want to commit when it is clear that there will be a new regulatory framework–those who participate in the deepwater offshore licensing rounds will likely be immune to the slight increase in higher taxes and royalties, as well as forced government partnership and equity in some projects, because the government does not have the technological wherewithal to participate. it’s also increasingly likely that the government may not be able to finance some of its activity in the future event it does chose to form a partnership with iocs, especially if the government’s surplus continues to decline.

A3: bongo’s extended family is powerful enough to create headaches for him and investors, but not strong enough to completely derail investment. that said, contracts penned with omar will be put under closer scrutiny. since coming in to power, ali bongo has surprised many by doing a clean sweep of his father’s corrupt business networks that have become deeply engrained in the country. as addax’s acquisition occurred in 2009–the time when ali came to power–addax’s targeting doesn’t come to a surprise for many gabon politics watchers who have seen ali increasingly cut the old patronage networks and create new links for him and his closest allies. the fact that the state parastatal has been operating in obangue, instead of the old direction générale des hydrocarbures (which houses many of the ancien regime) is a sign that ali, through his associates who run the parastatal, is slowly taking control of the oil sector.

this is not to say that ali has complete control over investment decision-making in gabon, as he continues to face backlash from his many half-siblings and extended family members who want a greater share of the pie, or a politically-important oil union (ONEP) which has been increasingly prone to strike as of late and briefly disturb global oil markets. ali’s extended family still pulls many political strings within the country–but not the majority of them–and could very well continue to make life difficult as the country tries to present a more transparent image of its oil industry that has long been thought of as a vehicle for corruption. they could flex their muscles by aggravating onep (which would lead to strikes, 1-2 day blips in global oil prices, as well as continuing to complicate gabon’s re-admittance to the EITI initiative. the latter would perpetuate the oil sector’s image as highly corrupt and discourage equity investment among those who are worried about american or european business corruption investigations, as seen in cobalt’s problems in angola and civil society backlash.

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uganda:oklahoma::kenya:texas

tullow oil’s discovery in its first well in the south lokichar tertiary rift basin, kenya’s find could change the preexisting commercial dynamics of east africa’s emerging oil plays in a similar manner that texas crowded out oklahoma’s discoveries in the early twentieth century. so far tullow has downplayed its ngamia-1 well’s 20 meters of net oil discovery on block 10bb in turkana county, but has hinted that adjacent acreage in kenya, and also ethiopia, could be significant in the company’s africa expansion strategy. the block’s operators—tullow, africa oil corporation, and lundin—have estimated reserves to be from anywhere between 30 – 45 bbls of oil in miocene era sandstones. kenyan president mwai kibaki and energy minister kiraitu murungi have compared kenya’s light, waxy crude with ugandan varieties. tullow had long written off the rift valley basin in favor of the albertine rift basin (which is ten times larger than what is in kenya and ethiopia), but recent discoveries suggest that the company many change how it views its east africa portfolio–essentially shifting more of its eggs in to its kenyan basket.

previous drilling campaigns have only explored at intermediate depths (approximately 1,000 meters), and tullow plans to drill almost 2,000 meters deeper to see if it can replicate its previous success. successful onshore campaigns have piqued the interest of kenya’s offshore potential, which is looking to compete with the flurry of discoveries off the tanzanian and mozambican coasts. however, across the world, daily rig rental rates have been steadily increasing, and in east africa the price tag can be as high as $600,000. and although the oil services industry plans to construct approximately 50 new rig this year, those interested in exploring kenya’s (and also uganda’s) oil will face difficulties in securing a rig, critical for the development of kenyan oil. the fact that there are few rigs under contract in the region suggest that ships must travel longer, to an unknown area. kenya—which predicts it will need up to half a dozen rigs to complete its exploration targets—will have to compete with tullow’s planned expansion in uganda, which is planning to drill up to twenty wells. and while somali pirates have taken a break from their own “exploration,” an increase in maritime commercial activity closer to their borders could incentivize a new piracy campaign.

the excitement around kenya’s oil discovery comes in the run-up to what will be hotly contested elections, which will likely be held in early 2013. while kenya’s embryonic oil story could share similarities with uganda’s drama with tullow and heritage surrounding payment on capital gains taxes (kenya does not have this on its books), the involvement of the controversial former foreign affairs minister moses wetangula adds a political dimension unlike what was seen in uganda. while uganda’s virtual one-party system ensures that politics stays out of commercial transactions, kenya’s vibrant, and at times violent, multipartyism means that business can be politicized.

although tullow oil and africa oil corporation have found themselves in favorable geological terrain, they could be sitting on questionable legal and political terrain, particularly if they decide to sell their blocks in the run-up to election season. the uganda oil rush has triggered a licensing rush in kenya’s tertiary rift basin, and the operators of 10bb were early to the game. a local subsidiary of canadian turkana energy stealthily emerged to sign a production sharing agreement before lundin, a current partner with the aforementioned two companies. two well-connected kenyans—amyn lakhani and wetangula—were the leading kenyan partners with turkana. turkana’s board agreed to a share-swap bid from africa oil in 2009, and eventually tullow purchased 50% of africa’s oil stake for about $34 million.

wetangula was appointed by president mwai kibaki, and has not been an anti-corruption crusader. an odinga victory looks increasingly likely in 2013, despite kibaki, kenyatta, and ruto attempts to reshape the “kkk” ethnic alliance that has for so long dominated contemporary kenyan politics in the wake of the icc indictments. an odinga win could see odm politicians target turkana and those companies who worked closely with them, if wetangula conspicuously contributes—in the same way that the ceos of ghana’s eo group, who contributed to the opposition npp during the 2008 elections, were targeted by the ruling ndc—to whomever becomes the pnu nominee for 2013.

who benefits from belinga?

in early february, rumors were circling that gabon was thinking about handing over the belinga iron ore project to bhp billiton after mines and oil minister alexandre barro chambrier met with bhp’s senior management in south africa. now it seems like this transfer may come to fruition, with a number of winners and losers.

in 2007, gabon gave the belinga project to the china national machinery & equipment import and export corporation (cmec) to develop it over a 25 years. cmec promised the government that it would begin mining belinga’s high grade iron ore reserves (64%) by 2011, at a rate of 30 million tons per year under a $3.5 billion investment program. the infrastructure plan included constructing a 500km railway, a hydropower dam and port. ever since china began to drag its feet on the 1 billion ton project, the gabonese government has become increasingly impatient with its suitors from the far east. bhp, who had long been waiting in the wing, had been courting the government in the event that china could not fulfill its obligations.

i am confident that the government will formally approve bhp’s acquisition of belinga, and that a number of winners and losers will emerge. bhp will have to manage expectations with the gabonese government on their ability to quickly build out enabling infrastructure. lower commodities prices have accelerated bhp’s slowdown in earnings growth so far this year, even though the company’s most recent interim earnings before interest and tax are expected to rise to $15.7 billion from $14.8 billion in 2011. the company’s full year earnings are forecast to drop by approximately 10%, but if one were to use spot commodity prices in calculating the company’s profitability, earnings would slump even further. given the company’s challenging financial situation, the question remains whether or not bhp will cut capital expenditure spending, and/or how it will prioritize investing in these new projects. in brief, bhp has to recover from its disastrous $20 billion shale gas plays, and belinga is one important piece of the puzzle.

although belinga is positive for gabon’s macroeconomic outlook, the country’s microeconomic outlook—employment and income distribution—will not improve because the quality of iron ore mined from belinga does not need to be beneficiated. in the absence of targeted social spending programs, gabon—which has a relatively low yielding, $1 billion eurobond—like nigeria, will continue to see growth without development. nevertheless, another indication as to why there is likely to be minimal governmental interference in bhp’s acquisition of belinga is that the australian giant’s investments squares nicely with president ali bongo’s desire to break the commercial ties of françafrique that marked his father’s administration. ali’s grip on the country is stronger than that of his father, as he has further personalized his family rule, divided the political opposition, and has skilfully walked the country’s ethnic tightrope by appointing a diverse group of individuals in his government. the centralization of political power in gabon allows for bongo to fast-track many of his preferred investor’s projects through the corresponding ministries.

belinga is one such project that bongo prioritizes given the profile of investors. bhp is partnering with indian abhijeet infrastructure ltd., who will link the project to the trans-gabon railway at booué. if the railway is quickly constructed, sundance resources, which is waiting for the cameroonian government to approve the terms of sale of its mbalam iron ore project to china’s hanlong mining investment, could choose to connect with the trans-gabon railway. although the cameroonian government recently declared the proposed land in rail corridor from mbalam to lolabé port for public utility, it is possible that hanlong (or sundance) could change its mind and decide that exporting iron ore through gabon. after all, the distance from mbalam to booué is about the same from mbalam to lolabé. in this scenario, whose likelihood increases in the event china abandons or brings in an outside partner to develop mbalam, gabon and cameroon would likely run in to the same squabbles as liberia and guinea are having over exporting iron ore from simandou. similarly, bhp could choose to connect export its iron ore through cameroon, especially given that sundance has recently signed a memorandum of understanding with equatorial resources to share iron ore infrastructure resources.

while bhp, gabon, and possibly cameroon could benefit from belinga, china certainly does not emerge a winner, as losing the mine is a further blow to its plan of diversifying its sources of iron ore. about 85% of china’s iron ore comes from australia, brazil, india, and south africa, and the government does not want to be too dependent on a handful of countries. the chinese government has embarked on a flurry of joint ventures and partnerships across west africa—in guinea (chinalco’s simandou), in sierra leone (shandong iron and steel group’s tonkolili), and in liberia (wisco’s bong mines)—with the intention of providing its own domestic steel producers with a stable and diverse supply of iron ore that would ultimately allow them to be self-sufficient. along with mbalam, belinga was to be completed owned by chinese interests (a first in its african iron ore expansion), giving it license to some of the world’s largest iron ore projects. ownership of projects with high-grade iron ore would permit it to skip the expensive process of beneficiation, which would allow it to bypass much of the local content pressures that would ultimately be demanded by host governments. further, direct access and control to some of the world’s best quality iron ore would allow china to challenge the oligopolistic pricing of iron ore by rio tinto, vale, and bhp. despite the shift from an annual to quarterly system that more accurately reflects global trends, china remains uncomfortable being at the whim of the big three. although west and central african iron ore projects will not be the catalyst for china to lead the change in the structure of global iron ore markets, the setback in gabon will certainly prompt it to look more aggressively for new sources of the strategically important resource.

derailed: why vale isn’t on track in the west african iron ore scramble

simandou—estimated to contain 2.25 billion tons of high grade iron ore—could possibly be the largest integrated iron ore and infrastructure projects in africa. jp morgan recently estimated that vale-controlled blocks could produce 50 million tons of ore by 2020, a project which would put simandou on the same level of south africa’s kumba iron ore. jp’s optimism, however, overlooks a number of risks investors should consider when looking at vale’s position in simandou.

a brief historical overview. under the autocratic regime of lansana conté, rio tinto acquired all exploration licenses for simandou’s four blocks in 1997, and converted them in to mining concessions in 2006 while conté was still in power. right before conté died in 2008, former mines minister mahmoud thiam, announced that the northern portion of simandou (blocks 1 and 2) would be taken from rio tinto—accused of taking too long to develop the mine—and given to bsg resources ltd. (bsgr), a company whose biggest shareholder, beny steinmetz, has strong links to a number of politically-sensitive mining deals across africa. the military juntas in control of guinea between conté’s death and current president alpha condé’s election in december 2010 refused to grant bsgr complete legal rights to the concession. as a result, bsgr sold its majority stake in blocks 1 and 2 to vale up front for $500 million, with billions more payable as the project reached completion.

condé has brought relative stability to guinea since his election in 2010, and is beginning to overhaul the mining industry. condé has purged the ministry of all vestiges of thiam (who profited from bsgr’s sale to vale), weakened the power of the ministry, and has appointed a new coterie of advisers loyal to him. a new mining code was passed last fall, which states that upon issuance of a mining title, the state is automatically granted at no cost a 15%, non-dilutable interest in the share capital of the title holder, with an option to buy an extra 20% in to projects at market prices. while the new law does not change the ownership or validity of mining titles or agreements that were negotiated prior to the new code’s adoption, the government has closely scrutinized the largest and most lucrative deals opaquely signed during the 2008–2010 political transition. in order to wash their hands of any wrongdoing during the messy political transition, rio tinto paid a $700 million bonus payment to the government and negotiated a series of staged buy-in options over 20 years up to the 35% cap before the passage of the new code. vale pursued no such strategy on the eve of the new code’s passage. as such, vale’s tarnished  image—which the guinean government didn’t believe followed the law through its association with bsgr—in the eyes of the guinean government has put the company on the defensive.

the promise to invest in infrastructure—ports, railroads, and roads—is the variable that could change how the condé regime views rio tinto and vale. the global quest for iron ore has spurred renewed talks on refurbishing west africa’s decrepit rail system. rio tinto has pledged $1.1 billion to conduct feasibility studies to construct a 650 km railway (trans-guinean railway) from their part of the mine to the coast, as well as build four-berth port that could export approximately 100 million tons of ore a year. it has also proposed to begin transporting iron ore on a 900km road from simandou beginning in 2015, while it waits for the construction of a railway so as to honor delivery contracts. further, rio tinto is waiting for final regulatory approval for its joint venture with chinalco from the government, which when finalized, will trigger an earn-in payment of $1.35 billion. i believe this will likely be earmarked for railway construction. due to budget constraints in the government, it is likely that the government will not be able to pay for its proposed 51% stake in the railroad, and thus rio tinto could be forced to construct the line through a build, operate and transfer program.

in order to change how the condé administration views vale, the brazilian mining conglomerate needs to invest much more in infrastructure projects than they already have. an increasingly bullish iron ore market for 2012 that favors larger miners is positive, but rising operational costs and an unresolved commercial dispute with china over the company’s valemaxes, suggests to me that vale’s financial will to invest billions long-term in infrastructure projects in guinea is waning. outside of sharing infrastructure with rio, the most cost-effective way for the company to show its commitment on infrastructure development will be to export their portion of iron ore from simandou through liberia. vale will need to work with bhp billiton (which is eyeing mt. nimba iron ore on the guinea-liberia border) to construct a 15 kilometer spur line to yekepa, liberia, and then rehabilitate the old liberian-american-swedish minerals company, a 275 kilometer railway between yekepa and buchanan. the construction of this line is all contingent on whether the guinean government can  agree with liberia over how much would be lost in taxes and transport fees if a railway runs through liberia. recent negotiations in paris have shown that the guinean government is more open to this idea than previously hinted.

in the event that vale pulls out of simandou—as it has suggested it could possibly do by the end of this year—chinese companies could decide to bid for the vale’s majority stake. china hasn’t been entirely successful in the west african iron ore scramble as evidenced in gabon’s belinga deposit. bsgr was very close to selling vale’s present stake in simandou to chinalco when it was initially on the market, and it is very likely that if vale were to relinquish (or lose) its position, chinalco or another company (such as baosteel or wuhan, already operating in liberia) could easily pick up vale’s pieces. china has already committed to funding four-fifths of guinea’s largest power project (the kaleta dam), in a move that possibly foreshadows a new resource-for-infrastructure deal between guinea and china.

the once and always king? dos santos, sonangol, and pre-salt

there’s no doubt that josé eduardo dos santos and the ruling movimento popular de libertação de angola (mpla) will win its legislative elections slated for sometime this year. but recent movements at sonangol reflect dos santos’ waning confidence in his ability to hold on to executive power and to secure his wealth inside and out of angola. manuel vicente, the widely-respected ceo of state oil parastatal sonangol was moved to the ministry of economic coordination on 30 january, an important bureau that was abolished in october 2010. as one of dos santos’ closest confidants, vicente’s appointment brings him closer to formal political decision-making, and positions him well to succeed dos santos when he steps down (most likely late this year).

sonangol’s new chief executive—francisco de lemos josé maria—previously served as the company’s financial director. lemos was most likely chosen to improve the financial transparency of sonangol, after human rights watch (hrw) declared that $32 billion dollars had been unaccounted. the imf quickly rebuffed hrw’s accusation, calling it “erroneous,” and that the funds went missing in a simple accounting residual on big-ticket infrastructure projects, like housing and railway refurbishments undertaken by sonangol. this report was a public relations nightmare for sonangol, as they look to grow millenium bcp, portugal’s largest bank by assets, and change the international perception that sonangol is not just another corrupt african parastatal. already sidelined with the other economic policy ministers within the government including abraão pio dos santos gourgel and josé de lima massano, finance minister carlos alberto lopes and minister of state carlos feijó—who is the true face of the finance ministry, but has been accused of corruption—could be sacked some time this year, if not see their informal roles drastically diminished. as oil is the country’s largest foreign exchange earner, sonangol essentially functioned as the de facto treasury; now that vicente has moved, it is likely that the ministry of economic coordination will play this role.

while dos santos djs and angola’s elites play musical chairs, angola—africa’s second largest oil producer—looks to outpace nigerian oil production in the short-term by developing its pre-salt basin. cobalt and maersk announced their first discoveries on blocks 21 and 23 in january, raising the profile for angolan deep-water. there is almost perfect geological similarity between brazillian pre-salt elements, including reservoirs and rocks, seals and traps, that makes the angolan play attractive. asymetric rifting, however, has created significant differences between brazil and angola’s potential reserves; brazil’s margin is characterized by lacustrine black to light oil in its pre-salt sequences, while angola’s margin most likely has a higher amount of light oil and wet gas/condensate (making angolan lng a potential global game changer—more on this in the coming weeks). a number of companies are well positioned to take advantage of the pre-salt play, such as cobalt energy and conoco phillips, while the ishares s&p global energy etf, with seven stocks with deep exposure to angolan pre-salt, looks particularly attractive.

further, unlike in brazil where pre-salt discoveries have only been found offshore, angolan pre-salt extends onshore. dos santos is positioning politically-well connected juniors to develop this acreage, who could possibly be lured by being exempt from signing bonuses or lower tax rates than their foreign competitors. angola’s banking sector (and south africa’s standard bank) is likely to benefit from the rush of new activity—although it has much ramping up to do to prepare for the newer, larger transactions—after dos santos passed a law mandating all transactions for services and equipment must be done through angolan banks.

this is all not to say that dos santos’ carefully managed succession and oil boom could run smoothly. in the same way that vicente and dos santos have developed an extremely close relationship, lemos and the head of the casa militar, general manuel hélder vieira dias júnior, (known as kopelipa) share a similar rapport that could challenge dos santos’ political primacy and seek to place their mark on the country’s oil and banking sectors. one of the reasons the mpla party conference has been delayed is because the inability for the party to come to a consensus over who will rule after dos santos steps down. while it is very clear that dos santos wants vicente to succeed him, many of the top military brass believe vicente has not paid his dues, in the liberation “struggle.” this rhetoric is not unique to angola; other southern african countries’ succession debates, like those in zimbabwe, south africa, and mozambique, are often framed in this manner. while the probability is still low, the lemos-kopelipa bloc could very well upend dos santos’ plan for vicente.