Alternative financing powers up in Nigeria

A business manager has two main decisions. On the one hand is how to start or grow and improve the performance of her business. This may include acquiring or expanding the business with investment in new assets or investment in initiatives that increase revenue or reduce cost. This, in Corporate Finance 101, is known as the investing decision. On the other hand is the – sometimes even more important – financing decision. In other words, how she pays for all this.
In the wake of the commodities price crisis, which started mid-way through 2014 and which has not fully been cured, financing decision making has been a major headache for managers, and even owners, of businesses in affected industries. This is particularly poignant for the oil and gas industry, as well as general mining industries, especially in countries like Nigeria.
Against the backdrop of the oil price crisis, which stretched till mid- to late 2016 and the recovery from which can still be considered weak to date, access to finance has become one of the key challenges faced by many industry participants, especially the indigenous, mostly mid-cap/independents in the E&P upstream sector. For this segment, financing challenges could be seen in two prongs. The first is the need for refinancing of existing obligations, comprising mostly debt exposure to local commercial banks. The second is financing requirements (for those who could even consider such opportunities) for acquisition of new assets and development of ones already owned.

FAILURE OF RISK PLANNING: As all industry participants, watchers and stakeholders know, the commodities market generally – and the oil market in particular – is volatile. Prices, a function of the demand and supply seesaw, are based on global socio-political dynamics that are largely beyond the control of businesses that often fall victims. Over history, at best, the rise and fall of prices can be called cyclical. Investment in that sector should therefore always pay keen mind to market risk evaluation in as conservative an approach as possible.
The local E&P firms that got into the Nigerian oil market by acquiring divested interests of IOCs in assets financed those acquisitions largely with expensive local commercial bank debt (ranging 18%-22%). Oil was USD 100-plus, and reserve valuations and cashflow projections (at that price) provided healthy-enough debt coverage. In addition, militancy in the Niger Delta region was largely subdued and production integrity still fair.
It was golden time, but it set the stage for the crisis now being faced by firms in raising financing, based on three main issues: excessive leverage; inadequate evaluation of progressive risk; use of mismatched capital – both in terms of projected asset valuation and debt tenor.
To date, the exposure of the local banking sector to oil and gas has remained largely toxic with increasing non-performing loans (NPL), which is yet to fully abate. Stanbic IBTC bank, for instance, reported a 249% increase in oil and gas NPL in 2017.
Given the perceived culpability of local banks in unbridled creation of debt facilities to local oil companies during the boom, now regulations have become stiffer, further drying up debt funding for companies and deepening their crisis. Companies have had to restructure their loans as revenues no longer match debt repayments.
Interestingly, as banks pummeled oil companies with bad debt to repay, you would expect most companies to seek new equity or quasi-equity capital to assuage the debt burden. However, most were vehemently against equity capital. Understandably, but not logically, given the low valuation that would undermine existing equity interests in such options.
Unfortunately, the terms of the existing debt – such as lien of banks on the customer’s production and cashflow – effectively rendered chances of securing new debt to zero. Eventually, some companies turned to the same scorned equity capital funding, but were unable to succeed. Some found alternative sources of funding to finance operations and acquisitions, but many initiatives have been unsuccessful.

ALTERNATIVE APPROACH: Against the foregoing backdrop, company executives are seeking solutions in the form of innovative financing structures and new sources of funding. As a firm of corporate finance investment bankers, we have been approached by various clients for solutions in this regard. While the issues persist, and funding oil and gas deals through traditional approaches remains a challenge, we have been seeing a number of innovative structures, including some in which we participated, that meet the needs of all stakeholders – the businesses and their investors – and deals are being closed.

Offtake prepayments used to support acquisitions
While buyers of oil have always been an important feature in the financing structures for the development of new resource projects, their commitments are increasingly being used to identify and finance resource investment and development, including acquisitions with upfront financing contributions. For project sponsors, the bankability of new projects typically depends on contracted future cashflows from foundation offtakers and may facilitate other investment streams such as debt.
On one of the deals we participated in and closed in late 2017, the offtake commitment of an IOC, was key in securing a restructuring commitment from a local bank.

Multisource funding structure for asset development
For greenfield assets struggling to find development funding, a combination of non-traditional funding sources is being used. In this structure, we have seen a cocktail of structures such as the paying of project development costs to service companies with equity in the project or convertible structures and other deferred cash payment terms to contractors – at least until the project is cashflow positive – vendor financing, and forward divestments of assets.
These multi-source funding structures that bring together different stakeholders to fund the development of a project have the potential to see many projects through to completion with little or no traditional bank finance at all. An example was used in Equatorial Guinea in 2016, where financing for a new development was secured with multi-source/multi-stakeholder funding commitments.

Streaming arrangements
Streaming essentially involves the exchange of future revenue, and the potential gains in prices, for funding injection through the sale of rights to purchase physical future production. The rights are to purchase of production, but not an economic interest carry, as in a royalty arrangement, which typically involves the grant of an economic interest based on future revenue or profit.
This approach has been used in the OECD markets, and has allowed companies with assets to capitalise on proven reserves ahead of production. It is not treated as debt or equity. It is non-dilutive, and allows the company to retain its debt thresholds with less restrictive terms. It should be an attractive option to local companies who are wary of equity and have maxed out borrowing capacity.

Working capital finance from offtakers
In recent times, a number of offtakers and commodity trading houses have entered this funding market either in partnership with lenders or as stand-alone working capital providers with products such as prepaid offtake finance facilities (structured as revolving loans rather than a discounted upfront lump-sum payments on the offtake). The central feature of these lending structures is that the lenders consider the inventory and/or receivables (supported by security over or title to these assets) to support working capital finance lines.
If structured properly, these arrangements can be very rewarding to all stakeholders. Lenders, which may be an offtaker with a stronger balance sheet, can look through the balance sheet of the producer and offer the producers cheaper finance or finance with more flexible structures from what would otherwise be the case with banks. Such offtakers also help with marketing and sales support, leading to even better efficiency and increased returns.

CAPITAL CHANGE: In the end, despite the changing sentiments on oil as a primary source of energy, the sector is expected to maintain its relevance into the near future. Accordingly, players in the space will have their businesses, if they can match the right financing with their respective strategies.
While investor’s plain vanilla – simple returns and risks – sentiments are not the only hindrance to raising new capital, given such political issues like the lingering non-passage of the Petroleum Industry Governance Bill, bridging gaps to investment with appropriate financing structures will go a long way to ensuring that products continue to flow.
The effectiveness of seeking and securing financing will, however, only be achieved with adequate evaluation of and provisioning for risks, appropriate leverage levels and use of financing structures most suitable to a project at hand, especially if the future will not be a repetition of history.

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