The Great Oil and Gas Conundrum

24 April 2017


A Firstline Securities Limited Blog by: Mike

 

WHAT IS THE GREAT OIL AND GAS CONUNDRUM? 

Despite current depressed oil and gas prices the expected trend of increasing global demand for oil and gas continues to drive the search for new oil and gas fields. Transparency International – the international watchdog for fraud and bribery – expects that over the next 20 years over 90% of oil and gas production will come from developing countries.

Those developing countries, although rich in oil and gas, are also home to some of the world’s poorest people.

This is the great oil and gas conundrum.

How can countries so rich in oil and gas reserves be so poor?

INTERNATIONAL OIL AND GAS COMPANIES WALK HAND IN HAND WITH CORRUPTION 

The world received another reminder on the 10th April 2017 that international oil companies are no stranger to corrupt and fraudulent practices, with the BBC announcing that senior executives at Royal Dutch Shell Plc (Shell) knew that money paid to the Nigerian government to secure the OPL 245 oilfield would be passed on to a convicted money launderer – the former Nigerian Minister of Petroleum, Dan Etete.

To understand that revelation one needs to backtrack to 1998 and have some understanding of the potential wealth Nigeria holds in its vast oil fields.

OPL 245 is an oilfield off the coast of Nigeria. OPL 245 contains an estimated 9.23 billion barrels of oil valued at close to half a trillion United States dollars (and that’s at current depressed market prices). The potential value of OPL 245 makes it the richest oil field in Africa.

So initially let’s go back to 1998.

In 1998 OPL 245 was awarded to a newly incorporated Nigerian Company called Malabu Oil and Gas Limited by the Petroleum Minister of Nigeria, Dan Etete.

At the time of the award Etete did not declare that he was the sole shareholder of Malabu Oil and Gas Limited, instead creating a fictitious shareholder to cover his tracks. Malabu Oil and Gas secured the rights to the field by the payment of a nominal fee to the Nigerian Government.

With than in mind we can move forward to 2011.

In 2011, Shell and the Italian oil company ENI acquired the Nigerian oilfield OPL 245 by paying US$1.3 billion directly to the Goodluck Jonathan’s Nigerian government. The Nigerian Government then paid US$1.092 billion to Malabu Oil and Gas Limited to release the rights that the company held to the field effectively enriching themselves as well as Don Etete.

Most of the money paid to Malabu Oil and Gas Limited has disappeared through a web of offshore companies and accounts. Approximately US$195 million is frozen in accounts in the United Kingdom and Switzerland pending conclusion of investigations.

The loss to the people of Nigeria is nothing short of devastating.

Both Shell and ENI have denied wrongdoing.

INTERNATIONALLY THE NET CLOSES IN

This blog entry might seem like a horror story but in fact the world has made some progress in counteracting fraud and bribery in the public sector.

In the United Kingdom, the Bribery Act was passed into law in 2010, and since 2003 the European Union has implemented a framework of initiatives aimed at combating corruption in the private sector. In addition, the United States had the Dodd-Frank Act until 14th February 2017 (see below).

The extent of the problem in the energy industry should not be under estimated.

Of the top 10 largest fines issued under the US Foreign Corruption Act, six have been levied on energy companies or companies serving the energy sector.

HERE COMES THE DONALD!

On the 14th February 2017, the administration of Donald Trump moved to repeal the rules aimed at forcing oil and gas companies to disclose payments made to foreign governments to secure lucrative mining and drilling rights.

The rules (referred to as the Cardin-Lugar regulations) were established under the Dodd-Frank Act. The Dodd-Frank Act contained a raft of extensive legislation brought in after the financial crisis aimed at fighting corruption.

One of the fiercest critics of those rules is Rex Tillerson, a former boss of Exxon and now Secretary of State in the Trump Administration.

On the 23rd June 2016, the UK Guardian Newspaper reported that Exxon is currently under investigation by Nigeria’s own Economic and Financial Crimes Commission over lucrative oil rights which were secured in 2009. In that year, the Nigerian Government accepted a bid of US$1.5 billion for a 20-year lease on the OSO, Ekpe, Edop and Ubit oil fields. Collectively those fields produce 580,000 barrels of crude oil per day, close to one third of Nigeria’s total crude oil production per day.

Consider that in the same round of bidding, the Chinese National Offshore Oil Company bid US$3.75 billion for the same rights.

Why would the Nigerian government accept a bid of US$1.5 billion when another party submitted a bid of US$3.75 billion?

Ever heard of Occam’s Razor?

OCCAM’S RAZOR 

Occam’s Razor is a principle that is attributed to the 14th Century English Friar William of Ockham (it is not known why or when the spelling of Ockham – the Surrey village in which William was born – morphed into Occam).

Adopted and reinvented by philosophers, scientists, and theorists alike, the most useful modern day definition of the principle is that when you have two or more competing theories that make exactly the same predictions, the simpler explanation is the better or more likely.

THE ANSWER IN A NUTSHELL

Shell as a case study gives us some suggested answers to the great oil and gas conundrum.

Too often wealth is diverted into the hands of corrupt politicians and insiders. Inadequate disclosure in the financial statements of large oil and gas companies mean that payments to corrupt officials never see the light of day. Ultimately bribery, corruption, fraud all pass by unreported and unchecked.

But fraud in oil and gas has a greater reach and extends into “local” oil and gas companies too. When companies like Shell develop oil and gas fields they use many local companies as service companies. Moreover, historically oil companies have favoured operating in foreign countries as joint venture partners with state-owned entities. Many of those local companies in Nigeria (and elsewhere) hide the true identities of their equity shareholders, and the state-owned entities follow poor corporate governance practices and have limited internal controls and checks and balances aimed at deterring and preventing fraud.

This allows corrupt politicians a “free hand” when negotiating with the large oil and gas companies: ‘obtain this field for development but you must use this “service company” to provide consulting services locally.’

All the above has terrible consequences for the local population.

Nigeria is a classic example (and it’s likely to be an example that is repeated in other countries).

The US$1.092 billion channelled into the coffers of Dan Etete is more than Nigeria’s spends annually in respect of its Ministry of Health Budget.

If that isn’t enough, consider that Nigeria cannot afford to fund an adequate health service for its population.

In a country where one in ten children die before they reach their fifth birthday that’s both a tragedy and the great oil and gas conundrum in a nutshell!

FOOD FOR THOUGHT?

Nigeria ranks 136 out of 176 countries on Transparency International 2016 Corruption Perceptions Index.

Trinidad ranks only 35 places higher in 101st place.

CLOSING THOUGHTS – TIME TO CONSIDER YOUR INVESTING STRATEGIES 

 

Firstline Securities Limited offers comprehensive coverage of local and international markets with a bias for the energy sector. Firstline offers several unique opportunities to put surplus cash to work either as your asset manager or investment advisor. Please contact us for more details at info@nullfirstlinesecurities.com or at 868.628.1175, we can discuss your investment needs in detail and craft a portfolio that makes sense for you. We look forward to hearing from you.

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