Investing in African energy
managing the challenges
Investing in African energy – managing the challenges
Introduction
Although the African oil & gas industry has had a tumultuous 48 months, the increased oil price has revived industry activity on the continent. If one looks at the Private Equity industry it might seem that they are mainly vying for investments in the renewable energy space on the continent; yet African oil and gas assets, like those globally, are still widely acknowledged as attractive targets due to their current affordability. PE firms are increasingly focused on emerging markets and large sums are currently being deployed in the energy sector, with Africa a major focus. Indeed, the Carlyle International Energy Partners (CIEP) fund alone raised US$2.5 billion of capital to be deployed in the energy sector, and is planning to raise up to another US$1 billion in a new fund.3
Investors are further attracted by the large infrastructure investments on the continent, particularly in the transportation sector which will help improve trade for oil & gas companies. In 2017 alone over US$71.6 billion was invested in transportation and US$36.3 billion in shipping & ports.4 With the oil price seemingly stabilising, one would expect asset valuation to become a slightly easier task, which should increase investor confidence both on the buy side and the sell side and subsequently lead to increased M&A activity.
However, while this investment is pleasing to see, it does not come without its challenges.
Challenge one – operating in complex and uncertain regulatory environments
Generally speaking, regulations are becoming more complex, with a trend towards greater local ownership, while a shortage of hard currency has created cash flow concerns in certain countries.
Regulations are also becoming more uncertain. Indeed, regulatory uncertainty continues to enhance the political risk involved in engaging in the oil & gas sector in Africa, and is harming the industry’s ability to continue to fulfil its potential. This is a continent-wide issue, but to illustrate the issues we can take a look at three country examples:
In South Africa, upstream regulation continues to be unclear; the separation of oil and gas from mining has still not occurred as referenced in the Mineral and Petroleum Resources Development Act. Only once regulatory certainty is achieved can the industry develop further.
In gas-rich Mozambique, the new regulatory framework introduced in 2014 reduced uncertainty, but multiple problems still exist for investors. These revolve around planning uncertainties due to the state’s tendency to be involved at any lifecycle phase, local participation requirements and the obligation for resources to be used domestically which will be tough at the early stage of projects due to the relatively unsophisticated market.5
In Tanzania, in July 2017 the country passed two laws which permitted the government to renegotiate contracts with energy companies. As yet, we are still to see if or when renegotiations will occur, but the potential is there to significantly reduce investor confidence.
3 Reuters.com 4 Deloitte, ‘A Shift to more but less’, African Construction Trends Report, 20175 PWC, ‘Learning to Leapfrog. Africa oil & gas review’, November 2017
Challenge two – dealing with uncertain insurance regulation
Frequent regulatory changes and complexities are mirrored in the insurance sector. The general trend in Africa is a drive towards higher levels of local retention, though the regulations can be opaque and difficult to interpret.
For example, if one looks at CIMA6 legislation regarding offshore oil, the ambiguity and complexities are laid bare. Some say that in conjunction with the CIMA code, offshore oil platforms are exempt from the 50% local retention imposed on various lines of business; platforms are said to fall under the risk classification “Marine Hull, lake and river vehicles: Any damage suffered by: a) river vessels; b) lake vessels; c) boats / ships,” which under part 6 of article 328 are exempt from article 308 of CIMA which demands the 50% local retention within the CIMA zone.
As we know, “offshore oil platforms” is a very non-descript title for the plethora of Upstream insurances one can arrange. Does this apply to all typical Upstream package coverages? Or is Control of Well and Liability (even for an FPSO) not to be given such dispensation? This exemption is based on a legacy clarification given by the CIMA regulator in 2014. Interpretation of this differs from country to country, stakeholder to stakeholder and serves to highlight the ambiguity. Logic would suggest that this loophole is limited. Where it is currently accepted in isolation without much confidence, it will most likely be shut down soon. As such, utilising a local partner is paramount in order to get full and up to date advice as to what is permissible under the CIMA code.
The 14 CIMA countries are not the only ones experiencing regulatory change. Both Ghana and Tanzania have recently seen the most radical changes in the reinsurance landscape, with strict rules on overseas cession. Taking hydrocarbon hotspot Tanzania as a case study, the Tanzanian Insurance Regulatory Authority (TIRA) has introduced new requirements relating to reinsurance arrangements for those insurers registered to conduct insurance business in Tanzania.
The changes have been prompted by the belief that there has been general exploitation of reinsurance arrangements, with a key focus on excessive use of international facultative re-insurance arrangements and 100% fronting of risks which could be partly retained locally.
In light of this, the recent regulatory changes are designed to increase retention rates, thereby increasing capacity within the country’s insurance sector, which should in turn benefit the wider local economy. Key points of the new legislation include:
the prohibition of 100% fronting, unless in exceptional circumstances
new levies for facultative placements outside the country
a clear statement that irregular packaging of risks with the aim of externalising them is banned and punishable by law
Challenge three – satisfying lenders’ requirements
Local regulation and compliance is never simple in Africa (and appropriate independent legal advice should be taken in all instances); where debt finance is deployed, satisfying lenders requirements is no easy task. Insurance programmes often form part of the security package, which if not executed correctly can result in a breach of warranty under the loan agreement. Equally where there are lender requirements regarding the minimum security rating of the (re)insurance package, this needs to be weighed very carefully against the local regulations around mandatory retentions in country.
Challenge four – managing currency risk
The African Private Equity and Venture Capital Association (AVCA) recently surveyed 42 global PE firms with African assets and 90% of those surveyed viewed currency risk as being either important or very important to their firm. Furthermore, 78% of respondents believed that African currency risk has increased over the previous 3-5 years, and 75% stated that currency volatility has had an adverse impact on their realised PE investments. Exit strategies are always at the forefront of investors’ minds before purchasing an asset and firmly embedded in the investment strategy from the start; however, currency risk led 46% of the AVCA respondents to amend exit plans.7
West Africa (Africa’s largest oil producing region) clearly reflects these fears, accounting for the most private exits in recent times. For example Nigeria has been badly affected by the recent low oil prices and the subsequent crash of the Nigerian Naira against the US dollar has led investors to look elsewhere. Whether this trend will continue with the stabilisation of the oil price, is yet to be seen.8
The general trend in Africa is a drive towards higher levels of local retention, though the regulations can be opaque and difficult to interpret.
6 Conférence Interafricaine des Marchés d’Assurances – the regional body of the insurance industry for 14 countries in Francophone Africa.7 African Private Equity and Venture Capital Association, ‘Volatility and Uncertainty: how private equity in Africa navigates through turbulent times’, November 20178 White & Case, ‘Africa Focus. Financing Africa: Challenges and opportunities’, Spring 2018
Challenge five – effective ESG fund implementation
If there is to be increasing exit deal volumes across the region, the way Environmental, Social and Governance (ESG) has been implemented by the fund will play an important role. ESG covers a wide-ranging agenda but is effectively a set of standards used to evaluate corporate behaviour.
88% of portfolio companies now formally report ESG monitoring results to their firm which, if positive, should help to maximise exit values.9 Dabney Tonelli, investor relations partner at Helios Investment Partners stated the importance of ESG in Africa stating, “All of our portfolio companies in some way are making life better for people and businesses in Africa. Through our investment activity we’re developing the next generation of business leadership potential, enhancing lives through access to information and technology, creating financial security, increasing financial inclusion, improving environmental care and quality and improving governance standard.”10
Poorly implemented ESG could lead to increased risk of community instability and political violence which, given the historical reputation of oil & gas companies, will increase reputational damage risk. Large-scale energy projects have a significant impact on local societies, affecting their environment, workplaces and communities. It is therefore crucial that investors manage their projects carefully, or they will face the associated risks of social unrest.
Conclusion – don’t be deterred!
Although many other risks are also firmly embedded in the African oil & gas risk landscape, investors should not be deterred. Understanding the issues is the first step; mitigation comes next. Investors can be confident that, allied with the right business and risk advisor, they can navigate these choppy waters to reap the long-term benefits of investing in this exciting region.
Poorly implemented ESG could lead to increased risk of community instability and political violence which, given the historical reputation of oil & gas companies, will increase reputational damage risk.
9 PWC, ‘ESG considerations for private equity firm10 The Economist, ‘A growth engine. Trends and outcomes of private equity in Africa’, March 2017
Alexander van Kuffeler is Head of Africa Specialty at Willis Towers Watson.
