Dr' B'O' Oramah

1
Critical Issues in Financing Indigenous Oil Field
Services Providers in Africa
NOT AN OFFICIAL UNCTAD RECORD
By

• Dr. B.O. Oramah

Director (Planning Development
Department) African Export-Import Bank
(Afreximbank) Cairo, Egypt
Paper Presented at the 8th African Oil Trade
ConferenceMarrakech, MoroccoApril 26 May 1,
2004
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• INTRODUCTION
• Afreximbank (www.afreximbank.com) has come a long
  way in bringing Structured Finance to Oil Field
  Services Financing in Africa. From 1998 to 2003,
  total approvals to the Sector amounted to USD 385
  million.
• Prior to Afreximbanks Structured Oil Field
  Services Financing Approach, Corporate Finance
  was the Instrument of Choice in Financing
  Operators in the Sector.
• The consequence was that Oil Field Services
  remained under the control of Large
  Multinationals.

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• The Sector remained an enclave with limited
  linkages to the rest of the domestic economies of
  African Oil Producers.
• In this Paper, I will share some of Afreximbanks
  experience in facilitating indigenous
  participation in the African Oil Sector through
  financiing indigenous Oil Field Services
  Providers.

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• 2. ACTIVITIES IN THE OIL SECTOR CAN BE BROADLY
  CATEGORIZED INTO
• Upstream Activities
• Exploration
• Drilling and production of crude
• Oil Field Services support the above activities
• Downstream Activities
• Refining
• Distribution and Sales

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2.1 THE UPSTREAM SECTOR 2.1.1 Africa's
Strengths Africa is well endowed with oil and
gas resources, accounting for about 10 of global
oil production and 6.4 of reserves Africa also
accounts for about 7 of global gas
reserves Increasingly higher quantities of oil
and gas reserves are being found in Africa's deep
and ultra deep offshore areas, especially in west
Africa. Africa produces high quality crude at
competitive costs The physical production
environment remains easier than in most other
major producing areas
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2.1.2 Weaknesses Volatile oil prices Wars/
community disturbances Environmental
problems In many countries, unclear rules and
regulations regarding award of Concessions Over
dependence on foreign technology and
skills Political instability Economic
instability Lack of Finance
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• 2.1.3 Prognosis
• Despite the weaknesses, activity will continue to
  grow driven by
• New technologies that have facilitated deep
  offshore activities
• Events in the Middle East that have accelerated
  geographic diversification
• Strong Oil prices
• Prolific nature of most basins
• Some policy support, e.g. Oil free zones in
  Nigeria and Angola

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Most activity in the near term, especially in
West Africa, will be off - shore to avoid
community problems and civil strifes and due to
huge discoveries already made Given higher cost
of off - shore activity, financing requirements
will increase Movement to off - shore will
require more logistics support increasing the
importance of oil field services.
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2.1.4 Major Oil Producers in Africa
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• 3. WHAT ARE OIL FIELD SERVICES?
• 3.1 Restrictively seen as Logistic Services -
  Marine Services, Provision of Facilities,
  Maintenance Services
• 3.2 Definition expanded (as Oil Industry evolved)
  to include Engineering, Drilling, Work - Over and
  other activities.
• Oil Services Market has enlarged as a result of
• Out-sourcing of most activities by Producers
• Increasing importance of off - Shore Activities
• 3.3 Accordingly Typical Project is executed with
  variety of contracts involving Services (See Fig.
  1)

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FIGURE 1OIL FIELD DEVELOPMENT PROJECT SHOWING
TYPICAL SERVICE CONTRACTS INVOLVED
PROJECT OWNERS
PROJECT
CONSTRUCTION CONTRACT
OM CONTRACT
SPARES AND MATERIALS CONTRACT
Services Ownership interest Service Contracts
awarded through JV Operator
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• 3.3 Typical Contracts are
• Those signed between Oil Producers (Oil Majors /
  Minors) and Major oil field services companies,
  for example
• Schlumberger
• Halliburton
• Baker Hughes, etcetera
• Contracts between Oil Producers and Minor Oil
  Service Companies
• Sub contracts between major service providers and
  minor Oil Service Providers.

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• 3.4 Indigenization of Oil Field Services Business
  is becoming a priority in some African Countries,
  such as
• Nigeria where target is 30 indigenous
  participation. A Cabbotage Law (with Cabbotage
  Fund) has been enacted to ensure, among others,
  more indigenous participation in Marine Services.
• Angola where goal appears to be 10
• Egypt where Egyptian Drilling Company (JV between
  EGPC and Maersk) does most drilling work

3.5 Goal is to capture huge amounts of money paid
to Service Providers and integrate the Oil Sector
with the Overall Economy
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• 4. OIL FIELD SERVICES
• 4.1 The Oil Field Services market is therefore
  segmented into three categories
• Major players
• Minor players
• Indigenous contractors
• Entities in category (i) do not have major
  financing problems since they can raise money in
  their name (Corporate Finance)
• Category (ii) entities are to some extent
  adequately covered financially
• Financing is principally a major problem of
  category (iii) companies (Indigenous Contractors).

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• 4.2 Xteristics of Indigenous Oil Services
  Companies
• small size of capital (USD 1 million or less),
  except a few in Nigeria that have grown
  significantly in size, e.g. the Adamac Group
• firms with limited experience in oil field
  services
• have no or limited borrowing track record
• corporate structure sometimes confusing
• small players with annual revenues of less than
  USD 5 million
• usually require financing far in excess of equity
  capital
• loan required usually of medium term nature as
  main use of loan is to acquire equipment for
  contract execution

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• 4.3 The Critical Issues in Financing Indigenous
  Companies Therefore Revolve Around How To Deal
  With
• Their Low capitalization
• Limited experience
• No borrowing track record and therefore no
  credible banking relationships
• Their Highly specialized assets with limited
  secondary market.
• The above factors mean that pure corporate
  Finance will be difficult
• Resort to local bank financing is constrained by
  lack of medium term funding in many markets

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• 4.4 Structured Financing by international banks
  is difficult also due to
• Small size of deals (usually USD5 - 10 million)
  and therefore returns do not justify the trouble.
• Small size of company puts company at a
  disadvantage when negotiating contract with
  majors. Thus, contracts may carry onerous
  clauses.
• Required funding of medium term nature meaning
  that international banks may provision for
  exposure.
• Companies unfamiliar with international financing
  making structuring work difficult.

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• Contract counterparties usually reluctant to
  assist in putting structure in place for
  example, Many may refuse to acknowledge
  assignments of contract or simple letters of
  instruction.
• Operations usually not well diversified to enable
  banks to diversify their risk.
• Due to their small size some are not able to buy
  adequate insurance to cover the risks in the
  business or to structure their operation to
  mitigate such risks for example, certain vessels
  may incur liabilities that can bankrupt the firm.

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• In Realization Of The Problems These Companies
  Face, Afreximbank Designed Special Means Of
  Supporting Them Hinged on a TOTAL APPROACH.
• To Deal With the Challenges Identified,
  Instruments used include
• Advisory services aimed at corporate
  reorganization and preparing borrowers to enter
  loans market
• Structured Finance to mitigate Corporate Finance
  Risks.
• Risk bearing support.

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• The Banks Experience Has Been That
• THE UNDERLYING BUSINESS IS BANKABLE IF FINANCING
  IS WELL DESIGNED
• SUPPORTING THE COMPANIES HELPS IN CREATING
  INDIGENOUS CAPACITY IN THE OIL INDUSTRY AND HELPS
  PROMOTE THE GOALS OF GOVERNMENTS OF AFRICAN OIL
  PRODUCING COUNTRIES.
• THE BANK'S INTERVENTION USUALLY HELPS IN BETTER
  CONTRACT THERMS NEGOTIATED WITH PRODUCERS.

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• THE TRANSACTIONS MOST TIMES GENERATE SPIN-OFF
  BUSINESS FROM OIL MAJORS.
• THE BANKS TENACIOUS SUPPORT HAS HELPED TO
  ATTRACT OTHER INTERNATIONAL BANKS TO FINANCING
  SUCH ACTIVITIES. ACCORDINGLY, THE BANK HAS BEGUN
  A MAJOR ACTIVITY OF SYNDICATING SUCH DEALS.

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FIGURE 2SECURED DIRECT LENDING
6. FINANCING STRUCTURES IN SUPPORT OF THE SECTOR
Lending Bank
5. Repayment of principal and interest
3. Disbursement
2. Assignment of Contract Proceeds
Producer
Contractor
1. Service Contract
4. Performance of Contract
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• Key Features
• BANK ASSUMES PERFORMANCE RISK OF COMPANY AND
  PAYMENT RISK OF PRODUCER
• TRANSACTION HINGED ON DEMONSTRATED TRACK RECORD
  OF COMPANY OR A TECHNICAL PARTNERSHIPARRANGEMENT
  WITH A REPUTABLE CONTRACTOR
• CONTRACT BEING BINDING, LONG ENOUGH AND
  ENFORCEABLE
• CLEAR INVOICING MECHANISMS
• IN MANY INSTANCES, THE BANK FURTHER SUPPORTS THE
  FACILITY USING LOCAL BANK GUARANTEES (SEE FIGURE
  3)

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FIGURE 3LENDING WITH PAYMENT GUARANTEE
Lending Bank
Guarantor b) (Local bank)
2. Guarantee (which may or may not be
collateralized) a)
6. Repayment of principal and interest
4. Disbursement
3. Assignment of Contract Proceeds
Producer
Contractor
1. Service Contract
5. Performance of Contract

• Securities taken include depositing of short-term
  treasury bills, partial cash collateral etc.
• Guarantee may be per aval.

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FIGURE 4MITIGATING PERFORMANCE RISK OIL
SERVICE INVOICE DISCOUNTINGAfreximbank Oil
Service Invoice Discounting Process
1. Service Contract
Oil Service Company
Oil Major (Service user)
3. Performs Contract and Invoices
4. Accepts Invoice (Confirmation of Receipt of
Service) and acknowledges Sale of invoice to
Afreximbank (Documents)
6. Purchase of Invoice (prepayment)
2. Approval
5. Documents
7. Payment
6. Purchase of Invoice (prepayment)
Afreximbank
Local Bank (Guarantor)
5. Documents
2. Approval

• This Assists Contractors In Bridging Liquidity
  Gaps

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• DEALING WITH CERTAIN RISKS/ PROBLEMS
• 7.1 Performance Risk
• Mitigant
• Use local bank with experience in oil services
  financing to assess and mitigate risk
• Producers do a thorough assessment of capability
  of Contractors so check with them
• Focus on those companies with good technical
  partners
• Afreximbank has gained good experience in proper
  analysis of such risks
• Restrict lending to invoice discounting

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• 7.2 Community Disturbances / Civil Strife
• Mitigant
• In Angola and Nigeria where these used to be
  rife, things are subsiding
• In some service contracts, this risk is retained
  by the Producers.
• 7.3 Premature Contract Termination Not Caused By
  Contractor Non-Performance
• Mitigant
• In many Service Contracts Early Termination
  Clauses ensure that the Producers retain the
  risk.
• Take insurance.

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• 7.4 Difficulty In Obtaining Acknowledgement of
  Contract Assignments by Producers
• Mitigant
• Not a generalized problem. However, Direct
  approach to Producer helps.
• 7.5 High Documentary Taxes
• Mitigant
• In many of the countries, Afreximbanks tax/ duty
  exempt status is being honoured so it makes sense
  to partner with Afreximbank.
• 7.6 Country Risk
• Mitigant
• Use Afreximbanks Country Risk Guarantee
  Facility.
• Use other PRI Providers.

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• 8. ISSUES TO NOTE AS YOU STRUCTURE YOUR DEAL
• Many Service Contracts are not assignable
  Proceeds of the Contracts are
• Understand Nature of Contract, i.e.
• Its term
• Termination clauses
• What is considered a satisfactorily completed
  service
• How payments will be made
• Day-rate (minimum and escalation)
• Milestones (what are they and are any third party
  actions required before milestone completion is
  confirmed?)
• Community disturbance clauses
• Force Majeure clauses, etc.
• What insurance obligations are to be borne by
  Contractor
• Environmental issues

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• Producers can delay payment so build knowledge of
  historical delays in arriving at tenor
• Agree with Contractor on Issuing Invoices
  promptly. For some Producers, Invoice tracking
  can be done on-line by subscription.

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8. Bringing Other International Banks In Support
of the Sector Afreximbanks Role 8.1 Dealing
with Country Risk
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AFREXIMBANK intervention as risk mitigant
Risk Period for lending bank
Figure 5 AFREXIMBANK COUNTRY RISK GUARANTEE
FACILITY - FLOW OF TRANSACTIONS
International bank assumes payment risk of an
African entity (through L/C issuance/
confirmation or other forms of financing
Afreximbank provides cover against certain
country risk events
At maturity, International bank is reimbursed by
obligor ?
At maturity, International bank is reimbursed by
obligor
Exposure Extinguished
Yes
Yes
No
No
Cause of Non-reimbursement is determined and risk
is shared
Non-reimbursement caused by commercial risk
(credit, documentary/administration risks and
fraud) events, force majeure and/or certain
country risk events
Yes
Yes
Afreximbank is discharged Lenders pursue security
from Borrower
Afreximbank is discharged Lenders pursue security
from Borrower
Non-reimbursement caused by certain country risk
events (exchange. control regulations, moratorium
on debt payment, change in law or policy
affecting the timing, currency or manner of debt
payment
No
Yes
AFREXIMBANK reimburses covered portion to Lender
and pursues reimbursement with country concerned
in accordance with Bank Membership Agreement
On recovery of repayment, Lending bank is
reimbursed the uncovered balance, less reasonable
costs incurred by Afreximbank in pursuing recovery
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• 8.2 Dealing with Lack of Experience and Local
  Knowledge
• Afreximbank has begun to leverage its proven
  track record and knowledge of the Sector and
  Markets to arrange syndicated deals in support of
  the Sector,
• Syndicated Deals Concluded USD 180 million
• Syndicated Deals in Pipeline USD 80 million
• 8.3 Extending the Frontier with its Innovative
  GASON Debuting in Nigeria (Figure 6)

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OIL SERVICE COs.
QUALIFIED LOCAL BANKS (BORROWERS)
FIGURE 6 GUARANTEED AFREXIMBANK-BACKED
SECURITIZED OIL SERVICE NOTES (GASON)
2. Security / Assignment
4. Oil Field Services
1.Contract
Recourse Guarantee (Per Aval)
On-Lending
OIL MAJORS (SUBSIDIARIES)
2. Acknowledgement
AFREXIMBANK Lender of Record
2. L.O.C
5. C.W.D
6. Repayment
2. Risk Participation Agreement
Credit Enhancement (Lloyds / AfricaRe AFREXIM)
3. Funding
ESCROW A/C
LENDERS (INTERNATIONAL BANKS)
May include Country Risk and Performance Risk
Guarantees Letter of Comfort Certificate
of Work Done or Accepted Invoices
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• Key Advantages of Deal In Figure 6
• Lenders benefit from Afreximbanks preferred
  Creditor Status.
• Lenders benefit from knowledge of domestic
  originator banks.
• Lenders benefit from a second way out comprising
  of a diversified pool of local banks with strong
  oil service financing capabilities.

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• Local banks are able to increase oil service
  lending by freeing their capital.
• Contractors benefit from cheaper and matching
  currency funding.
• Country benefits from greater indigenous
  participation in the sector by operators and
  local banks.

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• 9. ABOUT AFREXIMBANK
• Established in 1993 as a multilateral financial
  institution
• Shareholders include African governments, African
  private investors and non African investors.
• Authorized capital US750 million
• Mandated to finance intra and extra-African trade
• Headquartered in Egypt
• Branch offices in Abuja, Tunis and Harare

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• OPERATES FOLLOWING PROGRAMMES
• LINE OF CREDIT
• DIRECT FINANCING
• SYNDICATIONS
• PROJECT RELATED FINANCING
• EXPORT DEVELOPMENT FINANCE PROGRAMME
• INVESTMENT BANKING AND
• SPECIAL RISK PROGRAMMES, INCLUDING COUNTRY RISK
  GUARANTEE FACILITY
• ALSO OFFERS FORFAITING FACILITY
• CUMULATIVE APPROVALS SINCE 1994 TO DECEMBER 2003
  US6.68 BILLION

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10. CONCLUSIONS