Impact of COVID-19 and Saudi-Russia standoff on Nigerian oil sector
The Oil and Gas Sector largely constitutes the fundamentals of the Nigerian economy, accounting for over 90 per cent of the country’s foreign exchange earnings. Since the discovery of oil in commercial quantity by Shell-BP in Oloibiri in the present day Bayelsa State of Nigeria as far back as 1956, the economy of the country has largely remained monotonous and dependent on oil exports.
The 2020 Appropriation Act envisages a crude oil production volume of 2.18 million barrels per day with a $57 benchmark per barrel. As at January 2020, the price of Brent Crude was approximately $70 per barrel, however with the recent turn of events globally, especially the emergence of the novel Coronavirus Disease (COVID-19) and the resultant Saudi-Russia Oil Standoff, a chain-reaction of problems threatens the Nigerian Oil and Gas Sector.
COVID-19 and the Saudi-Russia oil standoff
COVID-19, which was first discovered in Wuhan City, Hubei Province of China sometime in December 2019 has now become a global epidemic with over 180 countries and territories affected globally and an estimated 246,107 reported cases as at 20th of March 2020. The rapid spread of the virus led to the drastic reduction in oil demand by countries in Europe and Asia who are major buyers of oil. In a bid to cushion the effects of the decline in oil demand on the global oil market, the Organisation of Petroleum Exporting Countries (OPEC) held its 178th Extraordinary Meeting in Vienna, Austria on the 5th of March 2020. However, due to disagreements between Saudi-Arabia and Russia, two of the world’s biggest oil producers, on production cuts, the price of oil in the international market took a nose-dive as a result of high levels of production with a disproportionate level of demand. The simple economics principle of demand and supply reveals that prices are bound to fall where supply is greater than demand. The result is a staggering and all-time low price of $27.40 per barrel for Brent Crude as at the 18th of March 2020.
In its latest report, the International Energy Agency (IEA) stated: “Global oil demand has been hit hard by the Novel Coronavirus (Covid-19) and the widespread shutdown of China’s economy”. Bonny Light, Nigeria’s premium oil grade as at 20th of March 2020 has dropped to $24.82 per barrel against a 2020 budget benchmark of 57 percent per barrel. Incontrovertibly, it goes without saying that the Nigerian Oil and Gas Sector and indeed the nation’s economy is on the brink of a downturn.
The National Bureau of Statistics (NBS), in its recently released Foreign Trade Statistics Report for the Fourth Quarter of 2019, had stated that the major buyers of Nigeria’s crude oil are India, Spain, Netherlands, France and South Africa, among others. These countries have recorded cases of coronavirus and the disease has had tremendous impact on their economy.
Challenges envisaged in the Nigerian oil and gas sector
In a newspaper report on Monday March 16, 2020 indicated that due to the oil crash, Nigeria may lose $8.63 billion Naira in the next six months as recession looms. Consequently, the Federal Government on Wednesday, March 18, 2020 announced a slash in the 2020 Budget by N1.5 trillion, which includes the N457 billion the government spends on fuel importation (PMS under-recovery). This was done in a bid to ensure that the nation’s economy does not go into recession in the midst of the COVID-19 pandemic.
It is however our considered opinion that a hovering economic recession is not the only challenge to be envisaged as a result of the fall in oil price in the global market. Several other issues are bound to surface. Some of these issues include:
Default in and/or Breach of Terms of Production Sharing Contracts (PSCs) and Joint Operating Agreements (JOAs): Parties to a PSC or JOA would have agreed on terms based on oil production levels/oil output and the price per barrel in the international oil market. The COVID-19 pandemic that has contributed to a sharp decline in the price of oil globally would undisputedly affect the estimated or projected Returns on Investment (ROI) of the parties to the said PSCs and JOAs, be it National Oil Companies (NOCs) or International Oil Companies (IOCs). Most of these agreements are made based on the prevailing oil price in the global market, with benchmarks set to cover unforeseen eventualities. However, the COVID-19 pandemic and the Saudi-Russia oil price war has led to a drastic fall in price per barrel and would most likely see parties to such PSCs and JOAs defaulting in their obligations.
Default/Breach of Terms of Oil Servicing Contracts and Sub-Contracts: The execution of PSCs and JOAs require several servicing contracts with sub-contractors for drilling, welding, pipeline construction, facilities maintenance, accommodation services, catering services, etc. The sharp decline in oil price will definitely impact these contracts adversely as such contracts are dependent on the price of oil and profits/earnings of the IOCs and Independents. The servicing contracts and/or sub-contracts may have to be cancelled, suspended or at best renegotiated depending on the terms of the Contracts as a consequence and this may lead to several legal issues between the contracting Parties.
Shut down of economically unviable oil fields: As a result of the rapid decline of oil prices, licensees of Oil Prospecting Licenses or Oil Mining Leases may be forced to cut further investments in prospecting for oil or carrying out further developments in the fields that have shown indications of not having oil in commercial quantities or uneconomic in the prevailing circumstances. Such shut down in operations would have legal repercussions for contracts already entered into with respect to the licenses/Leases.
Financial Indebtedness, Exposure of Guarantors and Insolvency of Operating Companies: Many oil and gas contracts are debt-financed with capital raised from both foreign and domestic lenders, usually in US Dollars. The effect of the fall in oil price globally is bound to adversely affect the ability of the Operating Companies to liquidate their indebtedness as well as expose guarantors to demand for liquidation of the debts guaranteed by them. In the worst-case scenario, small operating companies that do not have the size and resource base of the IOCs/IOSCs may find themselves in a position where sale per barrel or the current economic realities is unable to cater for their expenditure as projected income was drawn out based on existing high oil prices. This may undoubtedly lead to defaults in repayments with its attendant legal consequences.
Suspension of projects that have not reached the FID: The slump in the price of oil globally may invariably lead to the suspension of projects that have not reached the FID. Nigeria accounts for half of the total oil projects under development in sub-Saharan Africa. Some of the projects that have not reached the FID include Shell’s $9.7billion Bonga South-West/Aparo estimated to increase crude production by the addition of 143,274bpd, ExxonMobil’s $6.2billion Bosi and $8.2billion Owowo West estimated to produce 126,784bpd and 138,301bpd respectively. ExxonMobil’s $6.1billion Uge-Orso is estimated to produce 99,532bpd while Chevron’s $8.2billion Nsiko and National Agip Exploration Ltd’s $9.2billion Zabazaba are projected to produce 95,685bpd and 146,739bpd respectively. The cumulative effect of these and other oil and gas projects that have not reached FID and yet face the risk of suspension is estimated at $58.4billion, which would be very useful in boosting the nation’s economy.
Issues between FPSO/Support Vessels Owners and their Charterers: Charterers of FPSOs/Support Vessels have entered into agreements with the owners of such FPSOs/Support Vessels and most of such charters are based on the payment of agreed hire rates, which are in turn dependent on oil prices globally at the time of the charters. The oil price slump may affect the ability of the charterers to pay the agreed hire rates to the owners of the FPSOs/Support Vessels, thereby leading to default resulting in series of legal disputes.
Labour issues: Labour issues arising from inability to pay oil workers’ salaries and wages due to fall in companies’ revenue caused by fall in oil prices will abound. Labour and employment claims at the National Industrial Court of Nigeria arising from downsizing, layoffs etc coming from the oil and gas and allied sectors are projected to skyrocket if the price of oil remains at its present pedestal.
The way forward
As of March 20, 2020, there is no known vaccine or medication for the treatment of the novel COVID-19. There is also presently no indication that the Saudi Arabia and Russia will sheath their swords and bring the Saudi-Russia Oil standoff to a halt to restore equilibrium oil price. Therefore, oil operators, oil companies and stakeholders in the global oil and gas market and more particularly in the Nigerian oil and gas sector must take certain legal measures in order to weather the storm in the midst of the oil price plummet. Some of the major ways oil and gas sector participants can do this are:
Contract Renegotiation/Price Reviews: Some contracts may, subject to their terms, need to be cancelled outrightly, whereas others may be suspended or renegotiated to reflect the economic realities on ground and price of oil in the global market. This may however result in huge disputes and legal claims between and against several contracting parties. However, smart contract renegotiation and alternative dispute resolution mechanisms in the event of disagreements would go a long way to cushion the effects of the oil price fall on oil and gas operating and servicing companies alike.
Debt Restructuring: The inability of oil companies to liquidate its debts due to the oil price plummet can have devastating effects on the company ranging from pay cut for senior executives to lay-off of staff and possibly corporate insolvency. These companies, by seeking legal advice and entering into debt restructuring agreements with their creditors will avail themselves more time to source for funds from other investments and pools. Debt restructuring would invariably attract longer maturity periods or higher interest rates but would ultimately keep the company as a going concern in the hope that oil prices will go up in the near future or enable the company to diversify.
It is in the light of the above that we commend the Central Bank of Nigeria (CBN) for coming up with a directive contained in its Circular of March 16, 2020 which aimed at among others, to cushion the effect of the Covid 19 pandemic in the Oil & Gas, Agriculture and manufacturing sectors. In that Circular, CBN directed Deposit Money Banks ‘to consider temporary and time-limited restructuring of the tenor and loan terms for businesses’ in the listed sectors. This directive will go a long way in stabilising the affected businesses as well as Nigerian economy without causing devastating disruption in the system that will lead to insolvency, loss of jobs etc.
Force Majeure: Force Majeure refers to an event beyond the control of the parties, which frustrates or delays the performance of a contractual obligation. Under English Law, a principle similar to “force majeure” is frustration. This is where a contract cannot be performed or is delayed due to circumstances beyond the control of the parties to the contract. Such circumstances usually include those categorized as Acts of God such as floods, earthquakes, tsunamis, landslides, and other natural disasters. Other circumstances include unexpected change of government policy, legislation or change of government (usually by military coup or other illegitimate/unconstitutional/unconventional means).
The effect Force Majeure Clause will have in businesses especially in the light of the COVID 19 pandemic will depend on the exact wordings of the clause. If the Clause contemplates epidemic as a Force Majeure event or has an omnibus provision that could be interpreted to contemplate the impact of COVID 19, then there won’t be any challenge in the affected Parties declaring a Force Majeure event but if otherwise, the Parties would be bound to carry on with the performance of the contract. A standard oil and gas contract, be it a JOA, PSC or general Service Contract usually contains a Force Majeure Clause. A Force Majeure Clause in a Model PSC entered into by the Nigerian government and Oil Companies provides: “Any failure or delay on the part of either party in the performance of its obligations or duties under this Contract shall be excused to the extent attributable to force majeure. A force majeure situation includes delays, defaults or inability to perform under this contract due to any event beyond the reasonable control of either Party. Such event may be, but is not limited to, any act, event, happening, or occurrence due to natural causes; and acts or perils of navigation, fire, hostilities, war (declared or undeclared), blockage, labour disturbances, strikes riots, insurrection, civil commotion, quarantine restrictions, epidemics, storms, floods, earthquakes, accidents, blowouts, lightning, and, acts of or orders of government”.
A careful look at the above model clause as well as similar clauses adopted in other jurisdictions clearly indicates that fall in global oil price does not qualify as a force majeure event capable of relieving parties from liabilities for delay in performance or non-performance of a contract. However, the Principle of Causation may be used to link an event as a resultant effect of a primary cause, which primary cause is a force majeure event. If phrases such as “events resulting from”, and “as a result of” are attached to the force majeure events in a force majeure clause of an oil and gas contract, it can be argued that the resultant effect of the occurrence of a force majeure event will also amount to or qualify as a force majeure event. In such circumstance, therefore, fall in oil price would qualify as a force majeure event since it is directly linked to the outbreak of a global epidemic – CONVID-19.
However, the Model Clause reproduced above clearly covers ‘quarantine restrictions’, ‘epidemics’ and these words may be interpreted, in the light of the COVID-19 pandemic to constitute a Force Majeure event capable of relieving Parties from their respective obligations.
It therefore goes without saying, that elegant drafting of oil and gas contracts is critical to cover both foreseen and unforeseen circumstances as well as events that would specifically be covered by the principle of force majeure, those that would be covered as resultant effects of direct causation and those that will not be covered at all.
Arbitration/ADR or Litigation: Where Parties could not amicably resolve their contractual disputes in line with the terms of their contracts or other contractual innovations aimed at restoring the commercial equilibrium of the Parties, the Parties may resort to any dispute resolution mechanism or procedure specified in their contract. The common ones are arbitration and other forms of dispute resolution procedures such as conciliation, mediation and expert determination MedArb, which is a hybrid of Mediation and Arbitration. The Parties may also resort to litigation as a dispute resolution procedure to ventilate their grievances. In any event, it is necessary to seek for expert legal advice before opting for any dispute resolution mechanism having regard to the provisions of the underlying contract.
The Nigerian economy currently stands at a fragile position as its foundation is in serious threat of massive decline. This has become evident, as the dollar has constantly appreciated against the Naira within the last few days. Ultimately, to provide foreign exchange for the importation of essential goods, the CBN will be forced to draw down the Excess Crude Account, which already sits lower than it had been in the last decade, if the COVID-19 pandemic is not eliminated in the shortest possible time. Oil and Gas Companies and Oil and Gas Service Providers are therefore encouraged to seek for expert legal advice on appropriate legal measures to take in order to handle any dispute that may arise from their peculiar contract arrangement. Contract renegotiations, debt restructuring, and force majeure clauses are some of the ways to cushion the effect caused by the global oil price slump.
Ibebuike and Amadi are of the Foundation Chambers and write from Lagos.