Recent civil unrest across North Africa and certain countries in the Middle East serves a salutary reminder to investors of the inherent risks of emerging markets. North Africa, in particular, is strategically important to many international oil companies (IOCs) headquartered in Europe.
This is due to its proximity to the markets of southern Europe, the quality and accessibility of its oil and gas reserves, and its long-standing cultural and political links with Europe. Although Standard & Poor's Ratings Services sees no immediate impact from the unrest on rated European IOCs, events in the Middle East and North Africa (MENA) region are evolving rapidly and we continue to monitor them.
How important are North African countries to EMEA-based oil companies' production and how are individual companies affected?
North Africa is strategically important to a number of Europe, Middle East, and Africa (EMEA)-based IOCs because of the quality and accessibility of its hydrocarbon reserves. Libyan crude in particular is characterized as light and sweet (that is, it has low sulfur content), attributes that command a premium on world markets. North African gas, meanwhile, is important due to the pipeline import infrastructure to southern Europe (Spain, France, and Italy) and the liquefied natural gas (LNG) terminals that allow export Europe-wide.
According to the BP Statistical Review of World Energy 2010, combined production from Egypt, Libya, Tunisia, and Algeria in 2009 was 4.3 million barrels per day of crude and 159.4 billion cubic meters of gas. To put these figures in perspective, this is higher than the combined production of oil and gas from Norway and the U.K. In our view, the most challenging political situation is currently in Libya (the Socialist People's Libyan Arab Jamahiriya; BBB+/Watch Neg/A-2) where a number of leading operators, including Repsol-YPF S.A.
(BBB/Stable/A-2), Eni SpA (A+/Stable/A-1), BP PLC (A/Negative/A-1), Total S.A. (AA/Negative/A-1+), Wintershall (a division of BASF SE; A/Stable/A-1), and OMV Aktiengesellschaft (not rated), have shut production and evacuated personnel. At present, we believe that two-thirds of Libya's oil and gas production may be affected. We also understand that the Libyan National Oil Corporation (not rated) has reportedly declared force majeure as the reason for failing to meet its delivery contracts.
We understand that production in most other countries in the North Africa region is still largely unaffected by the political turmoil. Oil and gas installations are often located away from centers of population and may be offshore. Even Libyan production facilities, according to public sources, currently remain intact. Nevertheless, the oil and gas industry remains vulnerable to political risks of any host country because of its high reliance on critical infrastructure such as pipelines and loading facilities.
Which rated companies does Standard & Poor's consider are most exposed to the MENA region?
We believe Eni is the most exposed producer in the region, and has the largest exposure to Libya (see chart). Other producers with significant exposure to the region are Repsol, also operating in Libya, and BG Energy Holdings Ltd. (BG Energy; A/Stable/A-1), with a significant exposure to Egyptian gas and LNG. BG Energy's operations in Egypt are somewhat less of a concern, in our view, because Egyptian production continues and the country is currently not subject to the level of violence seen in Libya. A large percentage of BG Energy's gas production in Egypt is offshore, which may also help mitigate risk.
Other IOCs with operations in the MENA region include BP, Total, Wintershall, OMV, OAO Gazprom (BBB/Stable/A-2), and Statoil ASA (AA-/Stable/A-1+). However, we believe that the impact on these companies from the current unrest is likely to be less material because the percentage of their total production from this region is lower.
Critically, a large amount of production from the MENA region is subject to profit-sharing agreements (PSAs). Each PSA is unique and allows a different profile of recovery of investment for the IOC, royalty for the host country, and profit split between the IOC and the government. Owing to insufficient disclosure of PSA details by the IOCs, the effect of the current turmoil on each IOC's production, profits, and cash flows is difficult to estimate precisely.
How does Standard & Poor's factor in North African events into its ratings on IOCs?
There are five main components of political risk against which we assess companies involved in the exploration and production (E&P) of oil and gas worldwide, namely:
· The likelihood of resource nationalism/intervention. This covers the potential loss of a license or assets, or having to cede control--to a sovereign or related entity such as a national oil company--at below-market prices.
· Corruption.
· Fiscal, political, and legal uncertainty.
· Physical disruption. The risk of interruption of the production, shipping, or export of hydrocarbons.
· Structural constraints on commercialization and monetization of the volumes produced, including export volume quotas and price controls.
Our credit ratings on IOCs factor in exposure to both political and operational risks that may affect cash flow volatility. In our view, an E&P company with a high exposure to risky emerging markets should be well diversified and carry a stronger balance sheet at a given rating level compared with a company in a more stable industry that operates in a more stable political and fiscal environment.
At this stage, we don't foresee any near-term rating actions on IOCs. Nevertheless, we continue to monitor the situation and cannot rule out that our view may change over time. The main reason for the current status quo is that rated IOCs with the largest exposures to North Africa in general, and Libya in particular, are large and diversified multinationals. These companies have production assets spread out over several regions. The various political and fiscal risks that they face may be moderated by diversity over a number of countries. However, recent events across the MENA region suggest that emerging market country risks may be even more correlated than we have previously factored in.
Because North African economies are dependent to a significant degree on the exploitation of natural reserves, we believe that host administrations, over time, will align their economic interests with those of the IOCs. However, given demographic, social, and development pressures in the region, we don't rule out the possibility that the IOCs' contractual or fiscal terms may be revised. Recent events could, we believe, result in reduced sustainable cash flows or even large write-downs over the longer term.
Are there any benefits for IOCs arising from recent events in North Africa?
The political turmoil has provoked a spike in the global oil price, which was edging up even before events erupted in North Africa. In our view, the dynamic of the market could also be affected by the loss of high quality Libyan output, which might not be easily compensated for by increased heavier Saudi Arabian production or reserve sales--giving further support to higher prices.
IOCs' revenues do not necessarily rise in line with higher world oil prices, however, because of the increased use of PSAs and individual companies' unique mix of gas and liquids. Therefore, the current high oil price can only partially mitigate the impact of a material production cut, damage to assets, or a material change in the terms of a PSA.
Do recent events change Standard & Poor's view of how production in high-risk countries is factored into an IOC's rating?
We view the oil and gas industry to be significantly exposed to political risks through regulation, industry-specific taxes, and PSA terms. The current situation in North Africa highlights that even when the regime looks stable on the surface, more fundamental political and economic issues may have to be taken into account. There is also uncertainty as to how civil unrest may manifest itself in other countries in the MENA region. Although we believe that each country has its own set of factors that triggered the current unrest, some of the fundamental challenges might be similar.
Our ratings factor in each company's portfolio of country risks. In particular, our ratings on Repsol-YPF, BG Energy, and Eni are constrained by their degree of emerging market exposure. These companies benefit from some diversification and scale, which could help mitigate exposure to the risks of a specific country. Even so, recent events in North Africa demonstrate that diversification helps only to the extent that investments are not significantly correlated.
Smaller, less diversified E&P companies may be exposed to just one or two countries. In these circumstances, our ratings on such companies are normally in the 'B' category. Examples include Afren PLC (B- [prelim]/Positive/--), which is exposed exclusively to Nigeria, MB Holding Company LLC. (B+/Stable/--), which is exposed to Oman, and Melrose Resources PLC (not rated), which is exposed to Egyptian gas. Our long-term corporate credit rating on Melrose was 'B' with a stable outlook before we withdrew it at Melrose's request in August 2009.
