Proposed Solution of Petrobras in Nigeria: Valuation of the Agbami Oil Field FUQ-04-2010
Proposed Solution of Petrobras in Nigeria: Valuation of the Agbami Oil Field FUQ-04-2010
Proposed Solution
Petrobras in Nigeria:
Valuation of the Agbami Oil Field
Case Synopsis
David Passami, the VP of strategy for Petrobras Nigeria has to make an important decision. Statoil has made a $1bn bid for Petrobras’s 13% share in the Agbami (Nigeria) project. Petrobras has been in Nigeria since the past 10years and has invested $500mn in the country. Petrobras is going to start seeing oil revenues this year (2008) but there are many uncertainties associated with the projected cash flows. The idea is for students to evaluate the cash flows after putting tangible values to the uncertainties as well as to strategically analyze the options available to Petrobras at this point. Students are required to make a recommendation as to which option they would select and support their recommendation with reasons.
Objectives of the Case
By working through this case, students should develop an understanding of the political, economic, and social context around a strategic investment decision in an emerging market. Specifically, the case requires an analytical look at a specific industry (oil) in which major upfront costs are made with revenue and cash inflows expected 8-10years after the capital investment. The case asks students to evaluate both the explicit and implicit risks associated with a project or investment, complete a break-even analysis, analyze selling out versus staying invested in a project and understand the role of the cost of capital in analyzing financial returns.
Primary objectives of this case include:
- Risk assessment of the oil industry
- Risk assessment of the political, economic, and social environment in Nigeria
- Valuing Petrobras's share in the Agbami project through a NPV analysis
- Identifying the key uncertainties associated with staying invested in the Agbami project
- Evaluating the effect of each uncertainty through a sensitivity analysis on the value of the Agbami project
- Strategic recommendation on whether Petrobras should stay invested in the Agbami project supported by adequate qualitative and quantitative analysis
Why Oil?
Oil is an incredibly significant commodity. Oil is deeply ingrained into our culture as it was the driving force (and still is in the developing regions of the globe) behind industrialization. There is no country or area in the world today that can insulate itself from problems in the oil market. Oil affects every nation on earth with no exceptions.
Oil is remarkably pervasive in society and can be found in a multitude of commodities. It is a misconception that oil is merely present in petroleum fuel for cars. Oil is used for heating homes, running electric power plants, fertilizers and pesticides and a whole variety of plastics. In fact 1/3 of all oil consumed in America is for stationary uses, such as industries, businesses and residencies. It has also grown into a huge factor in international trade. Primary energy fuels represent 3.3% of total world GNP, with oil making up 2/3 of that. In addition, oil represents 7% of world exports.
Overall, oil now fulfills many important roles: Key global commodity, political bargaining chip, economic catalyst or, as the Gulf War showed us, excuse for military aggression. In any of these roles, oil is undoubtedly very important.
Why Nigeria?
Nigeria is the most populous country in Africa, the eight most populous country in the world, and the most populous country in the world in which the majority of the population is black. It is listed among the "Next Eleven"economies, and is a member of the Commonwealth of Nations. The economy of Nigeriais one of the fastest growing in the world, with the International Monetary Fundprojecting a growth of 9% in 2008 and 8.3% in 2009. It is the 2nd largest economy in Africa. Nigeria's economy depends a lot on it's oil wealth which is found abundantly in the Niger Delta. However, as is the case with many emerging economies, Nigeria still suffers from many political, social and economic issues which make it an interesting case topic.
Risk Identification and Mitigation
There are several risks and uncertainties Passami needs to consider before making his decision to sell out to Statoil or not. These risks can be divided into four generalized categories:
1.Project risks – those risk factors that directly impact the production of oil and affect the cost of capital
2.Market risks – those factors impacting the oil market as a whole
3.Sovereign risks – risks facing any business operation in Nigeria
Below is an in depth analysis of these risk factorsas well as potential mitigating factors.
Project risk:
General Risks / Specific Risks / Agbami Mitigating FactorsSovereign
Currency / Direct currency risk: Exchange rate and currency fluctuations can directly impact the value of goods and services sold.
Indirect currency risk: Macroeconomic policies can cause the local currency to devalue which has a secondary effect. Massive devaluation can cause major unrest in the country. / Oil sold in USD which takes a big bite out of the risk premium. All transactions regarding the export of oil take place in dollars. There remains some risk, as Petrobras exports to other countries and the dollar can move up or down against their currency. However, these movements are rather stable and there are adequate derivative markets through which such currency risks can be hedged.
Expropriation / Direct: The government can seize assets
Diversion: The government can divert exports
Creeping: The government can alter its taxation policies / Direct: Oil projects are capital intensive projects in which large capital investments are made get projects up and running. The government can seize some of the PSOs and sell oil in the thriving black market.Currently $10bn worth of oil barrels are stolen every year from the Niger Delta for illegal trade which has a corrupting effect on security services and institutions.
Creeping: The government can alter its taxation policies by increasing taxes (currently at 85%), can increase the royalties collected (currently at 18.50%) or can decrease the profit allowance (currently at 16%) which would have a negative impact on Petrobras's revenue in Agbami.
Diversion: There seems to be very little risk of the government diverting exports.
Though it is unlikely that Petrobras will exit Nigeria even if taxes and royalties increase, the government would not want to antagonize Petrobras or any foreign oil investor in the country through direct or creeping expropriation. The Agbami and other oil projects contribute to the economic prosperity in Nigeria with $55bn in oil earnings flowing into the treasury in 2007 and an estimated $76bn expected in 2008. A rational government decision maker would not want to change policies that could negatively impact these inflows into the state’s coffers.
Commercial International partners / Are any international partners involved in this project that lend credibility to the project and that could give Petrobras and Agbami a stronger hold in the region? / Petrobras has partnered with U.S. oil giant Chevron and Statoil in the Agbami project. Texaco has a technical sharing agreement with them. Many other international oil companies have made investments in the region. Petrobras has international commercial partners in the Agbami project which gives them a stronger hold in the region.
Involvement of Multilateral Agencies / Is any multilateral agency involved in the project which lends support to the project and benefits from the project proceeding smoothly? / Since 2008 the Nigerian government has begun to demonstrate political will to implement market-oriented reforms urged by the IMF, such as to modernize the banking system, to curb inflation by blocking excessive wage demands, and to resolve regional disputes over the distribution of earnings from the oil industry. It appears as though the government would work towards resolving any oil field related conflicts that may arise in the region.
Sensitivity of Project to wars, strikes, terrorism / Sensitivity of the project to civil unrest and strikes that could affect the ability of employees to carry on their daily work. One way to think about this is: is this project more sensitive to war and terrorism that other projects undertaken in Nigeria? / The Agbami project is not so vulnerable to strikes since it is a capital intensive project with many foreign employees that bring expertise of the offshore oil industry. However, the project is vulnerable to civil war and terrorism. Agitation for better resource control in the Niger Delta has led to disruptions in oil production. Competition for oil wealth has fueled violence between innumerable ethnic groups, causing the militarization of nearly the entire region by ethnic militia groups as well as Nigerian military and police forces. Offshore terrorist attacks have been rare but recently speedboat riding gunmen navigated more than 100km of open sea in darkness to attack Shell’s giant Bonga vessel, forcing the company to shut 200,000 b/d of oil production.
Agbami is as sensitive to war, strikes and terrorism as any other oil field in the region. Though there is civil unrest in the region, oil wealth has increased the GDP of the country (though income inequality has increased simultaneously). The government has the most incentives to maintain peace and stability in the region.
Sensitivity of Project to natural disasters / Natural disasters are unexpected sudden events which impacts with such severity that it is usually disastrous and uncontrollable. / Nigeria is exposed to natural disasters like oil spillage, drought and the most common of all, flood. However, the Agbami project is not more sensitive to such natural disasters as is any other project in the region.
Operating
Resource / Resources include availability of inputs and raw materials required for production. / Though Daewoo had brought the FPSO to Agbami in 2007, the FPSO had not yet come online and the field is still awaiting production. Aside from this resource being activated, Agbami has all the resources required for oil drilling.
Technology / Technology refers to the technological challenges required for ongoing and sustained production. / Deepwater projects are more technologically challenging than onshore projects. Technological risks are low as Agbami does not involve any new offshore technology. Petrobras brings the technical expertise and experience in deep water.
Financial
Probability of default / Default refers to the inability to make debt payments or to come up with adequate financing for completion of a project. / Petrobras has financed it's investment in Agbami through available cash and has not taken on any leverage. There is the small risk that the other partners of the Agbami project may run into a cash crunch delaying drilling and production. However, given that major investments have already been made into the project by large experienced partners, it seems unlikely that coming up with finances will be an issue.
Political risk insurance / Political risk insurance is a type of insurance that can be taken out by businesses, of any size, against political risk — the risk that revolution or other political conditions will result in a loss. / Petrobras has insurance in place protecting them against all political risks.
Market Risks
General Risks / Specific Risks / Mitigating FactorsPrice Volatility / The oil market is among the most volatile commodity markets in the world. As a general trend, falling oil prices affect the economies of various oil producing nations that depend largely on oil income. / Nigeria became a member of the OPEC in 1971; as a member, it is somewhat shielded from major fluctuations in oil prices by the OPEC which controls supply and demand to maintain global oil rates. However, even the OPEC cannot shield countries from a drop in oil prices caused by a major recession / slowdown in world economies.
Market Demand / Nigerian crude is of light, sweet quality for which there is a large market demand. / Nigeria is an important oil supplier to the United States. Over half of the country’s oil production is exported to the United States (see exports below) and the light, sweet quality crude is a preferred gasoline feedstock. Consequently, disruptions to Nigerian oil production impacts trading patterns and refinery operations in North America and often affect world oil market prices.
New market entrants / Oil upstream and downstream activities require a substantial capital investment as well as expertise and experience in the industry. There a big barriers to entry for new market entrants. / Petrobras’s expertise in off-shore drilling set them apart from new entrants that are still mastering the technology needed for such off-shore drilling techniques.
Sovereign Risks
General Risks / Specific Risks / Mitigating FactorsPolitical instability and corruption / The country has only re-achieved democracy status (in 1999) after 33 years of military rule. The current President of Nigeria is unwell and there are underlying strains of political unrest ready to erupt in the country. There is growing unrest as few individuals benefit from the oil wealth of the country adding to the income inequality. / The chance of return to military rule seem remote in Nigeria as the country has made rapid strides towards development and progress in the past decade. It has successfully dealt with many of the political and economic issues it faced.
Currency exposure / An unstable home currency creates uncertainty, hindering ability to make business decisions. A strengthening currency will weaken export demand, while a weakening currency will improve export demand. / All transactions regarding the export of oil beans take place in dollars. There remains some risk, as Petrobras exports to other countries, and the dollar can move up or down against the currency of these countries. However, these movements are rather stable and there are adequate derivative markets through which such currency risks can be hedged.
Expropriation / The government can seize assets, divert exports, or alter its taxation policies. / Nigeria’s economy depends largely on it’s oil wealth and it would not be in the best interest of the country or its leaders to antagonize oil companies by expropriating.
Valuation:
We created a pro-forma for Petrobras in Nigeria till the date 2024 in order to value the company’s Agbami project. Since Petrobras is going to start seeing revenues from Agbami in the year 2008 and the normal life of an offshore project is 16 years (not including the years invested in drilling and exploration), 2024 seemed like a good time period over which to project cash flows. Our pro-formas used the income statement ratios of Chevron in Agbami and adjusted Petrobras’s income and expenses proportionately. The changes in working capital as suggested in the case are 0 for the purpose of the NPV analysis. The capex figures, as mentioned in the case, are $7bn amortized over 17years. Since there is no debt for financing the operations, there is no interest expense. Based on the above cost of capital analysis, we obtained a cost of capital of 16.69% for the project factoring all sovereign, operating and financial project risks.
In order to evaluate the downside potential that a fall in oil prices can have on the Agbami project, different production schedules can be used which will result in different revenue figures. The Texas State Government oil price projections are more bearish and give a worst case scenario that can be used to get a range of values for Petrobras. The oil prices using futures are more optimistic. Students can also come with a 3rd in-between oil price schedule which averages the worse case and best case scenarios. We have also created a break-even price of oil (option 4 in the production schedule tab of the excel solution).
Using the Texas State Government oil price projections, as well as base case profit allowance (16%), royalty (18.50%) and tax figures (85%) we obtain a net present value of $618million. Given the offer price of $1bn from Statoil, it seems like accepting Statoil's offer is the best option in this case. However, students should consider the intangible value of relationships in the future on which there is an associated premium that is difficult to quantify (Relationships section on page 9 of the case). The Agbami opportunity gives Petrobras an opportunity to partner with the big players like Chevron and many others in the future. Exhibit 11 displays the world’s deepwater opportunities that could be potential opportunities for Petrobras. The value of the relationships though hard to quantify is larger than the ($1bn-$618mn) $372mn premium that Statoil is offering. Additionally, this is a worst case scenario of oil prices and making a decision on the basis of this scenario alone would be incorrect.
Using an average oil price projections, as well as base case profit allowance (16%), royalty (18.50%) and tax figures (85%) we obtain a net present value of $1.049billion. Given the offer price of $1bn from Statoil and the fact that David is willing to consider an offer price of up to 10% below that of the true value ($944.51mn in this case) of its stake in Agbami, it seems like Statoil has made a substantial offer in this case. Again, students should consider the intangible value of relationships in the future on which there is an associated premium that is difficult to quantify (Relationships section on page 9 of the case). Additionally, this is an average scenario of oil prices and does not consider more optimistic oil prices based on futures prices.