Key Commercial Issues Arising from the Guidelines on the Farm Out and Operation of Marginal Fields 2013

Sequel to the announcement of the Marginal Fields Licensing Round 2013 (“Licensing Round”) by the Minister of Petroleum Resources, the Department of Petroleum Resources (“DPR”) released the Guidelines for Farmout and Operation of Marginal Fields (“the Guidelines”), as well as Pre-qualification, Technical and Commercial Field-Specific Bid Submission Requirements (“the Requirements”). These documents outline the basis for the award of Marginal Fields, provide directives for their operation and identity certain matters to be considered by prospective operators.

A marginal field is any oil field in which available reserves do not make it commercially viable for the leaseholder i.e. International Oil Companies (“IOCS”) to develop. Such fields are located within existing Oil Mining Leases (“OML”) that are usually operated by IOCs and are left dormant for a considerable amount of time.

Due to the economics involved in petroleum exploration, marginal fields are unattractive to IOCs but can be viable investments for smaller companies with significantly smaller operating budgets e.g. indigenous petroleum exploration companies (“INDICOs”).  In recognition of this fact, Marginal Fields are farmed out of existing OMLs and awarded to third party operators to ensure their exploitation in accordance with the terms of a Farm Out Agreement.[1]

The Petroleum Act (“the Act”) forms the basis for the farm out of Marginal Fields. Under the Act either the President or a leaseholder with the approval of the President may farm out a a Marginal Field from an OML.

Marginal Fields are defined in the Act as “such field(s) as the President may, from time to time, identify as a marginal field”. In addition, the Guidelines expand the definition of a marginal field to include “any field that has (oil and gas) reserves booked and reported annually to DPR and have remained unproduced for a period greater than 10 years”. Such fields may be characterized by high viscosity crude oil, high gas and low oil reserves, or may be previously producing fields that have been abandoned for over 3 years by the leaseholder for economic or operational reasons.

The award process as outlined in the Guidelines is divided into 6 stages; application, prequalification, announcement of pre-qualified bidders, technical and commercial bid submissions, evaluation and announcement of successful bidders.  Critical points to note regarding the award process are as follows:

1.      Submission of Applications: The prescribed application forms have not been made available to the public despite the DPR’s notification that the Licensing Round will proceed as scheduled. Also, provisional timelines set by the DPR for application submissions have lapsed. Interested companies have to wait till definitive deadlines are issued and need to be extra diligent to obtain information that ensures their participation in the rounds.

2.      Prequalification: OnlyNigerian registered companies having at least 51% of the beneficiary interest being held by Nigerians are eligible for pre-qualification. Furthermore, the company’s objects must be limited to exploration and production. Interested companies  must have a minimum of 4 promoters, with no promoter owning more than a quarter of the company’s equity and at least one shareholder must have experience in the oil and gas sector.          

3.     Bid Submission: Pre-qualified companies are required to a pay data prying fee to obtain access to Online and Physical Data Rooms, after which they will declare their interest in select fields, with no more than three (3) fields being selected by each bidder. Pre-qualified companies are also be required to lease Data for each field at a fixed fee and an additional fee for Data Services (this is optional) may be paid where thecompany requires technical assistance regarding leased data. Upon review of relevant data, pre-qualified companies shall submit field-specific technical and commercial bids.

4.    Bid Evaluation: Bids will be evaluated by a Selection Committee comprising of DPR, leaseholder representatives and financial consultants (who will evaluate the financial instrument accompanying the bid).  Recommendations on potential awardees will be made to the Minister of Petroleum and the President for approval and successful applicants will be notified by DPR . Upon award of a Marginal Field, successful applicants will be obliged to begin negotiations with leaseholders on the terms and conditions of the Farm – Out Agreement, such negotiations should be concluded within 90days of the award.

A number of issues must be considered by prospective bidders looking to acquire Marginal Fields. These issues are elaborated below:

1.    Valuation Challenges: The valuation of a Marginal Field will undoubtedly, be an issue of paramount importance as the available reserves may form the basis for the funds utilized in securing the bid and developing the field. Since there are no indications that bidders will be given an opportunity for physical inspection of the Marginal Fields, steps must be undertaken to conduct independent investigations to ensure appraisals are well informed and commercial bids are well priced based on the attendant risks.

2.     Financial Considerations for Bidders: The ability of prospective bidders to secure adequate funding for the acquisition of Marginal Fields and its development to the point of production is pertinent. The Guidelines and Requirements clearly state that bids shall be evaluated with a view to accessing parties’ ability to promptly and efficiently develop the field. Thus, interested companies must ensure that funding issues are properly addressed not only as a pre-requisite for submitting a viable commercial and technical bid, but to ensure that it can develop the field expeditiously after the award. Some financial issues to be considered by prospective bidders are:

a.     Acquisition Costs: A key component in the award process for Marginal Fields is the payment of a signature bonus of US$300,000 within 120 days of the award of the field. Failure to pay this bonus can lead to the revocation of the award by the Federal Government. Interested companies must secure this sum in addition to other acquisition and development costs to mitigate against the risk of revocation.

b.    Cost of Development: Research has shown that a marginal field in the Niger Delta Basin can cost about $US40 to $US70million to develop in the initial years to First oil[i] (i.e. to the beginning of production on commercial basis) and as much as $US6 per barrel may be expended to extract petroleum..  Reliable projections on development costs and understanding of the intricacies of marginal field operations  may be a success factor for bids as such matters will be accessed during evaluation.

c.    Leverage on Foreign Partnerships: The traditional modes of funding Marginal Field acquisition and development is via bank financing and partnership with foreign financiers. Inviting foreign financial partners has become inevitable as Nigerian banks do not always have the capacity to provide the necessary finance. Also, unlike the IOCs, INDICOs may lack currently producing oil mining assets, which, in the case of the IOCs, could be used as security for finance.

d.    Lender Reservations: Interested companies need to be mindful of lenders reservations regarding policitical,regulatory and security risks, Lenders tend to worry that a change in the political climate can greatly affect their ability to recoup their investments. The uncertainty around the passage of new legislation such as the Petroleum Industry Bill might lengthen marginal field development timelines. Additionally, the security situation in the Niger Delta (especially with regard to onshore fields and the frequency of pipeline/facility vandalisation) has the potential to shut down production for significant periods of time and losses may be hard to estimate,

Bidders can address these considerations by exploring alternative sources of funding which include:

         i.         
Commodity Trading Houses: Bidders can partner withCommodity Trading Houses to secure development funding. These institutions may provide finance in exchange for the chance to offtake crude oil from the field as was done by Glencore last year via an  Exclusivity Off-take Agreement with Sirius Petroleum for the Ororo Marginal field in OML 95 (farmed out by Chevron).

       ii.        Reserve Base Lending: Some lenders may be willing to provide reserve base lending, which involves a non-recourse loan based on the expected present value of future production from the fields in question. Taken into account will be factors such as the level of available reserves, expected oil price, a discount rate, assumptions for operational expenditure, capital expenditure, tax and any price hedging employed. Such funding is potentially attractive to specific lenders, who may eventually want to syndicate or securitize the debt.

3.      Technology: Marginal fields sometimes require un-conventional technical expertise for development. Bidders must ensure that their technical bids cover the utilization of enhanced oil-recovery schemes, like gas injection and Plasma-Pulse(similar to gas injection), horizontal drilling and fracking (injecting fluid into the ground to create cracks that provide access to more oil and gas reservoirs) to extract the maximum potential from the fields..  The adoption of unconventional methodologies effectively leads to incidental costs and potential downtime in procuring requisite technical expertise. To mitigate this risk, Bidders should leverage on alliances with foreign partners, that can provide relevant such expertise.

4.     Joint Operating Agreement: Bidders must also be prepared to negotiate a Joint Operating Agreement if the fields are awarded to more than one company. Such circumstances pose a risk as parties have to conduct joint operations with strangers, therefore equitable considerations and top notch negotiation tactics will be required to secure Bidders interests.

5.    Shared Facilities: An offshoot of Marginal Field operations is that the awardee will, for economic reasons, most likely utilize existing facilities of leaseholders at a fee. Though the process of determining ullage fees is a commercial issue, the DPR is empowered under the Guidelines to adjudicate situations where leaseholders and awardees disagree on applicable ullage fees.

In spite of the delay in commencing the application process for the Licensing Round, it is certain that the acquisition of a Marginal Field can be very lucrative for interested companies that structure their technical and commercial plans appropriately. Adequate mitigation of associated risks and compliance with the Guidelines and Requirements are crucial to the success of bids. Also the formation of consortiums with good technical partnerships are a useful tool in optimizing the opportunity. In a nutshell, interested parties must take steps to value the Marginal Fields adequately in line with current realities and secure strategic financing to increase the chance of success and ensure the acquisition of commercially viable fields.