The natural resource discussion in sub-Saharan Africa can be pessimistic and fatalistic at times. Some struggle to see the upside, basing fears on challenges with infrastructure, local content and skills shortages. Others are fatalistic, suggesting that natural resources are a curse for the continent and its economies.
The reality is that much of sub-Saharan Africa’s abundant natural resources are still undiscovered.
Exploration in a number of countries will boost output and reserves for some already big producers as well as create a few first-time producers in the near term. That said, fund managers have struggled in 2016 to raise capital for sub-Saharan Africa-focused natural resource funds.
Let’s say you’ve raised a $1 billion fund to chase after the lucrative opportunities in the sub-Saharan Africa natural resources space. Here’s a look at the African market through that lens.
End of a commodity super cycle
Commodity prices started skyrocketing in 2000. Slowed temporarily by the global financial crisis of 2008 and a slight decline in 2011, the boom nevertheless persisted nearly 14 years. By the end of 2011, average prices for energy and base metals were three times as high as the previous decade. In some cases, some commodities – such as gold, iron ore and oil –were near the highest levels in 110 years.
If this was still 2013, there would be little discussion of potential decline or drastic downturn. But it is 2016 and we know what happened during the end of 2014 and throughout 2015. Slowing Chinese growth – not too far from the slower days of the late ’80s – has lowered the expectations on commodity prices.
The Federal Reserve’s interest rate hike in December 2015, which was the first one since 2006, boosted the dollar against other major currencies. Brexit furthered the dollar’s gains. This dollar value bump only added to the woes of commodities, mostly priced in dollars, by reducing the spending power of global raw-materials buyers and making other assets that produce yields – bonds and equities – more attractive investments.
The 2016 M&A market in the trough
The theme of low-deal values in 2015 rolled over into 2016. Deal count in 2015 remained relatively comparable to 2014 but value was down nearly 70 percent. That deal value is down about 65 percent more in 2016.
Nigeria is the best example of how the investors and operators were caught off guard. Numerous indigenous companies completed expensive acquisitions, specifically in oil and gas, shortly before the crash and now are strapped with debt loads difficult to cover. Thus trading prices have nosedived in Nigeria and across sub-Saharan Africa (again most noticeably in oil and gas). The moral of the story is that investors are cash-strapped with tighter equity and debt markets and are showing little excitement for the higher-cost and higher-risk opportunities across sub-Saharan Africa. That is the bad news of 2016 yet the opportunity for 2017 and it is where having a $1 billion dollar sub-Saharan Africa natural resources fund is opportunistic.
Going into 2017 and beyond
To date, 2016 can be summed up by a three themes: aggressive capital expenditure reduction across the board; comprehensive portfolio management and strategic allocation of energies and monies; and fewer distressed M&A transactions than predicted.
That said, the commodity price trough is creating more motivated sellers, opening creative minds, and building more consensus on valuations. Postponing transactions until prices return to higher levels is no longer a viable option for many natural resources companies, especially those with a focus in oil and gas. Liquidity pressures, margin pressures, generally sagging capital markets, and no certainty in a future OPEC production cut will force more assets on the market at increasingly more reasonable prices.
2017 and beyond likely more of the same
First, the focus will be on capital management. Large-scale development projects will be further re-evaluated, with some projects scrapped and those with sustainable economic returns promoted and allocated a greater percentage of available capital. Farm-outs will become attractive opportunities as capital-constrained companies seek additional capital for quality projects. Expect an oversupply of these farm-out opportunities in a buyer’s market.
Secondly, low mergers and acquisitions value will persist but there will be a recovery in volume of deals. Low commodity prices underpin the buyer’s market and will effectively keep deal values low. Distressed transactions of higher-quality assets are expected as hedges are weak, lender covenants are tested, and companies are light on capital availability. Distressed companies will also likely appear on the market if capital commitments to larger portfolios are greater than the capital markets are willing to fund.
Third, transaction structures will become increasingly more complicated. Contingent price transactions could feature more as buyers and sellers attempt to manage exposure to commodity price volatility and other future uncertainties. Decommissioning will also be on the table for discussion and play in transaction structures. And, for the fund managers with capital chasing opportunities, strategic alliances will grow as the market (buyers and prices alike) forces only the best operators to operate where they are best positioned.
Our favorite commodities to watch
Gold will be on the radar with shaky currencies, Brexit, and market uncertainty as the backdrop. A good sign for gold is the M&A activity in West Africa by well-capitalized North American and Australian gold producers. This includes Perseus Mining’s expansion into Cote d’Ivoire and Sierra Leone through the Amara Mining takeover, and Endeavour Mining’s buyout of True Gold Limited.
The official Article 50 triggering for Brexit, a potential hike in the U.S. federal interest rate, general global political volatility, and declining production in the near term spell higher price levels for gold. West Africa will continue to be the focus in this scenario.
Oil – also known as the black gold – will also star in the discussion. Buyers are more comfortable with the framework of $50 oil and can project the challenges in this price scenario. Choosing the best course in navigating it is less tied to hopes of a price recovery than to better management of capital and operating expenditure.
Managing those costs is comparatively more challenging in sub-Saharan Africa than other markets, but choosing the right operators for localized issues is possible. A price recovery – while not imminent but foreseeable in the long term future – is the windfall protection on any investment if the short term challenges are strategically managed.
Base metals are also all on the watch radar. Any above-expected performance with Chinese demand would change the price outlook, particularly for copper, zinc and nickel. But patience and caution are the stories with China rebalancing internally. China’s cuts in certain commodity imports, particularly coal, had dramatic effects on the market.
Our favorite countries to watch:
Democratic Republic of Congo
It’s home to more than 50 percent of the world’s cobalt resources and approximately a fifth of industrial diamonds. Oil exploration and production could vastly improve with infrastructure investment.
It’s home to massive iron ore deposits valuing more than $1.5 billion. You can also find nearly a tenth of the world’s bauxite deposits and massive gold deposits in the country.
If Tullow Oil’s project in Ghana was still in development stages, there would be some concern. Yet the costs are sunk and the production is moving along. Maybe it is an opportunity for deploying some capital. Gold mining is also tempting with the right partner. Cost management sounds like the easy catchphrase for concerns. But it is a big concern in Ghana for producers across the mining landscape. Hedging on a gold price uptick will seem easier than betting on a company’s innate ability to reduce costs in the short term.
The majors and indigenous players will be reshuffling oil and gas assets through divestments and some acquisitions. The key here is who you latch your future to. Taking educated and well-advised risk in the country is worth it. Security concerns are real as well as high operating costs. But a partnership with an operator with the right mix of indigenous ingenuity and previous experience locally and globally should create positive results in the near term and hit a homerun in any price recovery environment. Gas to power is intriguing in this scenario too, albeit the market requires some changes before it is an economically justifiable risk for a non-operated investment.
The Ahmeyim/Guembeul gas discovery is an interesting prospect for capital. The question remains how open U.S.-based Kosmos Energy is to exploring capital partners and how the publicly traded Kosmos sees valuations in this market.
Onshore developments in the region require more capital. Tullow is good at what it does and a fair-minded partner. They manage cost, even allowing some commentators to label the area as cost friendly. That may be a leap in positivity. Local media already suggest skepticism on production and pipeline development. As one person put it, businessmen and conference hosts both have tempered expectations for projects in the short term, which is reasonable in this price market. But let’s bet on some Kenyan ingenuity in the long term. Non-operated acquisitions can produce dividends over the long term.
Why not South Africa
Offshore exploration has been delayed due to costs. Price upticks in spurts will not change that situation. Throw in some regulatory uncertainty and political dancing by the parties for the 2019 election.
The election is a distance away but is on peoples’ minds today. That makes South Africa a quasi-volatile market to bet on despite its significant platinum, chromite and manganese resources as well as oil potential. And the mechanizing of production is meeting pushbacks from labor who wants increased wages and greater benefits or protections.
Thinking long term in sub-Sahara: Policy: risks and upside
Countries are banking more on natural resources than some policymakers say is feasible in the short term. For example, Nigeria and Angola require approximately $120 and $100 oil prices respectively to balance domestic budgets. This can be a plus or minus depending on how the country’s leadership responds.
On the positive side, some leaders are spending to improve infrastructure and partner across borders (with Uganda and Kenya as an example). On the negative side, some leaders are clamping down with more nuisance tax structures that worry some investors. Capital gains tax hikes are raising concerns in Gabon and Tanzania and there are delayed petroleum laws in the Congo, Nigeria, and South Africa.
Beyond policy concerns, other large scale risks must be addressed. Insufficient infrastructure and underdeveloped service sector mean slow development. But various countries are investing in small businesses development and training programs to strengthen local support and content. Natural resource investors could play a strategic and lucrative role in infrastructure depending on the country’s leadership and openness to the idea. Low liquidity in local banking sectors is an issue. Capital infusions from private investors helps but more will be needed to buoy working capital availability in the short term for indigenous players.
A $1 billion fund is limiting considering the vast opportunities in sub-Saharan Africa natural resources. Acquiring non-operating interests in projects will provide a much needed lifeline to some companies and should come at highly discounted values. It is fair and right to bet on an uptick in prices in the long term. Yet it is the best investment to navigate and improve during the low times and simply consider any uptick to be a windfall in the long term. Who is interested?