Last week Algerian football supporters attacked the headquarters of Algeria’s national oil company, Sonatrach. They were angry at the company, accusing it of not paying the salaries at Mouloudia d'Alger, the football club it owns. The attackers blamed this state of affairs for the average results of the club in the Algerian league.
If Algerians can be so angered by poor football performance, imagine their wrath when Sonatrach’s revenues decrease because of the global changes affecting the oil and gas sector. Such a downturn could mean that the company will be unable to continue to play a pivotal role in the economy of Algeria. We are entering an era of energy transition where resource-dependent countries, their state-owned companies and their populations need to prepare, get fit and build a strategy that will help them win the competition.
The coronavirus pandemic accelerated many trends that were already underway, including the energy transition away from fossil fuels toward renewables. The faster this transition, the more it threatens national oil companies and governments reliant on oil revenues—unless they prepare well.
Algeria, the largest oil and gas producer in North Africa, is heavily dependent on hydrocarbons for exports and government revenues, with oil and gas accounting for 60 percent of government revenues. Sonatrach controls over 75 percent of the country’s hydrocarbon production; it is the cornerstone of the economy, which makes it crucial that Sonatrach management and government officials heed global shifts.
A new corporate strategy?
National oil companies with dwindling proven reserves and a heavy share of high-cost geological assets among their potential future portfolios face serious possibilities of “stranded investments,” and could struggle to maintain expected production volumes, revenues and transfers to state treasuries. NRGI analysis shows that national oil companies in the MENA region could invest more than $66 billion in oil and gas projects that would not break even if the world keeps to its climate commitments. Sonatrach’s portfolio is the most vulnerable in this regard, with $12 billion in project spending (more than 25 percent of the company’s budgeted capital expenditure) slated for projects with a break-even price between $40 and $70.
Alongside the prospect of investing in high-cost projects, Sonatrach must continue to supply the ever-growing domestic demand for natural gas, which is sold to citizens at subsidized prices, thereby reducing the share available for revenue-generating exports. These challenges reverberate through the company’s portfolio, limiting access to finance and partnerships that would aid its diversification.
Sonatrach’s current approach to mitigate this uncertainty largely revolves around a shift to liquefied natural gas (LNG). This includes investing in existing and new LNG projects to diversify its gas export portfolio. The success of this approach hinges on the availability of domestic reserves and technology to unlock gas at a competitive cost—and on whether the demand for gas holds up or yields to increasingly cheaper renewable energy. In addition, Sonatrach must demonstrate commercial abilities to become an LNG trader (not just a supplier), expand internationally to secure a flexible and diverse portfolio, and harness financial resources to take positions in the gas value chain. However, we know that Sonatrach had to halve its spending in 2020 due to the collapse in the oil price, at the time limiting its capacity to expand into growth markets such as chemicals and plastics.
State of the government-Sonatrach relationship
Alongside the Algerian government, Sonatrach, like many national oil companies, shoulders significant financial responsibility for the wellbeing of citizens. Reduction in oil and gas revenues increases this pressure. So beyond the company’s business and investment strategies, the government of Algeria must reexamine the fiscal relationship between Sonatrach and the state, as long-held expectations about available fiscal transfers (of taxes, dividends and other payments by the company to the government) may be unmet. The International Monetary Fund (IMF) estimates Algeria’s fiscal break-even price—the oil price necessary in order to meet expected spending while balancing the national budget—at $92 per barrel. That figure increases monthly, and more so amid the pandemic. Based on the new budget, Sonatrach seems likely to set the price of oil at $135 for the barrel to break even fiscally—a price which is unlikely to materialize anytime soon (or possibly ever). This contrasts with many oil companies and analysts assuming the oil price for the next few decades will average $60 a barrel. Even as the pandemic abates, low oil prices are likely to prevail and price spikes will be the exception. Therefore, the government end its dependency on Sonatrach and seek new sources of cash.
Let’s talk energy transition
Sonatrach lacks funds and low-cost reserves and therefore will be less resilient to declining prices than the regional giants Saudi Aramco or Qatar Petroleum. It is therefore imperative for Sonatrach to conduct rigorous risk analysis around capital allocation decisions. Ultimately, both the government and Sonatrach must re-examine the company’s conventional assumptions about public expenditures, and the government must clearly define and explain to citizens the institution’s role in the country’s energy transition.
As profit margins shrink across the industry there is less margin for error, and so efficiency and integrity are more important than ever. Sonatrach should redouble its investments in transparency and corporate governance reform.
Already, Sonatrach has recently taken steps to improve its governance and transparency. In the 2017 edition of the Resource Governance Index (RGI), which assessed performance using 2015-2016 data, Sonatrach scored 47 out of 100 possible points, ranking 31st out of 52 assessed state-owned enterprises, a performance considered “weak” by the RGI. In a 2020 interim RGI assessment, Sonatrach scored 65 points out of a possible 100, which indicates an increase of 18 points and a transition from the weak to satisfactory performance band. That is a positive evolution that should continue.
Finally, the Algerian government and Sonatrach should create an inclusive space for the public to engage with government officials and company staff on the impact of energy transition on the country’s oil and gas sector. Together all stakeholders should debate solutions to the challenge presented by the shift to clean energy—citizen-oriented solutions.