FUQ-04-2010
Original: April 10, 2010
Proposed Solution
Petrobras in Nigeria:
Valuation of the Agbami Oil Field
This case was prepared by Nikita Agarwal, Jacob Anjilivelil, Mahesh Damodaran and Jesse Schwarz
for the Advanced Topics in Corporate Finance course under the supervision of Professor Campbell R.
Harvey and was written as a basis for class discussion rather than to illustrate either effective or
ineffective handling of an administrative situation.
Copyright © 2010 – all rights reserved. The Fuqua School of Business, Duke University, 1 Towerview
Drive, Durham, NC 27705, USA. http://faculty.fuqua.duke.edu/~charvey/Cases/index.htm
Proposed Solution of Petrobras in Nigeria: Valuation of the Agbami Oil Field
FUQ-04-2010
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:
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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.
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Proposed Solution of Petrobras in Nigeria: Valuation of the Agbami Oil Field
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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 Nigeria is
one of the fastest growing in the world, with the International Monetary Fund projecting 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 factors as well as potential mitigating factors.
Project risk:
General Risks
Sovereign
Currency
Expropriation
Specific Risks
Agbami Mitigating Factors
Direct currency risk: Exchange rate and Oil sold in USD which takes a big bite out of
currency fluctuations can directly impact the the risk premium. All transactions regarding
value of goods and services sold.
the export of oil take place in dollars. There
Indirect currency risk: Macroeconomic remains some risk, as Petrobras exports to
policies can cause the local currency to other countries and the dollar can move up or
devalue which has a secondary effect. down against their currency. However, these
Massive devaluation can cause major unrest movements are rather stable and there are
in the country.
adequate derivative markets through which
such currency risks can be hedged.
Direct: The government can seize assets
Direct: Oil projects are capital intensive
projects in which large capital investments
Diversion: The government can divert exports
are made get projects up and running. The
Creeping: The government can alter its government can seize some of the PSOs and
taxation policies
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:
taxation
(currently
collected
The government can alter its
policies by increasing taxes
at 85%), can increase the royalties
(currently at 18.50%) or can
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Proposed Solution of Petrobras in Nigeria: Valuation of the Agbami Oil Field
FUQ-04-2010
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
Involvement of
Multilateral
Agencies
Sensitivity of
Project to wars,
strikes, terrorism
Are any international partners involved in this Petrobras has partnered with U.S. oil giant
project that lend credibility to the project and Chevron and Statoil in the Agbami project.
that could give Petrobras and Agbami a Texaco has a technical sharing agreement
stronger hold in the region?
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.
Is any multilateral agency involved in the Since 2008 the Nigerian government has
project which lends support to the project and begun to demonstrate political will to
benefits from the project proceeding implement market-oriented reforms urged by
smoothly?
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 the project to civil unrest and The Agbami project is not so vulnerable to
strikes that could affect the ability of strikes since it is a capital intensive project
employees to carry on their daily work. One with many foreign employees that bring
way to think about this is: is this project more expertise of the offshore oil industry.
sensitive to war and terrorism that other However, the project is vulnerable to civil
projects undertaken in Nigeria?
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
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Proposed Solution of Petrobras in Nigeria: Valuation of the Agbami Oil Field
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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
Natural disasters are unexpected sudden
Project to natural
events which impacts with such severity that Nigeria is exposed to natural disasters like oil
disasters
it is usually disastrous and uncontrollable.
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
Resources include availability of inputs and Though Daewoo had brought the FPSO to
Resource
raw materials required for production.
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 Deepwater projects are more technologically
challenges required for ongoing and sustained challenging
than
onshore
projects.
production.
Technological risks are low as Agbami does
not involve any new offshore technology.
Petrobras brings the technical expertise and
experience in deep water.
Financial
Default refers to the inability to make debt Petrobras has financed it's investment in
Probability of
payments or to come up with adequate Agbami through available cash and has not
default
financing for completion of a project.
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.
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Proposed Solution of Petrobras in Nigeria: Valuation of the Agbami Oil Field
Political risk
insurance
FUQ-04-2010
Political risk insurance is a type of insurance Petrobras has insurance in place protecting
that can be taken out by businesses, of any them against all political risks.
size, against political risk — the risk that
revolution or other political conditions will
result in a loss.
Market Risks
General Risks
Price Volatility
Market Demand
New market
entrants
Specific Risks
Mitigating Factors
The oil market is among the most volatile Nigeria became a member of the OPEC in
commodity markets in the world. As a 1971; as a member, it is somewhat shielded
general trend, falling oil prices affect the from major fluctuations in oil prices by the
economies of various oil producing nations OPEC which controls supply and demand to
that depend largely on oil income.
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.
Nigeria is an important oil supplier to the
Nigerian crude is of light, sweet quality for
United States. Over half of the country’s oil
which there is a large market demand.
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.
Oil upstream and downstream activities Petrobras’s expertise in off-shore drilling set
require a substantial capital investment as them apart from new entrants that are still
well as expertise and experience in the mastering the technology needed for such offindustry. There a big barriers to entry for new shore drilling techniques.
market entrants.
Sovereign Risks
General Risks
Specific Risks
Mitigating Factors
Political instability The country has only re-achieved democracyThe chance of return to military rule seem
and corruption
status (in 1999) after 33 years of military rule. remote in Nigeria as the country has made
The current President of Nigeria is unwell and rapid strides towards development and
there are underlying strains of political unrest progress in the past decade. It has
ready to erupt in the country. There is successfully dealt with many of the political
growing unrest as few individuals benefit and economic issues it faced.
from the oil wealth of the country adding to
the income inequality.
Currency exposure An unstable home
uncertainty, hindering
currency creates All transactions regarding the export of oil
ability to make beans take place in dollars. There remains
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Proposed Solution of Petrobras in Nigeria: Valuation of the Agbami Oil Field
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business decisions. A strengthening currency some risk, as Petrobras exports to other
will weaken export demand, while a countries, and the dollar can move up or
weakening currency will improve export down against the currency of these countries.
demand.
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 Nigeria’s economy depends largely on it’s oil
exports, or alter its taxation policies.
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
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Proposed Solution of Petrobras in Nigeria: Valuation of the Agbami Oil Field
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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.
Using an optimistic 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 $1.481billion. 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 ($1.332bn in this
case) that of the true value of its stake in Agbami, it seems like Statoil has made a very low bid for the
Petrobras share in Agbami. This is without considering the intangible value of future relationships so in
the optimistic oil price scenario, Petrobras should not accept Statoil’s offer.
In order to evaluate the uncertainty that a change in royalty (currently @ 18.50%) can have on the present
value of the Agbami project, students can adjust these numbers to create different scenarios. In the event
of creeping expropriation, the Nigerian government might increase their taxes (currently at 85%) or
decrease the profit allowance figures (currently at 16%). We have created a drop down menu to allow for
different royalty, profit allowance and taxes on the A break even analysis can be done to determine how
low oil prices need to be in order to make the project futile for Agbami. This has been done (oil price
scenario 4) in the solution. Though not required, students can find an expected value of the field factoring
in all uncertainties and assigning equal probabilities to each scenario.
Real Options Analysis
There are 3 potential options available to Passami at this point in time:
Option 1: Stay invested in Agbami and Nigeria (recommended)
The NPV analysis yields different values for Petrobras’s share in Agbami based on the fact that there are
many uncertainties around the price of oil in the future as well as the drilling costs, royalties, production
schedule taxes and profit sharing allowance.
One option available to Passami is to reject the Statoil offer and stay invested in the Agbami project. The
advantages of doing so are:
 Through the newly formed partnership with Chevron and Texaco, Petrobras can make many more
global oil investments. As mentioned in the case, these are valuable relationships for Petrobras.
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 as well
as exhibit 11 showing potential deepwater opportunities).
 The Brazilian and Nigerian government can continue to share a good working relationship and
Petrobras could continue to establish itself as a premier player in deepwater production.
 Though the recent attack by the MEND on a deep-water oil facility is alarming, Nigeria has come
a long way in curbing ethnic and political unrest and has made much progress in the past decade.
The government is also trying to implement the market-oriented reforms urged by the IMF
showing the desire for progress and economic upliftment.
 The key reasons for entering this project were the sweet quality of oil and the transportation costs
and those had not changed.
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Proposed Solution of Petrobras in Nigeria: Valuation of the Agbami Oil Field
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FUQ-04-2010
Staying invested in the project would also be keeping with the long term objectives of the
company which are to accelerate out-of-Brazil expansion plans.
Option 2: Selling Petrobras’s share to Statoil
Using the average and bearish oil price forecasts, it seems to make sense for Petrobras to sell their share
to Statoil. From a pure numbers perspective, Statoil has made a good offer for Petrobras’s share in
Agbami.
There are many advantages for Petrobras to exit Agbami and eventually Nigeria.
 Though the country has progressed in the past decade, it still struggles with political and
economic instability. The attack by the MEND is a reminder of the past violence that the country
has seen.
 Petrobras has been invested 10 years in Agbami and is still to see revenues from oil. Exiting at
this point would prevent any further capital investments into the project.
 Statoil is already a partner in the Agbami project and selling out would be a seamless process.
Maybe, Petrobras could negotiate a higher acquisition amount with Statoil.
 The cash flows from the project are shrouded with uncertainty and given the bearish news from
the US unemployment, a recession could majorly affect prices of oil, demand for oil and in turn
revenues.
Option 3: Looking for additional potential buyers of Petrobras’s share in Agbami
The only advantage of this option over accepting Statoil’s offer is that Petrobras might be able to get a
much higher price for their share in Agbami. However, finding a new acquirer might be a time consuming
process. Additionally, selling out to a new partner would require approvals from the existing partners of
the project which may be hard to get.
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