Nat Vora, Chief Financial Officer, Mubbadrah gives a ringside view of the challenges, options and opportunities in the year ahead.
With oil trading at around $50 per barrel, are you optimistic about the economic and financial prospects over the next 12 months?
The oil price plunge since mid-2014 has been as a result of a number of factors including changes in underlying supply and demand conditions, amplified in the short term by a sharp appreciation of the US dollar, a shift in Organisation of the Petroleum Exporting Countries (OPEC) policy, and abating geopolitical risks. Although the supply capacity of relatively high-cost and flexible producers, such as the shale oil industry in the US, is already adjusting to this low-price environment, most of the underlying factors point to persisting weakness in oil prices over the medium term. Over the medium term, oil prices are projected to recover gradually from their current lows, but will remain below recent peaks and could witness more volatility. The pace of the recovery in prices will largely depend on the speed at which supply will adjust to current market conditions.
Oman is expected to remain committed to maintain its project spending, which is seen supporting non-oil growth in the near term. The recent decision to scrap a crude oil production cap and push for a steady rise in oil output is expected to help the oil sector slightly. This should also help the non-oil sector. As the production is expected to continue to grow, the effect on oilfield services companies would be cushioned as well. The overall view remains cautiously optimistic. The important thing to look out for is going to be the trend of oil prices over the next 12-18 months, as long as the prices hover in the range of $50 and/or show a sustained uptrend over the next two years, the impact on the economy could be sustainable.
Given the new reality, is it getting difficult to raise credit in the market?
Thus far, no credit squeeze has been felt in the market. However given the current low oil price scenario, shrinking levels of liquidity in the local market and potential stress/default situation in some of the sectors most notably the commodities sector, banks may become more cautious and selective in picking up their credits. There indeed could be a tightening of credit in the near to medium term. The recent ratings downgrade of some of the major Omani banks is likely to affect the liquidity and as a consequence the price of funding.
It is a positive step that two of the local banks have tapped international markets to source new funds/capital to finance their operations in last two quarters. In addition, Omani corporates also have the option of accessing regional banks.
Is financial preservation through cost cutting and improving efficiencies an important priority for 2016?
Indeed, it will be important. However, this is a dilemma that CFOs have to contend with in this scenario. It is important for the CFOs to be prudent while making their cost cutting choices to ensure that any measures adopted are not knee jerk reactions to the situation and do not harm the long term growth of the company. It is important for the companies to realise that any cost cutting measures should be employed with a view to tide over a difficult situation while preserving the inherent strengths of the company so as to not jeopardize future potential and growth. I feel that most companies must embark on using important tools such as LEAN management to improve efficiency and thereby find savings.
How are you striking a balance between risk management and future business opportunities?
In business it is important to foresee the possible risks at all times. As a company we try to analyse the business environment for the immediate and medium term. This enables us to assess the risks that might affect our business. Once the risk is assessed, we then work on categorising the type of risks that we face. If a project carries certain inherent risks; it is best to avoid such project or assignment in order to eliminate the risk. We then look at risks that are unavoidable but manageable; we evaluate risk optimisation for such projects which basically entails finding a balance between the benefits or gains relative to the negative risk undertaken. Ultimately we look at transfer of risk by procuring insurance covers. It is important to understand that Insurance by itself does not eliminate the risk; it can at best be described as an after event compensatory mitigation.
We also consider spreading the risk over the group thus sharing the impact and not jeopardise a single unit while bearing the risk. In challenging economic environments, we ensure that undertaking a certain venture should not adversely affect our current business operations; at the same time we look at the long-term viability of the venture. If the venture has the right risk profile and is likely to enhance the future sustainability and the overall business we would go ahead with such venture with its inherent risks. If the venture is likely to affect the existing businesses or is not lucrative in view of its inherent risks we may delay or even pull out of a project.
It is also important to realise that the current situation would also throw open a lot of opportunities in the form of availability of attractively valued businesses and assets, which have long term viability and which complement a company’s existing businesses. It is prudent for a CFO to hold a certain minimum amount of cash/credit line to capitalise on such opportunities.
Is there a danger that the stress on short term financial reduction may compromise long term business performance?
As I said earlier, companies need to focus on ensuring that the measures we adopt today to tide over the current perceived weakness in the global and regional economy driven by lower oil prices should be with a view to maintaining a long term perspective of business growth. There is an imminent danger if organisations take a short term view and engage in restructuring without giving due thought to protecting future potential growth opportunities, they may find themselves in a weak position when the markets improve and fresh opportunities present themselves.
Is effective planning and forecasting becoming more challenging as oil prices fluctuate from the $60-$40 per barrel range?
Large long term sustainable businesses are built upon due processes to ensure that these businesses are well prepared to overcome such economic downturns, especially in a cyclical industry like oil and gas. One of the challenges this volatility brings about is investor’s unpredictability, cautious and conservative approach towards expansion into newer territories/sectors. Companies would have to re-adjust their expansion plans accordingly. As the steward of a fast growing company with plans to expand operations into multiple territories, I’ll be keenly assessing our current operations and how slowdown in investments and lower oil prices could impact our existing projects and investments. Pros and cons of each investment, expansions will be studied in detail before it is undertaken. The oil and gas industry has recently seen incredible volatility in oil prices.
Large price swings, especially those due to geopolitical and macroeconomic events, are difficult to predict. As such, oil and gas companies face a challenge not seen in other industries in planning and forecasting. In reality, any oil and gas company trying to plan projects with changing oil price assumptions faces a large challenge. Decisions to undertake or forgo a project during periods of oil price swings can easily lead to a loss of profit or failure to commence a profitable project. Additional funding sources may need to be utilised and performance targets may not be met. Understanding that oil prices will swing in unexpected directions outlines the difficulty that oil and gas companies have in financial planning. Creating a financial model that can incorporate unpredictable inputs is a difficult process that requires both upfront thought and capable professionals. The best method for mitigating this unpredictability is by relying on its expertise gained and track record to build and use models that are dynamic; the ability for models to quickly and accurately respond to changes in baseline assumptions is essential.
Therefore it is essential in the challenging environment of oil price fluctuations that companies use dynamic planning and forecasting techniques to overcome effect of volatility in Oil prices in the medium term.
Can your share your thoughts on the region and Oman’s macro-economic outlook in 2016?
The oil price outlook is highly uncertain, the general sentiment is that the oil price decline is expected to persist into the medium term. The combined effect of rising stockpiles of oil, uncertain geo-political situation, no reduction in production, and warmer than usual winter point to further fall in the oil prices. The speed and magnitude of the oil price decline could potentially trigger financial strains due to tightening of liquidity and increased cost of borrowings.
The lower prices will affect growth in the Middle East economies, slowing it down as compared to previous years. The government in these predominantly oil dependent economies will have to contend with falling revenues causing increasing deficits. The governments would have to rely on deficit containment and funding measures. This could predictably cause tightening of liquidity in the financial markets.
For companies, an important factor would be to manage their costs and monitor cash flows closely to ensure that business operations are not negatively impacted as a result of the tightening of liquidity, increase in credit spans and higher cost of borrowing. The resultant slowing in the growth could cause many projects to be delayed, deferred or even cancelled. The businesses will have to find ways to augment their revenues and manage their costs. I would say in terms of strategy and company policy, one would look to move cautiously and avoid riskier regions and projects while focusing on ensuring that the current businesses are insulated from the volatility.
What in your opinion will be the big trends of 2016 in Oman, regionally or globally?
In the region and in Oman, some of the major trends that can be envisaged in the falling oil price scenario would be for governments to look at measures to contain their spending and increase channels of revenue. This could see measures such as:
- Innovative initiatives to fund new projects
- Replacement of existing growth model through economic diversification to reduce dependence on the oil and gas sector.
- Reduction in subsidies
- Introduction of new taxes such as VAT
- Realignment of the current Corporate tax structure
- Privatisation of government owned companies
Many of these policy initiatives would have a positive long term effect on the economy. This process of restructuring would end up in building a more sustainable, diversified and resilient economy better equipped to face economic uncertainty and downturns.