Governance at the Strategic Fuel Fund

Since press reports first surfaced in May 2016 about the sale of 10 million barrels of crude oil by the Strategic Fuel Fund NPC (SFF) from its strategic reserves, the SFF has received continuous media attention not only on account of that sale but also as a result of its other activities. This brief provides a summary of the current status of the issues that have arisen at the SFF, a state-owned enterprise, within the wider context of governance at state-owned entities.


The Strategic Fuel Fund NPC (SFF) is a wholly-owned subsidiary of the Central Energy Fund SOC Ltd (CEF) which is, in turn, also a state-owned company. CEF’s mandate is derived from the Central Energy Act, No. 38 of 1977 and its focus is on the security of energy supply for South Africa. This includes the oil, gas, coal and renewable and clean energy sectors. It reports to the Department of Energy as its primary shareholder. Its wholly-owned subsidiaries also include PetroSA.

The sale of South Africa’s strategic fuel stock

Following reports in the press on 26 May 2016 about a secret (or, at least, unpublicised) sale of South Africa’s strategic fuel stock by the SFF, the CEF defended the sale. A Reuters report of the same day, stated that the condition of the sale of 10 million barrels of crude oil was that it would not be exported and so the Government considered it as part of its strategic stockpile. The Reuters report quoted Tseliso Maqubela, a director in the CEF, as stating that the SFF had sold 10 million barrels of crude at USD28 a barrel and that the oil was sold below market prices because it was deteriorating in quality. According to the Reuters report, Brent crude prices ranged between USD35.98 and USD44.82 a barrel during December 2015, when the sale is reported to have taken place. The report also mentioned that the CEF had confirmed that South Africa continued to have access to 90 days’ worth of oil reserves and that a condition of the sale had been that the oil would not be exported. Other press reports mentioned the fact that the sale took place in a “closed” tender without the Treasury’s knowledge.
The CEF issued a press statement on 7 June 2016, in an attempt to explain the context within which the SFF had taken this decision to sell. According to the statement, the SFF had decided in October 2015 that the strategic stock management model needed to be amended, as the pre-1994 model meant that, because of a vast quantity of oil stocks, large amounts of working capital were tied up for long periods. The CEF press statement further stated:
“The grades stored by SFF for strategic crude oil stocks were based on producing a slate of products for Clean Fuels 1 and lubricant manufacture. The grades which need to be repurchased for strategic stock are different and will have to be Clean Fuel 2 grades. SFF will also have to diversify to refined petroleum product storage as part of strategic stock.
Rotation of strategic stock has therefore both technical and economic benefit for the country. Storage of crude oil for long periods of time (in our case since 2001) results in the deterioration of the quality of the crude oil and reduction in the volume. Moreover, rotation in a low price crude oil market results in the preservation of the value intended and is an attempt to increase that value. There are at least four margins to be extracted from the rotation which enhances economic and financial value.
It is important to note that since 1994, the government has not granted SFF any funding for the holding of strategic stock, which is the current global practice when an agency holds strategic stock on behalf of Government.
Strategic stocks are only available under declared emergencies and are not to be used for operational supply disruptions. The role of government is to ensure that there is sufficient crude oil stock that can be accessed in case of an emergency.
SFF owns two storage facilities, Saldanha and Milnerton tank farms situated in the Western Cape. The Saldanha facility is the bigger of the two with 6 on the ground storage tanks with a capacity of 45 million barrels.
The Rotation of the Strategic Stock is financially and economically advantageous to government as SFF will generate more than US$ 15 million on the storage or a R180 million per annum over a period of five years. The alternative economic value proposition of the stock lying in tank is that it could lose about 1% of the stock per annum.
Moreover, this was dead stock which tied up SFF’s working capital. SFF has through the rotation reduced the burden on the working capital and ensured that SFF is able to ensure security of supply in new ways while simultaneously generating income. The alternative to the rotation of Strategic Crude Oil Stocks is that Government will have to fund SFF from the fiscus for some R7 to R10 billion depending on the price of crude oil and product stock which is a big ask from National Treasury considering the pressing Government infrastructural development priorities.
Globally the models for the holding of strategic stock have also changed. In many countries Government no longer completely funds the holding of strategic stock.
In December 2016, following a Ministerial Directive from the Department of Energy, 10 million barrels of crude oil stock was sold to the following companies: Vitol/Vesquin, Venus Trade/Glencore and Taleveras based on a transparent market related price formulae. The sold stock pile still remains in tank at the SFF Saldanha terminal with SFF having the first right to buy the crude oil and supply the market in the event of a crisis. Furthermore, the department of Energy is engaging the National Treasury on the treatment of the transaction.”
CEF’s 2015/2016 annual report, added that “22% of the group revenue was generated by SFF, which generated a revenue of R4.5billion. R4.1 billion of the SFF revenue was derived from the sale of strategic stock.” However, it should be noted that the CEF said in its presentation to the Parliamentary Energy Committee on 8 November 2016 that the stock rotation generated R3.9 billion.
According to a statement issued by the Minister of Energy on 27 July 2016, she met with the Boards of the Central Energy Fund (CEF) Group of Companies on 14 July 2016. The meeting was convened in the Minister’s capacity as Shareholder of the CEF Group of Companies and included the Boards of CEF, Petroleum Oil and Gas Corporation of SA (PetroSA), the SFF, iGas, the Petroleum Agency SA (PASA), and African Exploration Mining and Finance Corporation (AEMFC). According to the statement, the Minister shared her concerns around the recent lapses in governance in the Group, and the need to strengthen both the governance and oversight responsibility of the CEF over its subsidiaries. The statement continues as follows:
“The CEF was directed to undertake a thorough review of its governance processes as well its turnaround strategies for the subsidiaries in the group. The Minister also raised specific concerns around the Strategic Fuel Fund and directed that a thorough review be conducted of SFF contracts from the 2014/15 financial year to date. This review will include all contracts and transactions entered into in terms of the Ministerial Directive issued to the SFF, inclusive of the Strategic Stock Rotation and Storage and Leasing Agreements concluded. This process will establish whether the transactions were implemented in accordance with the conditions as set out in Ministerial Directive, and whether these followed due process and were above board. Any lapse in governance processes or irregular actions will be further investigated.”
Regarding the Minister’s reference above to “recent lapses in governance” in the CEF Group, it should be noted that, quite apart from the strategic stock sale, the SFF had been involved in another controversial matter. It had submitted an offer to purchase certain assets of the Chevron group, without Ministerial consent, as a result of which the Department of Energy stated that it “was disturbed at the complete disregard for governance processes”. At the end of June 2016, the Minister announced an investigation and that she had accepted the resignation of the SFF Chairman (Riaz Jowoodien) and the acting CEO Sibusiso Gamede. It was subsequently announced in September 2016, that the chairman of the CEF, Xolani Mkhwanazi, had been relieved of his post by the Minister for his role in this affair. 
In presenting its 2015/2016 annual report to Parliament’s Porfolio Committee on Energy on 8 November 2016, the CEF confirmed that the Auditor-General had indicated that the National Treasury had not been informed of the rotation transaction of 10 million barrels of reserves, as required by the Public Finance Management Act. It also confirmed that a review of contracts was being undertaken by UK-based lawyers Allen and Overy. The decision was taken to appoint a foreign firm in order to avoid any bias in the investigation. The CEF confirmed that any governance lapses were to be investigated as part of that review. The CEF also confirmed that the strategic fuel stock actually owned by the state at the moment is very limited, but that they have a right of first refusal to buy back the stock that had been sold.

Conclusion and some questions

In summary, there is a complete lack of clarity as to the circumstances not only surrounding the sale of 10 million barrels from the strategic stockpile and the terms on which they were sold, but also the SFF strategy in dealing with what one would assume is a very important issue. The attempts by the CEF to explain the situation have not been successful. In the process, they have managed to raise more questions than they have answered.  
The following are the most obvious areas which remain unclear:
  • How can a sale of stock which stays where it is, be called a rotation? Nowhere has a replacement of stock been announced.
  • According to CEF statements quoted by the press, the stock was sold at USD28 per barrel. The fact that the minimum Brent crude oil price during that period was approximately USD35 a barrel, raises obvious questions as to why a substantially lower price was agreed and on what basis it was done.
  • What volume was sold to each purchaser and what conditions were placed on the sale of the stock? The CEF has confirmed that they have a pre-emptive right to buy it back. This does not provide an adequate answer, since several other questions arise: does the State have a right to buy it back when it needs to or is there only an option to buy it if another buyer makes an offer? If the SFF does have a right to buy it back, how is the price to be determined?
  • Regarding a potential buy-back of the stock, one needs to keep in mind that it was reportedly sold at USD28 a barrel. The current spot price is around USD48m. To buy back the 10 million barrels at the latter price would therefore entail an additional outlay of USD200m (or approximately R2.8 billion) over and above the amount received for the sale. Were there any provisions in the sale agreement to hedge any future buy-back price, or was the CEF just left with an open position? The stock was sold at what was probably the bottom of the current multi-year oil price cycle and unless a hedging arrangement was put in place, the SFF has taken a gamble on where fuel prices will go to in future.  If the oil price decreases to below USD28 a barrel, they could be able to make a profit, but that scenario looks extremely unlikely.
  • Were the conditions of the sale market-related, especially regarding the price?
  • What were the effective fees paid to the purchasers? Even if no specific fee was agreed, the cost of the transaction would be quantified by the difference between the funds received and a market-related price, after adjustments for any justifiable premiums or discounts.
  • Were fees paid to any persons other than the purchasers ?
  • It is difficult to make sense of the CEF justification for the sale. Was part of the purpose for the sale a way to boost the SFF’s current cash holdings in an effort to improve its apparent financial strength? 
It is comforting that the Minister has now taken the step to involve a well-established and reputable law firm to conduct the investigation. (Allen and Overy belongs to the so-called “Magic Circle” of London law firms.) It is not only hoped that answers will be given to the many questions that the affair has raised, but also that the Minister and the Department of Energy will take the necessary steps to strengthen the governance in the entities which they control. This episode should be considered within the wider context of governance in state-owned entities in general, about which there is widespread and increasing concern.
Anton van Dalsen
Legal Counsellor