Thursday, May 5, 2011
Posted by STRATFOR
Nigeria is Africa’s largest oil-producing state, producing more than 2 million barrels per day of light crude. With proven oil reserves of 37.2 billion barrels (along with undeveloped natural gas reserves of 5,200 billion cubic meters), Nigeria can sustain this daily volume of production for many years to come. But the country’s oil and natural gas sector has been rife with corruption, burdened by decaying infrastructure and inadequate refining capacity and vulnerable to militant violence. While the latter appears under control for the time being, the former have yet to be fully addressed. Any attempt to reform the industry would affect output projections, and thus is an important development not only for Nigeria but also for international oil and natural gas markets.
The most ambitious attempt thus far is Nigeria’s Petroleum Industry Bill (PIB), first proposed in 2008 and amended many times since. While there are no guarantees that it will pass any time soon — if at all — a new parliament session convening in May could provide fresh impetus for the bill, which would impose a sweeping administrative and regulatory restructuring of Nigeria’s oil and natural gas industry. As written, however, the bill would also threaten a wide range of deeply entrenched interests and would fail to tackle a number of barriers to industry growth. Despite widespread opposition, Abuja is hoping that a current combination of high oil prices and increased international competition will allow the PIB to be passed and enacted during the upcoming parliamentary session.
The PIB and Political Developments
Hydrocarbon operations in Nigeria are currently governed by an aging legislative framework that excludes crucial aspects of the sector such as natural gas production. While talk of reform had been circulating for many years, the first draft of the PIB was presented in 2008. Since then, the bill has been amended numerous times as the government has sought consensus among various stakeholder groups. In the process, a lack of transparency and a rumor that different working drafts are in circulation have made the bill’s evolution problematic. Concerns about its impact on profitability and contract sanctity also have led international oil companies (IOCs) to consistently oppose the PIB’s passage.
Nigerian President Goodluck Jonathan has vowed that the PIB will pass before the end of his current administration on May 29, when he will be sworn in for his first elected term as president. On Feb. 23, the country’s parliament began a clause-by-clause debate of the PIB’s provisions. On March 6 it became apparent that members of the Nigerian National Petroleum Corporation (NNPC) as well as IOCs were blocking the bill’s passage. Lawmakers later expressed the need for further consultation. After considering only two paragraphs, parliament announced its intention to revisit the bill again on April 19, an act that never occurred because of the country’s busy election season. It is now unlikely that any progress will be made on the PIB before parliament is dissolved ahead of the presidential inauguration in late May.
The PIB is intended to serve as a comprehensive legal framework for the Nigerian oil and natural gas industry and as a vehicle for achieving diverse government objectives related to the sector. These include:
* Increased state revenues.
* Freeing the NNPC from dependence on federal funding.
* Deregulation of the downstream sector.
* Development of natural gas production in conjunction with the Gas Master Plan of 2008.
Currently, the NNPC is Nigeria’s dominant hydrocarbon regulatory body and state-owned oil and natural gas company, with widespread responsibilities in the energy sector. The PIB would create independent entities from a number of NNPC divisions, reassigning responsibilities for policy-making; technical matters; upstream, midstream and downstream operations; natural gas regulation; and research and development. In addition, joint ventures between IOCs and the NNPC would be converted into incorporated joint ventures, with the NNPC focusing solely on commercial operations. The bill also includes a revised taxation and royalty regime that would significantly increase the government’s revenue.
Still, none of these measures would directly promote the growth of operational capacity within the NNPC. While the independence of regulatory agencies could reduce the potential for conflicts of interest, tensions would likely linger as the nascent agencies grow into their new responsibilities, and the amount of bureaucratic obstacles related to licensing and oversight would probably increase.
Joint Ventures, Upstream Oversight and the NNPC
Six major joint ventures between the NNPC and the IOCs account for most of the production from Nigeria’s proven reserves (as much as 98 percent, by some estimates). The NNPC holds a majority share — typically 60 percent — of each joint venture and serves no operational role. Major IOCs involved are ExxonMobil, Royal Dutch/Shell, Chevron Corp., Total SA, Agip and ConocoPhillips. Under the PIB, the shareholding, organizational structures and operational roles of the existing joint ventures would be carried over to the new incorporated joint ventures.
The conversion of joint ventures into incorporated Nigerian entities would free the NNPC from dependence on the state for funding, allowing it to approach capital markets for external financing. Currently, crude revenues pass directly into Nigeria’s federation account and are not available to the NNPC for use as working capital. This means the NNPC must meet its financial obligations through monthly cash calls, which are based on annual budgets submitted by the IOCs and are funded from the government budget office. In practice, disbursements are often delayed or insufficient, and the NNPC has continually struggled to meet its financial obligations. As a result, more recent projects have adopted production-sharing contracts (PSCs), in which the IOCs pay all costs and reimburse themselves from resulting revenues. No material changes to the PSC legal framework are proposed in the bill.
Holders of existing joint-venture and PSC licenses and leases would be required to reapply for their respective contracts within a year of the PIB’s passage. To date, no guarantees of renewal have been provided to existing license holders.
Previous reform efforts in Nigeria have addressed the independence of the regulatory authority from the NNPC, and the two functions have been combined and separated on a number of occasions, depending on the priorities of the incumbent government. The separation of these functions under the PIB is merely the latest in the ongoing expansion and contraction of NNPC responsibility within the sector. While outwardly attempting to reduce conflicts of interest, such moves have left the basic power dynamics and institutional dysfunction of the status quo intact.
The NNPC is widely regarded as a corrupt and ineffective organization that enables a broad patronage network. Its role in the industry has nonetheless remained consistent as the country has shuttled between civilian and military rule. This stability is highly valued in the industry, despite the inefficient manner in which it is achieved. The almost complete lack of indigenous operational capacity means that IOCs have retained an indispensable role in hydrocarbon production in Nigeria, developing strong influence networks through which they are able to protect their interests above all.
Oil production in Nigeria began in 1956, and since then natural gas has been derived largely from associated fields or has been “flared” (burned off) rather than captured. This has been due to the absence of a reliable legal framework, which has limited the exploration and development of unassociated fields. More recently, liquefied natural gas has started to take off, mainly for export, with production rising 178 percent since 2000, with projects such as the West Africa Gas Pipeline, a 676-kilometer (420-mile) export facility supplying Ghana, Togo and Benin set to come online in 2011. Despite this progress, natural gas production in Nigeria remains in its infancy.
The Nigerian government wants to stimulate internal demand for the use of natural gas in power generation and industrial applications, which it considers crucial for both energy security and economic development. Electricity generation for domestic needs has been a high priority, at least rhetorically, of the last three administrations, which have wanted to improve on the limited and unreliable electricity supply. To date, price controls on retail electricity have deterred investment in the capital-intensive supply infrastructure required to service the local electricity market, and with those controls remaining in place, commercial opportunities in the Nigerian market will remain nonviable. While the PIB includes wholesale and retail pricing provisions for electricity as well as other products like refined gasoline, it would also provide a very broad mandate for the newly formed Petroleum Products Regulatory Authority to continue to regulate prices, something the authority is likely to do.
In a further obstacle to developing the oil and natural gas sector, the PIB would separate oil and natural gas licensing, while current legislation provides combined rights for exploration and operation. By separating the contracting frameworks, the ongoing development of associated fields would become more difficult, since the operator would be required to hold two licenses. In theory, the measure is intended to reopen the natural gas licensing field, but in practice it would likely increase bureaucratic obstacles and the cost of the licensing process. Financing the development of natural gas reserves with oil revenues would also become more difficult, and while the legal framework would provide some certainty for producers, the proposed terms are unlikely to be economically attractive.
Despite being Africa’s largest oil producer, and having four domestic refineries, Nigeria currently relies on imports of refined petroleum products to meet local demand. The government sees the deregulation of this sector as crucial to energizing the local economy, though it is in the downstream component of the industry where endemic corruption and patronage networks are most entrenched. Under the NNPC, a lack of investment in maintenance and refining capacity has kept product output well below local demand. The shortfall is met by product imports, the contracts for which represent some of the most lucrative business opportunities in Nigeria. By constraining import supply, marketers have been able to create scarcity, which in turn has enabled the development of a thriving black market for petroleum products, particularly motor fuel.
These conditions have also been a boon to militants and their political patrons in the Niger Delta. “Bunkering,” which involves siphoning off crude from a pipeline, transporting it offshore for refining and then back to Nigeria for sale on the black market, is a tremendously profitable organized-crime activity that involves not only militants and politicians in the Delta but also government military officers.
Under the PIB, downstream activities currently overseen by the NNPC would be transferred to the newly created and wholly state-owned National Transport Logistics Company (NTLC), which would have operational responsibility for pipelines and the transportation, storage and distribution of crude-oil products. Operations that would be transferred include the Warri, Port Harcourt and Kaduna refineries as well as pipelines, storage facilities and distribution infrastructure. In removing the downstream responsibility from the NNPC and establishing an independent regulator, the Petroleum Products Regulatory Authority, the PIB goes only partially toward addressing the problems that plague downstream operations. As in the case with natural gas, the bill is unclear in its commitment to remove price controls from the crude side of the ledger. It is widely recognized that the NTLC will seek to privatize its new asset holdings, although it is unlikely that it will attract sufficient foreign interest unless pricing reform is enacted. But the subsidies are viewed by the Nigerian populace as the only meaningful contribution that the government can make to improve their lives, which means that attempts to repeal them would likely spark significant protest.
The PIB proposes a new fiscal regime to govern both incorporated joint ventures and PSCs for oil and natural gas production and seeks to increase federal revenues from the industry. The representative body for industry producers in Nigeria, the Oil Producers Trade Section, calculates that the government take under the current joint-venture fiscal regime is already one of the highest in the world at 82 percent, and the proposals for the new regime would see this take rise to 91 percent. Including the share taken by the NNPC, this would limit IOC returns to approximately 2 percent, a level that is likely to deter investment in the sector by rendering many new and existing projects uneconomical. Similarly, where PSCs are concerned, the new regime would see the government take rise to approximately 89 percent.
Implications of the PIB
Missing from the PIB are guarantees to existing investors and a focus on the barriers to investment, specifically price controls and entrenched patronage networks. By imposing its terms on both new and existing operations and requiring operators to reapply for existing licenses, the bill threatens contract sanctity and would increase the risk premium applied to future investment decisions. This, along with stricter fiscal provisions, has put the IOCs, a critical stakeholder group, in opposition to the bill’s passage. While the IOCs have registered their support for industry reform and many of the measures laid out by the PIB, the effects of the new fiscal regime on shareholder returns are substantial. The PIB also does little to limit the power of the president and energy minister. Both would retain the ability to significantly influence the industry by having full control over the staffing of key positions and the extension of leases.
Expectations of sustained upward pressure on global energy prices have presented the Nigerian government with an opportunity to extract greater returns from existing operations while betting that IOCs will still be interested in investing to meet rampant market demand. The quality of Nigerian crude means that IOCs have little alternative but to continue to operate in the country, where competition has increased in recent years with the entry of IOCs from China, India and South Korea. By moving to increase rentals on concessions and significantly tighten rules on the relinquishment of leases, the turnover of undeveloped fields is likely to increase. In turn, the government is betting that with the Chinese and Indians especially keen to lock in access to hydrocarbon reserves wherever they can, any investment slack from the IOCs will be picked up by its Asian partners. It is notable that the government has used the threat of Chinese competition against its existing partners before.
There is no doubt that the Nigerian oil and natural gas industry can perform more efficiently and on a greater scale and that reform is required to achieve this. The PIB is a broad and ambitious piece of legislation that seeks to remodel the industry and provide the much-needed basis for its future development. However, the limitations of the bill — and the opacity with which it was written — mean that significant domestic political and IOC opposition remains. Once nationwide elections have determined the makeup of the new parliament, the speed with which the PIB is passed and enacted will indicate just how much consensus for reform there is within the government.
Ultimately, it must be noted that the Nigerian state is a vast patronage network with decisive power vested in the president. Competition for ever-greater allocations of oil revenue has created an artificial reliance on the central government, with the NNPC serving as the chief enabler. Hence, any attempt to restructure the NNPC will affect the country to its core, impacting entrenched political power bases as well as average Nigerians who are growing ever more dependent on gasoline and electricity for living a modern life.