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Nigeria hits a rough patch as oil producer after missteps

A series of missteps threaten to unseat the country's place as a prime oil producer

For years Nigeria's oil sector has seemed destined to be consumed by violence, environmental degradation and the corruption that has plagued its industry. All the while, the country has remained the largest oil producer in sub-Saharan Africa, a central player in Opec and a key supplier to the US for nearly two decades. But the industry has rarely faced a more troubling outlook. Policy missteps, persistent security threats, surging levels of oil theft, stagnant output and investment, the rise of US tight oil and a host of other problems have left Nigeria struggling to find its place in the shifting global energy landscape.

A potent symbol of the industry's malaise has been the failure to pass the long-planned Petroleum Industry Bill (PIB). The wide-ranging legislation was first put before the country's National Assembly nearly five years ago, and has gone through several iterations since. Initial hopes that reform could put the industry on a firmer foundation and revitalise investment have given way to bitter recriminations between government, civil and industry groups all vying to shape the future of Nigeria's most important industry. Oil sales account for about 80% of the government's revenue and the industry makes up around 15% of the country's GDP. 

The PIB has a number of broad-reaching aims, including the breakup and part privatisation of state-run Nigeria National Petroleum Company (NNPC), improved transparency in the industry, increased government revenues from oil and gas production and liberalisation of the gas, and oil-refining and marketing sectors, among others.

But even where the broad goals of the legislation are laudable, the specifics, analysts warn, fall short of delivering. On transparency, for instance, the PIB includes some provisions that mark a major step forward on disclosure and non-confidentiality for upstream deals. That is clearly needed. A report commissioned by the Oil Ministry carried out by Mallam Nuhu Ribadu, the head of the Petroleum Revenue Task Force, was leaked to Reuters in October last year. It reportedly found that over $30 billion in revenue had been lost over the past decade because of sweetheart deals signed between government officials and foreign companies, with little oversight or transparency. The report did not allege that the foreign companies had broken any laws, but highlighted the lack of accountability measures in Nigeria's oil legislation.

Controversy

There are problems with the planned legislation, too. Although the proposed law would improve transparency in some ways, in others it leaves the door open to abuse. For instance, the PIB would allow the president to continue to unilaterally grant licenses and leases without an open bidding process, potentially leaving the same kind of political favouritism that has been a corrupting force in the industry in the past.

The PIB also calls for the creation of a Petroleum Host Communities (PHC) Fund, which would set money aside for producing regions. Communities in the Niger Delta, responsible for about three-quarters of Nigeria's 2 million barrels a day (b/d) of oil production, have felt left out of the country's oil boom. Those communities have watched hundreds of billions of dollars worth of oil leave the Delta since production began in the 1950s, but have seen little cash, infrastructure or basic government services come back.

An inter-agency team that worked on a previous iteration of the PIB (one of many versions) recommended funnelling 10% of companies' after-tax profits directly back to the communities where they were operating. The latest version of the PIB retains the 10% provision, but gives the Oil Ministry broad discretion over how those funds are disbursed to communities. Rather than helping redress local concerns, analysts warn, the lack of accountability or transparency built into the system risks further exacerbating tensions between the central government and Delta communities.

The bill would "impede improvement in transparent management of revenue from the petroleum sector," said the Nigerian section of the Extractive Industries Transparency Initiative, a group that campaigns to improve governance of natural-resource development around the world.

If NGOs are worried about shortcoming in the bill's transparency measures, it is the fiscal terms that have oil executives up in arms. For foreign companies with their eyes on the country's potentially huge offshore reserves, it is the proposed tax regime for deep-water projects in particular that looks especially galling. The PIB would increase the government's take from 61% now to 73%, petroleum minister Diezani Alison-Madueke said in September last year.

Shell, the biggest foreign investor in Nigeria, has been the most outspoken opponent of the bill among Nigeria's foreign majors. It reckons that the uncertainty surrounding the bill is holding up around $30bn of investment in deep-water projects. "All deep water, most gas and some oil projects will not take place under PIB terms," Mutiu Sunmonu, the head of Shell's Nigerian business, said last year.

Alison-Madueke has disputed industry claims that the proposed fiscal terms are too harsh, saying high oil prices justify the bigger slice for the government.

The bill needs to strike a "fair balance between government and contractor to ensure that risks do not outweigh rewards," she said recently. Sunmonu echoed that comment in February, saying the bill should "provide optimal revenue to the government while providing sufficient incentives for new investment to fuel growth". So far, though, the two sides seem far from striking that balance.

As a result there is no consensus on when the PIB might actually pass. Some are still optimistic the law could be enacted this year, while others see it no closer to passage than four years ago. "There's a number of things to discuss, and I find it very difficult to see how we would end up with a PIB by the end of this year," Wale Tinubu, the chief executive of Nigerian independent Oando, said in February.

Concerns about the future of Nigeria's oil industry go beyond the PIB. "Operating in the Nigerian oil and gas environment can be long and tortuous with costs at the high end of the global scale. There are a multitude of security-related issues that have to be dealt with on a daily basis," Shell's Sunmonu said at a conference in Abuja last month. "In the recent past, militancy has simply been replaced by industrial scale oil theft and sabotage. We, and others, have had to shut-in significant production; spend huge amounts on replacing and repairing hardware and deploying massive resources to clean up spills."

In early March, Sunmonu told reporters that oil theft had become so bad the company was considering shutting down the 150,000 b/d Nembe Creek Trunkline in the Niger Delta. He said over 60,000 b/d of oil was being stolen from Shell alone.

Some local communities, NGOs and politicians argue that Shell has not done enough to maintain its pipelines and prevent the sabotage that has led to large-scale environmental degradation in the Niger Delta. In late January, a Dutch court partly agreed, ruling that Shell Nigeria had to pay a local farmer for damage caused by an oil spill after a pipeline was sabotaged.

Shell's Sunmonu, though, says the situation is beyond its ability to control, and has urged the Nigerian Joint Task Force - an arm of the Nigerian security forces deployed in the Niger Delta - to 'step up their game'. "I really want to put it to you that we are in a crisis. We are in a crisis as a country because this is something which I worry is beyond the capacity of any individual company or beyond the capacity of a country to solve."

He said that the scale of the operations was so large that a shadow oil industry was taking shape. Illicit oil refining is well known in the Delta, but Sunmonu says oil thieves are now setting up barge-building yards, storage facilities and tank farms.

Figure 1: Nigeria oil production
Table 1 : Nigeria by the numbers

Billions of dollars of refining investment on hold in Nigeria

In May 2010, China seemed to throw a lifeline to Nigeria's moribund refining sector when it pledged to invest around $23bn to build three refineries along Nigeria's coast. Two years on, those projects are foundering. The Chinese backers have taken a step back from the plans until they get more clarity on the fiscal regime that will be put in place under the proposed Petroleum Industry Bill (PIB, see main article).

In total the refineries, which are proposed to be built in the financial capital of Lagos as well as Bayelsa and Kogi states, would add around 750,000 barrels a day (b/d) of refining throughput to the country's nameplate capacity of 445,000 b/d.

The investment is sorely needed. Nigeria's four refineries - Port Harcourt 1, Port Harcourt 2, Kaduna and Warri - have never produced at their full capacity and have deteriorated after years of underinvestment, poor maintenance and accidents. The plants have also suffered as pipelines and other transport infrastructure that feed the refineries have been damaged by sabotage.

In October, the last month for which government data are available, the four refineries processed just 55,000 b/d of oil, around 12% of nameplate capacity. Through the first 10 months of 2012, the refineries ran at just 18% of capacity. The result is that oil-rich Nigeria has to import about 80% of the estimated 280,000 b/d of refined products it consumes.

The government has recognised the need to invest in its downstream infrastructure. "We want to focus on rehabilitation of strategic depots, jetties and pipelines because of the direct impact these facilities have on the rate of economic and social development of our country, and its people," Andrew Yakubu, a managing director at NNPC, said in February. "Huge investment is required in all these facilities to meet the growing need of petroleum products."

But investment has been virtually non-existent. The 300,000 b/d Lekki plant in Lagos, Nigeria's biggest city, was supposed to be the first refinery built by NNPC and its Chinese partners, with a target start-up date in 2017. But no site work has been carried out in the past two years and the project's Chinese investors are now having second thoughts. Proposed terms under the PIB would likely raise the tax burden on downstream operators.

For investors, even more worrying is the absence of any substantial consideration of the future of the refining sector in the latest version of the PIB. As an Ernst & Young analysis of the bill notes, the only mention of refining in the bill is a section that gives a proposed Downstream Petroleum Regulatory Agency authority to regulate the industry.

“Given the fact that precisely the matter of construction and operation of new refineries is a major issue in Nigeria, this seems a major omission. The PIB 2012 does not provide any guidance or framework for the Agency as to how to deal with refineries," writes Ernst & Young.

As frustration has mounted, relations between international oil companies (IOCs) and the government have soured. The oil industry generally tries to keep its quarrels behind closed doors, but in Nigeria they have spilled out into the open. In December, an anonymous Total official was quoted in the Nigerian press threatening to shelve the $15bn deep-water Egina project over frustration with the slow pace of the project and the way contract tenders had been handled by NNPC.

That prompted a riposte from the state-run oil company. "NNPC... will not be stampeded or browbeaten into abandoning its firmly established process of contract award by what it termed calculated media blackmail ostensibly by the IOCs and other interested parties," the company said in a statement. The public war of words between the projects' investors does not bode well for the future of one of the country's few deep-water projects. 

Table 2: Upcoming oil projects in Nigeria
Table 2: Upcoming oil projects in Nigeria

Independents push

Yet Nigeria's deep waters are where the IOCs see their futures in the country. As those IOCs have started a slow retreat from the onshore fields, a new class of Nigerian and mid-size independents have moved in. The risks in places like the Niger Delta have become too high and the discoveries too small for the majors, but not for smaller domestic companies such as Seplat Petroleum Development Company, Oando and Atlantic Energy. The companies benefit from their local knowledge and often their close government connections.

"Independents will step into the areas where majors are retreating," said Austin Avuru, the chief executive of Seplat. "There is still a lot of potential, even in these areas where there has been production for a long time.

Seplat helped pave the way in 2010 when it became the first Nigerian independent to acquire permits from an IOC. The company bought operating stakes in the onshore licences OML 4, 38 and 41, which produce a combined 30,000 b/d, from a consortium of Shell, Total and Eni subsidiary Agip.

"The security risks will not go away, but independents can deal with that," one executive says. "One of the ways to overcome the security challenges is with proper engagement with the local communities. That is something the local companies can bring," says another. "Where local companies have moved in the number of incidents and the length of downtime has decreased."

While uncertainty surrounding the PIB has slowed big offshore projects, this has not been true for smaller onshore projects. "The market for acquisitions has been very active and aggressive over the past 12 months," said Frank Pluta, an executive at Standard Chartered, a bank.

In December, Oando agreed to buy ConocoPhillips's Nigerian assets in a $1.79bn deal. Oando will acquire four onshore licences, a stake in the proposed Brass LNG project and two offshore licences. The deal added 43,000 barrels of oil equivalent (boe) a day to Oando's output and 213m boe of reserves.

The combination of increased competition among independents and the drying up of bidding round opportunities has quickly pushed up the value of Nigeria's onshore acreage, which could slow the pace of deal making. "Transactions are happening at $3 to even $8 per 2P barrel of reserves, in earlier bid rounds assets could be acquired for less than $2/b," Avuru said.

Yet while some independents have managed to carve out a space for themselves, the broader problems in Nigeria's oil patch have dimmed the industry's outlook.

NNPC says that renewed insecurity in the Delta means Nigeria is now hoping to keep oil production flat this year at between 2.4m b/d and 2.5m b/d. (Output in January was just over 2m b/d, according to Opec.)

Last year, minister Alison-Madueke said that Nigeria hoped to increase oil production capacity to 4 million b/d by 2020.

But that target will be difficult to reach. There has been very little exploration, especially in the deep-water oil province, in the past three years as companies have waited on the PIB. In 2011, just three exploration wells were drilled. Activity appeared to pick up somewhat in 2012, but was still clearly below expectations for a country that still holds enormous potential. That lack of exploration, and so lack of discoveries, will translate into a slowdown in projects in development in a few years.

Wood Mackenzie has said that, rather than the substantial increase in production seen by the Nigerian government, output could fall by as much as 20% by 2020 because of a lack of investment.

Moreover, Nigeria is facing increased competition for investment dollars from within the region and beyond. Where companies see trouble in Nigeria they see opportunities in Angola, Gabon and Namibia's pre-salt province, and the emerging Transform Margin oil plays in Ghana, Liberia and Sierra Leone to the north.

NNPC is also concerned by the rise of shale oil in the US, not just because it is the country's largest export market, but because it could lure away potential investors (see article). "The shale-oil situation is growing very fast. We have to be able to offer real value or we risk falling into a position of weakness," one NNPC official says. "China is deeply involved. They are buying assets. And the US is investing in China," the official said, concerned that as the energy landscape shifts, Nigeria risks being left behind. 

Figure 2: Oil and gas infrastructure of Ghana
Figure 2: Oil and gas infrastructure of Ghana
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