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Nigeria to renegotiate fiscal terms for offshore PSCs

The timing of renegotiation of fiscal terms for offshore production-sharing contracts (PSCs) signed two decades ago is questionable for state-owned NNPC

It comes at a time of low oil prices in an industry already lacking regulatory clarity. Nigeria relies on oil for over 70% of its overall revenues and while it is keen to ensure a greater return from oil, renegotiation of contracts will not come easily.

NNPC’s new group managing director Ibe Kachikwu 15 September announced a planned review of the fiscal terms of the PSCs, first signed with the major oil companies in the early 1990s, to help solve NNPC’s ability to fund its share in joint venture oil operations and to incentivise investment in frontier fields in Nigeria’s deep and ultra-deep waters.

“We intend to begin the process of the re-negotiation of the PSCs to see what value chain and improvements we can have from these contracts. Some of the contracts were negotiated over 20 years ago and they have since been overtaken by new realities in the industry,” Kachikwu said in the statement. The PSCs attracted major oil companies owing to their favourable fiscal regimes, as the companies were given a higher profit share for the higher-risk projects offshore.

The incentives encouraged mainly western oil majors to develop Nigeria’s biggest fields including Bonga, Akpo, Usan Egina and Erha. Output from deepwater fields account for 40% of Nigeria’s roughly 2m barrels a day (b/d) output. The remaining ouptut comes from the joint-venture fields and independent producers.

While the scale of the planned changes remains uncertain, analysts said that the prospect of altering the existing contracts has sent tremors through the western operators. They question whether it is realistic for the government to attempt to renegotiate terms now when oil prices are hovering below $50/barrel.

“The planned revisions will create scope for commercial disputes, given the legal ambiguities and current tough conditions,” Control Risk’s senior analyst, Roddy Barclay said in a published research note.

Kachikwu, a former ExxonMobil executive vice president, has made it clear that NNPC intends to evaluate all of the PSCs with the majors which were signed in the early 1990s and which the government maintains are too favourable to the IOCs. At the time Nigeria also included a clause in the PSCs that allowed for their renegotiation after 15 years. Many of the contracts have already hit that 15-year mark.

IOCs need incentives

But industry experts have warned that IOCs need incentives to invest in deepwater exploration – supposedly Nigeria’s growth sector. The IOCs have been very reluctant to accept new fiscal conditions and renegotiation of contracts contained in the ill-fated Petroleum Industry Bill (PIB) were among the highly contentious issues that led to the delay of its passage into law. The companies argued that proposed changes to the fiscal terms would make some projects unviable, particularly deepwater projects that involve greater capital spending in the period before production starts.

It has taken six years to bring the bill, which is expected to reform Nigeria’s oil taxes and overhaul the NNPC, to a vote, which was largely due to wrangling between the government and the oil industry. The delay in passing the bill has cost the state billions of dollars’ worth of lost investment.

A deputy director of the Emerald Energy Institute, Chijioke Nwaozuzu, believes the PIB holds the key to further restructuring of the industry and said it needs to be modified to remove or adjust the contentious aspects within it, particularly the fiscal terms. The industry reform would at least give credibility to what fiscal terms would apply in the future, he says. “The passage of the PIB and entrenchment of a ‘win-win’ set of fiscal terms are crucial to setting off the kind of investment in exploration and production we would like to see in Nigeria,” the Port Harcourt-based Nwaozuzu says.

President Muhammadu Buhari’s administration has indicated it will relax the stringent fiscal terms for the companies. While this will help ensure Nigeria retains its competitive edge, lobbying and disagreements around the PIB means any eventual version of the bill will be watered down in its key terms to facilitate its passage, says Barclay. “The process is likely to be drawn-out and problematic.”

Nwaozuzu is adamant that time is not right for renegotiation of key contracts. He said the current climate of low oil prices dictates that reserves additions have to come from significant foreign investments in exploration and production. “Without this, oil reserves will continue to be depleted with continuous production and exports. It is such significant investments, particularly on offshore petroleum exploration and production, that will enable Nigeria to achieve the 4m b/d production by 2020,” he says.

Ecobank’s head of energy research, Oni Dolapo said that target would be difficult to attain given the current rate of field decline, lack of investment in reserve replacement and low investment in field development. Risks associated with oil theft are also making investing less attractive. “A more attainable target would be to ramp up output to 2.5m b/d over the next two years, and possibly to 3m b/d in five years,” he says.

Wood Mackenzie analysts in a research report published in August warned that Nigeria’s continued success as an oil and gas producer depends on its ability to replace its produced reserves. “Unfortunately, exploration activity in the past decade has been low and success rates disappointing,” it said. It also said that excessive bureaucracy leads to cost escalation and many projects struggle to break-even on a pre-tax basis in a $60/bbl market. “If these issues remain unresolved, Nigerian oil production will begin to decline within five years.”

New fields

No new major oil fields have started production since the 125,000 b/d Usan deep water field came on stream in February 2012. Shell’s Bonga North West field came online in 2014, which at peak production is expected to pump 40,000 b/d.

Earlier in October, Shell started pumping crude from the Bonga Phase 3 project, an expansion of the main Bonga field development. The Bonga field, which began producing in 2005, was Nigeria’s first deep water development in depths of more than 1000m and has produced over 600m barrels to date.

In September, ExxonMobil said it had started production ahead of schedule at the Erha North Phase 2 offshore project. The project is expected to develop an additional 165m barrels from the already producing Erha North field.

Together, at peak production Shell’s Bonga Phase 3 and ExxonMobil’s Erha North developments will pump roughly 110,000 b/d. Dolapo says the additional production was a “positive” development for the industry. “I think the key influencer in the global market is currently demand. Thus, it pays Nigeria to ramp up production as much as it can to compensate for the impact of the decline in oil prices on its revenue,” he says.

Nevertheless, joint-venture funding shortfalls and declining or deferred capex investment caused by uncertain fiscal terms and low oil prices mean there is very little exploration and appraisal drilling happening now. For years, NNPC’s contribution to its joint ventures has fallen short of what it owes. But its joint venture spending was cut to $8.1bn in 2015 from the $13.5bn provision in 2014. Kachikwu recently admitted that the NNPC owed $6bn in joint-venture obligations.

Consultants Wood Mackenzie said revenues from deepwater PSCs could be further raised, with the government increasing its share of profit oil on a case-by-case basis with oil companies. “Every percentage point increase in government take would generate a further $1bn over the lives of the projects,” it says. But it warned that the government would have to take care not to stifle new investments by “aggressively” increasing its take.

According to Barclay, contract renegotiations are likely to focus primarily on the older PSCs and those in ultra-deep water that have the lowest tax and royalty rates. Those PSCs with stability clauses in their fiscal terms that have not expired or are immune from re-opener talks are likely to be better secured against adverse changes, he says.

By pitting the government and industry against each other at a time of tough conditions in the industry, tensions will arise and commercial disputes are bound to occur, he says. However, “radical forms of political risk” such as the cancellation or removal of licences are unlikely; as are forced renegotiations without trade-off concessions, given the negative message that this would send to the industry, Barclay says.

PricewaterhouseCoopers' Nigeria energy leader, Darrell McGraw cautioned that there is still no certainty on whether the government or NNPC will enforce any of the proposals to impose changes to industry contracts or regulations.

“What I would say is that a year or two years ago, there was pessimistic regulatory uncertainty, and now there is an optimistic uncertainty” in the industry. “The reason being that the PIB cast a spectre of doubt over the future of the oil and gas Industry and what effect that would have on industry stakeholders,” he says.

Anti-corruption platform

Buhari swept into power in May this year on a promise to root out corruption and he vowed to overhaul the oil sector. He said his government will recover what he called “mind-boggling” sums of stolen oil money. He has pledged to publish in full an audit of NNPC’s accounts which was carried out by PricewaterhouseCoopers in February. An earlier investigation in 2013 by former central bank governor Lamido Sanusi found that NNPC had failed to pay $20bn in revenues to the government account between January 2012 and July 2013.

The arrest of the former oil minister Diezani Alison-Madueke earlier in October in the UK on bribery and money laundering offences has been positively received in the country. Alison-Madueke left office in March after the former president Goodluck Jonathan was defeated by Buhari in the presidential election. However, she was released the same day.

Nigeria’s Economic and Financial Crimes Commission has also begun questioning four former executives at NNPC while the Department of State Services is cooperating with the UK, suggesting that further arrests could be underway in Nigeria.

Manji Cheto, a London-based vice-president and risk analyst at consultancy Teneo Intelligence says the investigations will undoubtedly raise concerns for industry players, both domestic and foreign. In a research note, Cheto said that some of the biggest-ever divestments in the history of Nigeria’s oil industry began under Alison-Madueke’s tenure, with several IOCs selling some of their onshore oil licences to local companies. These assets sold off by the European majors Shell, Eni and Total will now be reviewed by the Buhari government.

“This sort of shake-up of Nigeria’s oil industry is no doubt long overdue, but the populist-leaning Buhari government is likely to treat all cases as ‘guilty until proven innocent’, potentially hurting sentiment in the short term, particularly at a time of low crude prices,” Cheto says.

McGraw does not dispute the importance stamping out graft but he also believes the government should not overemphasize its anti-corruption agenda at the expense of reviving the country’s oil and gas industry.

“This I think this is very important and you might get different views in Nigeria as to how far down the road we need to go,” McGraw says. The view, by many is to move forward, to focus on increasing the country’s oil production and boosting revenues so that corruption doesn’t happen in the future.

In the last five years, Nigeria's oil sector has been hit by rising costs, stagnating production, slower demand for its oil and widening corruption scandals.

Kachikwu for minister?

Nigeria’s senate began screening for cabinet positions October 13 as president Muhammadu Buhari starts to form his administration four months after taking power. The president has been criticised by some observers for being slow in naming a cabinet while the economy is struggling with falling oil prices. Under the constitution, Buhari, a former military ruler, must select a minister from each of the 36 states.

Among the name of nominees is Kachikwu who is expected to be named state minister of petroleum while the president takes on a supervisory role in the ministry.

Reports out of Nigeria 14 October said the president would seek a new group managing director of NNPC if Kachikwu’s ministerial appointment is approved by the senate. Tipped for that position is NNPC’s current head of exploration and production, Maikanti Baru from the northern Bauchi state.

Reports in the Nigeria-based Cable newspaper said Buhari was “uncomfortable” with some of Kachikwu’s actions, specifically his proposal to sell off the country’s four refineries. Buhari by contrast believes that the ailing plants should first be repaired before further discussion of a sell-off.

Kachikwu will most likely to be offered a ministerial role, a move that could delay any changes to oil legislation in the short to medium term. The most striking feature in the appointment of Kachikwu, who hails from the Niger Delta, is that he is an outsider, having been appointed from outside the NNPC.

“Although he does not fit the traditional mould of an NNPC appointee or an oil minister – he is not a technical oil person, and is an outsider to the NNPC – in the current environment that is probably a good thing. We believe his legal background puts him in a good position to navigate the legal complexities of unbundling the NNPC,” saiys Exotix’s African economist, Alan Cameron.

Nigeria’s oil industry has been under pressure lately from declining oil prices and endemic corruption that plagues the industry. Reforms in the sector are badly needed to help boost state coffers by reinvigorating investment and raising its oil production.

There seems to be mixed views as to the wisdom to making any significant changes to the fiscal terms of older PSCs but it would seem that a resolution of this issue is likely to take place sooner rather than later and perhaps before the PIB is passed into law.

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