Nigeria's election hangs over energy sector
Africa's biggest economy is growing again. But next year's vote is stalling reform and investment in its crucial energy sector
Nigeria's economy has made a sluggish recovery over the past 12 months. After a plunge into negative growth last year, higher global oil prices are beginning to heal the wounds to state finances. The next 18 months will be fraught with political risk, but if investors are smart, they can hover over lucrative market positions and prepare to take a spending plunge when the time proves right.
In oil, there'll be intense scrutiny of Total's Egina floating, production and storage offshore project over the next year. Once up and running, the FPSO will process 100,000 barrels a day of oil. But the sailing may not be easy. Militants in the Niger Delta say they may target the Egina, and analysts believe the government would be wise to heed the warnings. Offshore attacks are more complicated than onshore ones—but they've been carried out with some success before.
Project operator Total has set an ambitious start-up date for the end of 2018, so any attack would affect the schedule. Analysts view a date in early 2019 as more likely, limiting the number of projects that are likely to get off the ground this year.
Also in oil, the ministry has yet to issue a bid round for its marginal fields, which were originally to be offered in 2017. President Muhammadu Buhari has still not given approval for the auction. It will probably now have to wait until after the presidential elections next year.
In gas, Nigeria's sector hasn't escaped the global depression of the past three years. An absence of investment has slowed potential export projects and a lack of clarity on the role of joint ventures is also complicating the picture. Compounding the problem is that Nigeria has failed to keep pace with more competitive emerging gas provinces in Senegal, Mauritania and Ghana; while on the other side of the continent Mozambique and Tanzania are absorbing much of the foreign gas investment by offering better terms for investors.
2.3m b/d—Oil output forecast in Nigeria's 2018 budget (500,000 b/d more than production in January)
The country's flagship project and juiciest cash-cow, Nigeria LNG, is planning to install a seventh train, which will add an extra 8.5m tonnes a year of liquefaction capacity to the existing 22m t/y. But delays are apparent there, too. A final investment decision had been touted for 2018, but this target date has been pushed back several times. Foreign direct investment will be needed to carry out the expansion since state company Nigerian National Petroleum Corporation is revamping its terms for joint ventures. Simply put, NNPC doesn't have the funds to put up its side of the financing for such a project at this stage-it's already on the hook for more than $6bn of cash-call obligations.
NLNG train 7 is competing with several other planned liquefied natural gas-export projects, but analysts still consider it the likeliest to go ahead, eventually. NLNG first needs to secure buyers for the gas, though, and this will be trickier. Customers increasingly seek more flexibility, not necessarily more volume, in their contracts—a strategy NLNG has always eschewed. Aside from that, NLNG faces the more immediate task of finalising contracts to remarket volumes from trains 1-3, meaning it's unlikely that train 7 will reach its FID this year.
Nigeria's oil industry investment is still largely dominated by the big majors with a proven track record in Nigeria, among them Total, Eni, Chevron and Shell. For newcomers, Nigeria hasn't yet adapted its outdated oil legislation to be favourable enough when measured against upstream investment elsewhere. It's seen as a less-rewarding destination than Mena countries or the US. Making matters worse, new legislation is unlikely to be passed until after the next general election.
Despite repeated claims that Nigeria wants to improve terms to lure foreign investors, the result has been disappointing. Upstream investment has been slow. And when it has happened, it's often been the domain of under-qualified indigenous companies that have taken a risk that only now is beginning to pay off. There are several reasons. First, as long as new oil and gas legislation remains unapproved, investors are chary, fearing new guidelines could undermine the investment case. Second, Nigeria's oil breakeven costs are now higher than can be found elsewhere. The cost of producing a barrel of oil in Nigeria is around $20, according to NNPC. In Iraq, by comparison, it's still around half that figure.
Militancy also remains a real concern. It's been one reason why companies with a track record in Nigeria, including Shell and ConocoPhillips, haven't renewed some contracts.
In the medium term, investors will watch for progress on the Fiscal Policy Bill and the Petroleum Industry Bill. Both could significantly change investment terms for international oil companies. For example, the fiscal bill proposes many fewer tax breaks for IOCs, as well as a system of royalty payments, rather than taxes. The key point is that royalties only need to be paid when there's output (as opposed to income tax based on profits). In addition, at the moment the royalty rate is based on water depth, but the fiscal bill will look to abolish this, meaning that some companies that are currently paying nothing in royalties may be subject to higher payments.
Nigeria's National Assembly has, at least, passed its Petroleum Industry Governance Bill, though it awaits presidential assent. The PIGB deals primarily with the dismantling of the NNPC into separate entities. That ought to be positive—but industry sources aren't sure the president will make it law. "The break-up of NNPC, which is the core of this project, means high-placed managers would lose their jobs. There will be a lot of pressure on Buhari not to sign it," says Malte Liewerscheidt, vice-president at Teneo Intelligence, a risk-advisory firm.
Emeka Akabogu, senior partner at the Nigeria-based law firm Akabogu and Associates, takes a different tack, saying Buhari might gain some popular support by signing the bill into law. "There is a consensus that NNPC needs to be more efficient, and the breakup of NNPC was supposed to create this efficiency, so I don't see why it should be a problem," Akabogu says.
This new bill would certainly bring some major amendments to Nigeria's energy sector. While existing contracts would be unchanged, the designation of the contracting parties may change, Akabogu says, and there could be some disruption to the decision-making process. One of those changes will likely be related to the grant and review of licenses, which at the moment are the sole responsibility of Nigeria's oil minister. The new system will require more stringent criteria for approved blocks, Akabogu says. This continues the direction of Nigerian domestic oil policy, to break up centralised powers.
Akabogu still views Nigeria's upstream market as an essentially attractive opportunity for investors, although he admits that its viability remains intrinsically tied to the global oil market. Big opportunities do, however, await in greenfield projects in the downstream and also in infrastructure, he says. The domestic market could, in particular, see widespread change after the elections.
Indeed, Nigeria's elections in 2019 hang over its energy sector. Campaigning has already begun and President Buhari is, for now, leading the polls to win another mandate. It's not a foregone conclusion, though, and after a year marked by poor health and his absence from major government meetings several parties are pitted against him. Politicians from his own party, the All Progressives Congress, have called for him to stand down.
And hopes for legislative progress between now and next year's election have dimmed. "The main effect of the election campaign will be to distract the government from governing," says Ben Payton, Head of Africa at Verisk Maplecroft, another risk-advisory firm. "Political considerations suggest that the window for major legislation to be passed before the elections will soon close."
A major political shake-up would be risky for investors, but re-election for Buhari may be feared, too. The president's approach to Nigeria's economic issues has come in for some hefty criticism.
Either way, projects that aren't yet sanctioned are unlikely to make much progress until the next presidency begins. In the meantime, the government will try to convince voters that it has engineered a recovery from the spate of militant attacks in 2016, which at one stage had slashed oil output by a third. Any projects that do get negotiated between now and the next term would need strong guarantees that the contracts would be honoured in the event of a change of government, cautions Akabogu.
Calmer waters: stabilising Nigeria's energy sector remains key to its economic development
The threat of sabotage is also lingering. Investors have good reason to be concerned, following fresh threats from the Niger Delta Avengers, the group behind many of the attacks in 2017. Although the government thinks it has pacified the militancy, its main method is to pay off fighters—and it doesn't have as much money to hand out as it once did. As a result, the negotiations are yet to be finalised.
Aside from the revived threat of the Avengers, Biafra separatism has surged lately, which could potentially restrict goods and transit to the Niger Delta region, curbing oil and gas activity and even resulting in force majeure on certain assets, Payton says. Some solace is found in the fact that the more recent militants in the Delta don't have political motives, meaning they are unlikely to unite with the much more politically motivated Biafrists.
"The best we can hope for is basically [to get] back to where we started in 2009, so essentially there is not a need for the government to pay off the militants," says Teneo's Liewerscheidt. "They put in some money so the oil keeps flowing and that's that."
After last year's recession, Nigeria's larger macroeconomic picture is looking healthier. The country has managed to restore foreign-exchange reserves, meaning that if militants attack oil output Nigeria should have enough liquidity to stabilise the exchange rate in the short term. Institutional investors have welcomed the development, but it's unlikely the government will choose to liberalise the foreign-exchange market, despite repeated requests.
Efforts to diversify away from oil have been slow, though, and the country still relies on it for over 80% of its export earnings. Last year, Nigeria officially ended its recession, but its non-oil economy is still shrinking in size, suggesting that the growth has been cyclical, rather than structural. Higher global oil prices have helped, in other words, and have themselves hindered the efforts to diversify the economy to be ready for another price slump.
Even now, despite the rise in international crude prices in 2017, Nigeria isn't earning as much as its 2018 budget planned on, partly because it set ambitious forecasts for oil production: 2.3m b/d. According to Opec's secondary sources, production was just over 1.8m b/d in January, and analysts don't think the higher target is plausible—stabilising production at today's level was the work of several months. At least the budget was less bullish about prices, basing the spending plans on a price of $45 a barrel, about $15/b less than the market offers now. This leaves some wiggle room for the government. A budget revision is unlikely, Leiwersheidt says, even though the new one includes a 20% increase on last year's spending plans. Meanwhile, economic growth this year should come in at 2%: modest, but an improvement compared with the contraction seen in previous years.
Nigeria's domestic market
One area that seems destined for much-needed reform after the next election is Nigeria's downstream. Historically, the government has kept a tight leash on the market by capping products prices—a gift to consumers but a deterrent to investors, given the low returns this offers. Indeed, so low are capped prices that they have opened up an arbitrage for trading products across borders. The system needs an overhaul.
"The industry players and every common-sense view of the market has said it needs to be liberalised," Akabogu says. "Anything that happens between now and June [or] July next year would only be a slight increase in prices. But they may choose to liberalise in June [or] July ."
The domestic power market is a case in point—and has become a hotbed for political debate. Nigeria's minister for Power, Housing and Works, Babatunde Fashola, recently announced that power tariffs would remain frozen, which is bad news for debt-laden power generators and distributors, which argue that current domestic tariffs are too low to turn a profit. Further debt write-offs may be in store, but will do little to resolve the underlying supply-side problems affecting the industry.
One major power development should come on stream this year—the Azura power project, with 1,500 megawatts of nameplate generation capacity. But infrastructure is problematic: it's doubtful that the Nigerian grid is physically capable of absorbing so much power. The first Azura unit came online in January and the last two units are scheduled to come on stream by the end of the first quarter.
"My understanding is they are not getting enough gas to run at full capacity," says Jubril Kareem, power markets analyst at the Nigeria-based Ecobank. He doubts that the figures released by the government about grid capacity are accurate.
22m t/y—Nigerian LNG export capacity
Efficiency has improved in 2018 and there have been fewer reported power cuts since the beginning of the year. But the real power-loss figure is almost impossible to measure because of a lack of metering. Installing metering across the country will, therefore, be integral to improving access to power. At the very least, it would let consumers keep track of how much power they're using and distributors measure accurately and invoice customers accordingly.
Likewise, Nigeria holds opportunities for gas. A fire on the Escravos-Lagos pipeline in January was a reminder of how heavily the country depends on the supply for the bulk of its gas-to-power capacity. It would make sense to spread this risk with development of new gas pipelines and infrastructure. The improvement in international energy prices may give investors more enthusiasm.
"Basically, it's about getting gas networks connected to power plants," Kareem says. "This has been an issue for a while. This improved in 2017 but looking into 2018 I believe the most important thing because of the political space will be to keep the pipeline safe."
As for the militants who lurk constantly in the background of Nigeria's sector, they may get a chance to be involved in some projects themselves. A government initiative would turn illegal modular refineries in the Nigeria Delta into legal export facilities. The revenue from this would be reinvested into the Niger Delta and the initiative would act as an incentive for militants to stop their attacks on oil infrastructure.
But the presidential elections will inevitably affect all this, too. Also, expect the approaching vote to affect the dynamics of the Delta's militancy. Upstream investors eager to capitalise on Nigeria's healthier economy—and its undoubted need for development and capital—would be wise to tread slowly and carefully until the political dust settles early next year.