Institutional developments and legal changes restructure Nigerian energy sector

Taking office in March 2015, Muhammadu Buhari, president of Nigeria, has made improving governance a top objective for his administration, with the energy sector one of his first priorities. Central to this is an overhaul, already in the works, for the Nigerian National Petroleum Corporation (NNPC) – the state-owned enterprise that both regulates and operates in the energy sector – as well as a long-awaited updating of the legal environment.

The president has spearheaded a number of the initiatives, having retained the oil portfolio for himself, with the reform-minded former ExxonMobil executive Emmanuel Ibe Kachikwu having served as his junior minister and chairperson of the NNPC until July 2016. While executive actions have comprised much of the recent activity by the government, legislative moves are also pending.

With the sector awaiting the National Assembly’s vote on the nearly decade-old omnibus Petroleum Industry Bill (PIB), a long-awaited first reading of the reform bill came in April 2016, upstream firms told OBG they are looking for more than just conceptual and structural changes. Upstream exploration, particularly offshore, has largely been on hold. This is in part a function of the bear market for crude that began in the second half of 2014 – the rig count has been below 30 since 2015 – but the PIB’s potential to become law has created uncertainty about the long-term profit-sharing system in the sector, and international oil companies (IOCs) have been more reluctant to commit to new ventures.

Familiar Outline 

Much of the outline of the current reform process follows the broad strokes of the various drafts of the PIB, which was first proposed in 2007 as an omnibus law to replace the patchwork of 16 existing laws that govern energy. The PIB has yet to pass parliament and has gone through numerous revisions over the past nine years; however, it has largely retained a few core elements at every stage.

Among other changes, it would increase the government’s overall share of energy-sector revenue, but also clarify and distinguish the roles of the NNPC and the Department of Petroleum Resources (DPR), which currently share regulatory functions. The NNPC would see its oversight powers shifted to the DPR, or a new entity, and would be free to function as a standalone national oil company. This conflict of interest has previously led to a range of concerns over transparency and governance issues, including a series of investigations over the past two years that found the NNPC to be withholding as much as $16bn in revenues owed to the state.

Ongoing Changes 

Among the most immediate actions the government has taken was the replacement of NNPC’s eight executive directors with four new people. At the middle-management level, the number of executives was cut from 122 to 83.

The government also began an audit to determine how much is owed to the IOCs that the NNPC partners with in joint ventures (JVs), which as of October 2015 was said to be at least $7.5bn. As of mid-2016 audits were still ongoing, with the Federal Ministry of Finance announcing another that would involve the NNPC but also other revenue-generating agencies. Kachikwu has also increased transparency at the organisation since August 2015, and it now publishes a monthly newsletter with statistical updates.

Part of Kachikwu’s original plan announced in August 2016 was to unbundle NNPC’s subsidiaries into 30 separate companies, each with chief executives to be held responsible for the performance and financial results of their operations. But in doing so Kachikwu found was pushing past the limits of what was possible without legal reform. A formal unbundling of the company would require legal changes to the NNPC Act of 1977. So those 30 divisions were instead reshuffled, grouped by role into seven divisions: upstream, downstream, refining, gas and power, ventures, finance and services. This could be a temporary solution, depending on whether the National Assembly passes a version of the PIB that allows for the deeper reforms originally proposed.

Downstream Changes 

Along with the changes to the overall structure of the NNPC there have been significant reforms to many of its downstream procedures, in particular in how the company ensures the supply of end-user products.

Nigeria’s four refineries have for years produced at either a small fraction of their overall capacity of 445,000 barrels per day (bpd), or not at all – the combined utilisation rate was 22% in 2013, for example. The NNPC’s refining subsidiaries have failed to address the problem, so another of its entities, the Pipelines and Product Marketing Company (PPMC) developed a makeshift response by instituting swap arrangements in which some of the crude the refineries cannot take is exchanged in international markets for the finished products the market needs.

PPMC has signed contracts with private companies both foreign and domestic to manage these trades, and roughly $35bn in oil was exchanged in swaps from 2010 to 2014, according to research by the Natural Resources Governance Institute (NRGI). However, the NNPC has not always received fair value for the crude exchanged or sold in these deals.

NRGI found that in 2013 just 58% of the value of the crude sold reached the national Treasury. In its 2015 partial audit of downstream operations, the auditing firm and consultancy PwC recommended that the NNPC Act be changed. “It appears the act has given the corporation a blank cheque to spend money without limit or control,’’ it concluded.

All existing swap deals were cancelled in August 2015, ending those contractual relationships with both foreign and domestic importers in the process. The NNPC then signed new versions, in which the swaps were replaced by a system of direct crude sales and direct purchases of refined products. Kachikwu said the new structure will create a savings of $1bn. The first two contracts went to Total and ExxonMobil, bringing IOCs into this part of Nigeria’s energy sector for the first time. Several more were also signed, including one with a domestic importer, Sahara Energy, although a number of domestic importers failed to win new contracts.

Refineries 

These new contracts are seen as a short-term fix, because the state hopes the domestic refineries will soon provide enough end-user fuels to end the need for imports. The problems at the refineries are due to a lack of maintenance over the years, as well as fire damage at the one in Warri, in the south-east. In March 2016 Karim Belkaid of Entrepose Delattre Bezons Nigeria (DBN), a French engineering, procurement and construction firm, said the facilities were operating at about 30% of overall capacity. “Nigeria’s refineries produce significantly less than their production capacity due to years of neglect and a lack of investment in maintenance and upgrades,” Belkaid told OBG. Even without problems at the refineries, running at full capacity would be a challenge, as Nigeria’s pipeline network is continually under attack from militants, causing supply disruptions to the refineries. Margins and cash flow also pose challenges, given that some fuels in Nigeria, led by premium motor fuels, are sold at regulated prices, whereas crude is sold at market prices – a problem that has slowed investment in the power sector, where efforts at incentivising private investment in electricity infrastructure has been constrained by low tariffs, which dampen interest.

Furthermore, a new 650,000 bpd refinery is currently being built by the Dangote Group in Lekki, east of Lagos, and the impact of that facility – which would be more than enough to supply the whole country with fuels – is uncertain.

Should investors find solutions to overcome these obstacles, access to capital remains a hurdle in any potential refineries privatisation. The electricity privatisation was largely financed by domestic banks, which have tied up 40% of their lending capital in either oil, gas or power projects. They are expected to be less willing to lend to energy projects in the near future, which suggests that foreign capital would be necessary to make up the shortfall.

Upstream Amends 

One of the major focal points for reforms in the upstream segment is the existing NNPC JV structure used for ownership of most onshore oil blocks. The NNPC has a majority stake in these JVs, formally held and overseen by its subsidiary National Petroleum Investment Management Services (NAPIMS), but with corporate partners holding operational responsibilities. Capital expenditure is shared in proportion with ownership stakes, and the NNPC has typically struggled to meet those cash calls on time, due primarily to burdensome bureaucracy and slow payment processes.

The JV structure can also cause complications on an operational level. On an annual basis NAPIMS is tasked with reviewing, approving and monitoring work plans submitted by the operators for the fields. Companies have reported wait times of six months or more before these plans are approved. Once this is done, the major contracts required to execute the plans must also be approved.

New Structures 

Options proposed in the past to reform the sector include restructuring JVs in order to allow the private sector partners to raise capital from outside interests, and a move for onshore blocks to abandon the JV structure in favour of production-sharing contracts, which is the arrangement the IOCs work under for offshore acreage.

Another proposal from officials is an NNPC sale of some or all of its stakes in these JVs, or in other assets such as the refineries. The NNPC’s share of the JVs is typically either 55% (for those signed with Royal Dutch Shell) or 60%. Therefore sales of 6% or 11% would allow oil producers to gain more control, which would likely improve their access to outside capital to finance operations. Asset sales could also bring a quick surge of dollar-denominated cash for the government, which would support the weak naira, and drew support in May 2015 from Godwin Emefiele, governor of the Central Bank of Nigeria. He had said at that time that reducing the NNPC’s stakes in JVs to 15% would raise $75bn. “Even if just enough was sold to let the private sector own a controlling interest, that would make a big difference,’’ said Cyril Odu, CEO of African Capital Alliance, a pan-African investment firm based in Lagos. However, with oil prices significantly lower now, and their direction uncertain, this idea was widely seen as unlikely as the first quarter of 2016 drew to a close – both buyers and sellers might be reluctant to commit to a sale price.

Paths To Finance 

For now, the NNPC has found another means of addressing the problem of meeting its cash calls: the Accelerated Upstream Financing Programme, which is an alternate short-term reform effort to secure bank financing in new ways. The first deal was announced in September 2015. It was a $1.2bn financing package for the joint venture between the NNPC and Chevron Nigeria. The money came from a group of domestic and foreign lenders, including the UK’s Standard Chartered Bank and Nigeria’s United Bank for Africa.

This is the first loan to the Nigerian energy sector without earmarks for a specific project, to be used instead for ongoing work across a variety of fields or blocks. The money will be used to drill 36 new wells over the next three years, both on land and offshore. The NNPC’s JVs with other firms were expected to follow suit with similar financing deals.

Ultimately, the range of reforms plans currently on the table is impressive, and with the restructuring of the NNPC and renewed momentum on the PIB, the outlook is more encouraging now than it has been in years. Despite these developments, however, it will take some time to see the fruits of the current restructuring efforts. “It is inconceivable to think that any government has all the answers,’’ said Ainojie Irune, head of communications for the indigenous exploration-and-production company Oando, “Even understanding the problem will take time.”