The dire need for a rebirth of the oil, gas downstream industry
The oil and gas downstream Industry remains largely import dependent due to Nigeria’s dismal domestic refinery production. Over the last five years (2012 – 2017), the local refineries owned by the Nigerian National Petroleum Corporation (NNPC) have operated at an average capacity utilisation of 16.5 percent. NNPC intends to improve the operational capacities of the refineries and reduce importation significantly by 2019.
The national oil corporation is currently engaged in a series of negotiations with a number of private investors to improve the operational efficiency of these refineries and to possibly construct modular refineries within these plants. Refinery production may also improve in the near term if the Dangote Refinery construction meets the 2020 operational kick-off target.
In spite of the plans to ramp up local production of refined petroleum products, adequate investment in the distribution network is highly germane. The distribution network of the downstream industry relies significantly on the tanker trucking system due to the inefficiencies of the pipeline network – which is subject to at least a thousand breaks annually. Over 95 percent of refined petroleum products are transported by road. Some of the other key challenges affecting the Industry include government regulations on pricing, inadequate funding, sensitivity to foreign exchange volatilities and increasing rate of pilferage.
Not so much of a good era for private downstream operators
Petrol accounts for almost 80 percent of white fuels consumed in Nigeria and is also the only petroleum product with price controls. The Nigerian government ended the payment of petrol subsidies in 2015 and reviewed the price of petrol downward from ₦87 to ₦86.50 per litre. This coincided with declining global crude oil prices in 2015 (average Brent price: 2014 – $99pb, 2015 – $53pb). Nonetheless, the subsidy claims from the prior years (pre-2015) still remain outstanding, with claims accumulating to over ₦800 billion as at October 2017. These accumulated subsidy claims have impacted the financial health of downstream operators, leading to weaknesses in the Industry’s bankability, while constraining growth.
In May 2016, the price of petrol was reviewed upwards to ₦145 per litre to enable a full cost recovery for importers of petrol, following the devaluation of the Naira. The sustainability of the capped price and the petrol market’s operational dynamics came under pressure in 2017 as global crude oil prices rebounded. The increase in crude oil prices translated to an uptick in the price of refined petroleum products in the global market. This has led to a wide disparity between the international price of crude and Nigeria’s regulated pump price. The regulated price regime has created several impacts on Nigeria. Firstly, it creates arbitrage opportunities in neighbouring countries (such as Benin, Togo, Niger and Chad), where petrol is sold at higher prices. The regulated petrol price regime has also resulted in the ‘resumption’ of petrol subsidies and the payment of under-recoveries, currently borne by the NNPC.
The relatively high price of refined petroleum products in the global market and the rigidity of the pricing template on cost elements like the exchange rate of 285NGN/USD, has made it unprofitable for petroleum marketers to import and sell at the regulated pump price. Following the difficulties in the import of petroleum by downstream marketers, NNPC became the major supplier of petrol for most of 2017 and now in 2018. Due to the cost differences, NNPC incurred cumulative losses of ₦144.5 billion in 2017 and has spent an average of ₦40billion monthly in 2017 on under recoveries. The 2018 budgetary allocations to a number of key Federal Ministries are well below ₦40billion. The fiscal impact of the petrol price controls and subsidies is fast becoming acute, particularly if the price of petrol pump is neither reviewed nor liberalised.
The kerosene – LPG market connection
Owing to more investments in distribution infrastructure for cooking gas, the consumption of kerosene continues on a downward spiral. Increasing health consciousness and awareness of the need for more environmental friendly cooking fuel options have also bolstered the consumption of cooking gas. The consumption of kerosene has declined by an average of 27 percent over the last four years (2013 – 2017). Given the removal of subsidies on kerosene and the improving LPG market, we expect consumption to dip further in the near to medium term.
The argument for improving domestic production of petroleum products
There are several arguments against the viability of refineries, given the divestment in a number of refineries in certain parts of the world. Nonetheless, we believe Nigeria could benefit from capturing this viable part of the oil and gas value chain.
First, the price of locally refined petroleum products are likely to be cheaper than imported products due to the high cost structure in imports’ logistics such as carriage and freight charges as well as demurrages. Another key benefit will be the economic benefits from the multiplier effect of refineries. There are possible employment gains from supporting businesses, given that refineries do not typically require a high number of personnel, such as logistics service providers, petroleum retailing, service companies (waste management, plat treatment, shutdown support and data management). We also believe a thriving refinery segment of the downstream industry could pave way for export opportunities to the Sub Saharan Africa region and create a thriving market for petrochemicals.
The path towards regulatory certainty
The Petroleum Industry Bill, expected to incorporate key laws and regulations for all oil and gas operations is categorised into four tranches: Petroleum Industry Governance Bill (PIGB), Petroleum Host and Impacted Communities Development Bill (PHICDB), Petroleum Industry Administration Bill (PIAB) and Petroleum Fiscal Bill (PIFB). The Nigerian Senate and House of Representatives passed the PIGB in May 2017 and January 2018 respectively. In June 2018, draft PIGB was transmitted to the Presidency for assent into law. Key recommendations of the PIGB will be the liberalisation of the refined petroleum market and harmonisation of regulatory functions to a sole regulatory body. In the event that the PIGB is approved, the regulatory focus will be centred on creating the enabling environment for private sector investments, particularly building a strong antitrust framework. Nonetheless, we are conscious of the complexities and significant changes to institutional frameworks this bill will require. In addition, given the tenuous political environment currently focused on the 2019 elections, we do not expect the PIGB will be given the attention it requires.
In conclusion, we believe that despite the positive outlook on the crude oil market, the fiscal burden from the heavily regulated market could stoke higher macro risks as it leads to an expansion of the fiscal deficit. In our opinion, to pare back the burgeoning fiscal deficit, the Federal Government would need to liberalise the white petroleum market while divesting from key downstream assets (storage depots, pipelines and refineries).
AUGUSTO & CO
Augusto & Co is a research, credit rating & credit risk management firm