Refineries should be retained by NNPC

That the Buhari Administration will encourage NNPC to hang on to the state-owned refineries is not a bad idea, provided appropriate rehabilitation, upgrading and expansion programs thereof are timely developed and implemented. That the refineries are operating at a fraction of their name plate capacities also is not terminally fatal. Poor maintenance policies, which can be changed, have been responsible for the present state of the refineries. Such policies are reversible. The equipment are not aging physically; technological improvements thereon can be incorporated in the rehabilitation and upgrading programs.

The alleged aspiration of the Vice President on medium-term reduction in pump prices of petroleum products, and the way this is to be achieved, is the focus of this piece. The commentary that ensues will use simplified terms and terminologies to facilitate its understanding by the average reader.

Fundamental law of refining economics

All refineries, whether simple or complex are subject to the following economic relationship: Gross Margin (A) = Gross Revenue (B) – Feedstock Cost(C).

Gross Margin A, is the total financial benefits obtainable from the operation of a refinery, which is available for settlement of or payment for all operation and maintenance, expenses fixed overheads, capital charges, local taxes, and net profit, if any. There is nothing the refinery can do to increase or diminish Gross Margin other than through appropriate technological configuration of the refinery processing scheme, complemented with good, efficient, and safe operating and maintenance practices.

Gross Revenue, B, is the aggregate financial revenue derivable from all saleable products. It is the aggregate value of price of each product multiplied by the yield or fraction of each product obtainable from a barrel of feedstock. Price is subject only to market forces, except if controlled by governmental authority, while fractional yield depends strictly on technological configuration of the processing scheme. Good operating practices will only serve to eliminate or minimize losses.

Feedstock Cost, C, is the cost per barrel of crude oil and, where applicable, other raw materials, other than chemicals and catalysts, charged into the refinery. For this discussion, and typical of all existing refineries, crude oil is the only feedstock being charged into the refineries. Needless to repeat, crude oil price is subject only to international market forces, unless subsized by government, and supplied to the refineries at lower price.

There are 4 classes of petroleum refinery; simple Topping Plant, Hydroskimming Refinery, Medium Complex Refinery, and Highly Complex Refinery. The industry has an international rating schemes and indices that compare the potential performance of refineries. A simple explanation of this is as follows: the more higher valued products such as Gasoline (Petrol), Kerosene, and Diesel Fuel(AGO or Automative Gas Oil), the so-called White Products are required, and the less lower-valued products such as Fuel Oil, the so-called Black Products, are desired, the more complex the refinery configuration must be. The break even price is the price of crude oil. Topping Plant has the lowest rating while Highly Complex Refinery has the highest rating, with Hydroskimming Refinery and Medium Complexity are in between in that order.

The old Port Harcourt Refinery is a Hydroskimming Refinery, while the New Port Harcourt Refinery, Kaduna Refinery and Warri Refinery are Medium Complexity Refineries. The proposed Dangote Refinery is High Complexity Refinery. The so-called Modular Refineries will fall between Topping Plant and Hydroskimming Refineries.

From the law of refining economics and current crude oil price levels, Topping Plants will have negative gross margins, Hydroskimming Refineries will have mostly negative to zero gross margins, Medium Complexity Refineries will have moderately positive gross margins while Highly Complexity Refineries will have significantly positive gross margins. No amount operating excellent can significantly change these outcomes, but poor operations can make the outcomes worse for all categories through increased downtime, refinery losses and increased energy consumption.

Vice President’s aspiration over product prices

Petroleum refineries are petroleum fuel infrastructures, and, like all infrastructures, they should be reliable, efficient, safe, and as competitively priced in their services or products as possible. The Vice President is consequently conceptually correct to aspire to lower pump prices, if they can be obtained competitively.

This can be achieved in only one of two ways from the law of refinery economics if the refineries are to operate with positive margins; by granting discounts in crude oil prices, for merchant refineries that purchase crude oil and sell products. This is probably outrightly unacceptable. There is nothing else that can be done. For processing refineries that charge processing fees for contract refining services, cost of crude oil is irrelevant, as are product prices. However, government can influence pump prices by general improvement in port services, eliminating demurrage, and lowering tariffs.

New refineries are far more expensive than the older, efficient refineries operating worldwide and supplying products to the Nigerian market.

These refineries are typically operating at marginal cost, as their capital costs have been fully amortized. The only cost advantage domestic refineries will have over these older export refineries is transportation cost differential. It is in the interest of the fuel consuming public that all domestic refineries operate within this transportation differential without any subsidy.

Timing is another matter altogether. It is most unlikely that any newly licensed refinery of any complexity will be in operation in less than 3-5 years of its licensing date because of the planning, procurement, and construction period required.

Location of new refineries

One is at loss to decipher what is meant by allowing the new licensees to build near State-run refineries. Clearly, one can surmise that modular refineries are being contemplated. All I want to say about this is ‘‘BUYER BEWARE’’.

Where is the space to build any type of refinery near any State-run refinery? Is this a surreptious attempt to sell or lease refinery land or property to private enterprise? Which refinery infrastructure will be shared, when the existing infrastructures are either unreliable, inadequate, or both? Why would NNPC want to compromise the competitive market siting of its refineries by encouraging private competition within or near its facilities? Would NNPC not require any spare space or facility for future, profitable upgrading and expansion of its own facilities? These issues deserve careful consideration.

Importation of Products

Whatever initiative, private or public, is undertaken right now to add new production capacity to the existing domestic refining capacity, result therefrom will take at least 3-5 years for fuel therefrom to reach the pump station, depending on availability of financial resources to the initiator. Consequently, the nation might as well as adjust to the reality of continuing importation of petroleum products for the next 3 years or so until Dangote Refinery becomes operational. I am not aware of any other current consequential refinery project that will stream before Dangote’s.

Importation of the appropriate products in the required amount is far more desirable and less destructive of aggregate national financial resources than to continue to refine crude oil allocations without Fluid Catalytic Cracking Units (FCC Units) being operational. Operating the refineries without the FCC Units is mere value destruction because a lot of Fuel Oil (LPFO and HPFO) is produced which has much lower market value than the crude oil from which it is produced, notwithstanding the high political patronage premium on Fuel Oil Lifting Rights Allocation.

In this regard, it is rather gratifying that the Buhari Administration has finally sanctioned the discontinuation of Offshore Processing Agreement, OPA. With the new Direct Sale-Direct Purchase (DSDP) policy, it will be far more straight forward and cost effective to purchase only the White Products required directly from offshore refineries, than to have to contend with negotiating the quantities of Fuel Oil and losses from the crude oil exchanged for the products. NNPC can sell the crude oil directly, and import products on competitive market prices, which are published daily. Private marketers can also import products directly, or should be allowed to.

NNPC refinery published profitability data

The purported profit and loss data published on the NNPC refineries are unreal and meaningless. They are also unnecessary, least of all in the format presented. The data are based on purely internal, and therefore subjective, cost transfer arrangement, processing fee arrangement, whereby cost is transferred between PPMC and the refineries. NNPC need not subject herself to unnecessary public opprobrium through presentation of incomprehensive financial performance data.

It would be far more useful if NNPC would report unedited and straight-forward operating performance data each month on each refinery such as crude run, product yield and losses, and downtime, if any. This is a change the public will welcome, and which NNPC can use to properly track the performance of its assets.

Kachikwu’s refinery rehab plans

Like all external appraisers of NNPC CHALLENGES, Dr. Kachikwu most probably misconceived and miscalculated the depth of these challenges. It was probably too hasty, and perhaps a little imprudent, of him to proffer solutions to problems he had neither studied nor even apprehended. Otherwise he would NOT have given the assurances of radical improvement in the operating capabilities of the NNPC refineries to the Senate of the Federal Republic of Nigeria as he committed to during his first appearance at the National Assembly. Such grand-standing hyperbole in serious issues of public performance and governance was completely unnecessary.

Nevertheless, if Dr. Kachikwu would follow through on his expression of confidence and trust in his technical workforce, and allow them to properly develop a sensible and profitable roadmap, he no doubt will be able to provide the focused, single-minded, and accountable leadership indispensable to navigating the roadmap and restoring NNPC refineries to profitable, sustainable and reliable operational status. This, to repeat, will take time: Several Years!

Upgrade and expand NNPC refineries

NNPC refineries have already satisfied the most fundamental criterion in establishment of a petroleum refinery; location in the heart of the market that the refinery will serve. While this was not so in the beginning, it is so now in the case of all 3 refineries, especially if one considers the operating period that any new capital injection will consider. That is, one will consider a period of starting from 2019 onward. By that time, it is every Nigerian’s hope that our national economy shall have recovered and shall have been set on balanced growth path so that fuel demand will be robust in all regions of the country. Consequently, it would be fool hardly for NNPC to forego this competitive advantage.

Secondly, NNPC refining assets are grossly under-utilized, and they are, without exception, among the newest in the world. They may not have been properly maintained, but they are far from being candidates for the junkyard. Some technologies may be old or outdated, but this is not uncommon in the industry, which regularly upgrades such technologically outdated assets with new technological developments. It is much cheaper to do so, than to establish grassroot facilities.

Thirdly, the land occupied by the refineries was acquired when it was relatively easy, and inexpensive, to acquire such real estate properties from indigenous communities for public use. It will be therefore outrightly foolhardy, and possibly illegal, to share the occupancy with a private competitor.

Fourthly, NNPC is by far the largest, if not the only, repository of refining operating knowhow and culture. This asset should not be lightly discarded.

Lastly, there is indeed a new Sheriff in town, who, fortunately, mid-wived the birth of NNPC, and is familiar with its past achievements. He can understand future possibilities, if realistically conceptualized.

The proposal

NNPC refineries can, and should be, upgraded technologically and their capacities expanded to competitively cater to the demands of at least their immediate regional markets in the decades starting from 2020.

NNPC can retain the services of appropriate world class Basic Technology Providers to provide the Technology and Design for economically feasible upgrading and expansion of the refineries as well as bankable feasibility studies for such proposals.

NNPC can implement such upgrading and expansion by rotation, based on a schedule to be developed jointly with the Licensors, and realistic funding plans.

NNPC can fund these development programs based on their own merits, because they are inherently very profitable and attractive, without recourse to Federal Government purse other than Sovereign Guarantee of Loans, and approval of allocation of Foreign Exchange to meet loan repayments as due from savings in foreign exchange that will accrue from proportional reduction in products imports.

For avoidance of doubt, these refineries can be expanded by 50-100 percent of their present capacities at a price level not higher than 50-60 percent of the cost of grassroot or greenfield refining barrel. In order words, the expansion will cost about half of what equivalent brand new refinery will cost in general.

It is not the intent of this commentary to prescribe specific pattern of development. But, it is hereby categorically affirmed that such development is feasible, necessary, and perhaps even inevitable, irrespective of future ownership or proprietorship of the refineries.

Further issues on NNPC refineries expansion

The most critical issue that will impact any refinery upgrading and expansion plan is funding. Fuel subsidy will directly impact this plan in several ways. From the law of refining economics, the Gross Margin is the total cashflow available to the Owner to service debt, among other overheads. Government will not allow NNPC to accumulate cash as long as Government funds fuel subsidy. The import of this is that no lender will lend NNPC any money if there is any danger that NNPC’s ability to repay the debt from current revenue derived from free market operation would in any manner be impaired or threatened.

In any case, after 28 years of fuel subsidy, it is unrealistic to expect that some future good will still come from fuel subsidy. All our institutions and values have fallen victim to fuel subsidy.

Secondly, construction of new crude oil supply pipelines to the refineries, and enhanced security systems for both the existing and new pipelines will be necessary. These pipelines, in some cases, may be amenable to outright private or private-public joint venture development initiatives.

Thirdly, upgrading and expanding of Kaduna Refinery should be given high priority because it serves the breadbasket of Nigeria, whence comes most of the food for the country, and which market therefore should be competitively supplied petroleum fuel products in order to keep agriculture production cost down and food prices low. Nevertheless, the existing plan to convert the FCC Unit at Port Harcourt Refinery to RFCC Unit should be pursued, and integrated into an overall upgrading and expansion plan.

The alarm raised recently by a former Presidential Adviser over the suitability of Kaduna Refinery to process non-parafinic crude oil is false. Kaduna Refinery was designed to, and can process, either or both Naphthenic and Paraffinic Crude Oil. Also, the instrumentation system has been fully digitalized since initial commissioning in 1980, and can be upgraded again as necessary along with technological improvements, if and when necessary. Until then, the refinery will perform well as designed.

In summary, price modulation should not be a necessary pre-condition or important criterion for new refining capacity in the country. What is desirable is price competitiveness, which can be achieved only by opening the Nigerian market to full international market forces. There is sufficient natural entry barrier confronting imports to make domestic players reasonably comfortable and secure, while protecting the consuming public from monopolistic price manipulation tendencies.

NNPC refineries are strategically sited, and should be retained by NNPC. Rather than collocate modular refineries within these assets, they should be upgraded and expanded, but without any financial involvement by the Federal Government.

Fuel Subsidy should be removed and the market fully deregulated in order not to impair NNPC’s ability to obtain financial for potential asset upgrading and expansion plans, amongst other reasons. Fuel Subsidy, in any case, has outlived its usefulness, if it ever had any. On the contrary, Government should introduce fuel tax to generate sustainable funding for road transportation infrastructure development, mass transit and rural development, and free the nation permanently from dependence on crude oil.

BABAJIDE SOYODE

Engr. B.A. Soyode had first-hand experience in the development and the management of 2 of the 3 Nigeria’s refinery complexes, and the evolution of the third one