Power sector conundrum: Optimizing gas supply to power sector
From existing statistics, Nigeria arguably has proven gas reserves of 182 trillion cubic feet (Tcf), according to the EIA, making the country with Africa’s largest gas reserves and the world’s 9th largest gas reserves. Nigeria’s gas reserves are estimated to last for over 100 years at current exploitation levels. Majority of the natural gas reserves in Nigeria are located both offshore and onshore Niger Delta region. Nigeria’s gas reserves are far larger than its crude oil reserves.
Statistics by the Nigerian Gas Company (NGC) show that only about 53 percent of Nigeria’s gas production is monetized. Total gas production is about 7.9billion standard cubic feet per day (bscf/d). Of this amount, 1.05 Bscf/d representing 12.7 percent of total gas production is consumed domestically (power sector and gas based industries). 15 percent of gas production (1.2bscf/d) is flared daily, 31.6 percent of gas production (2.5bscf/d) is re-injected or utilized for normal operational usage in oil production while 40.5 percent (3.2bscf/d) is exported as LNG.
Currently, Nigeria flares the second largest amount of natural gas in the world, following Russia. Using data from the Annual Statistical Bulletin by the NNPC, Penspen Limited, a global engineering and energy consultancy based in London, estimates that Nigeria has flared over 30tcf of gas since 1964 (since records began) till 2012. Using a price of $2 per thousand cubic feet (Mscf) of natural gas, this equates to over $60billion flared!
Nigerian Gas Master Plan (GMP)
An objective of the Nigerian Gas Master Plan is to profitably harness Nigeria’s vast gas reserves and reduce the gas flares by monetizing it, hence create more wealth and diversify the economy. The Nigerian government plans to achieve this by strategically deploying policies aimed at promoting gas-to-power generation, gas-based industrialization, cooking gas (LPG) for domestic usage and high value exports in the form of LNG/GTL to international markets. The Government also plans to monetize natural gas by increasing supplies to neighbouring West African markets through the regional gas pipelines.
Some of the key strategic policies articulated in the GMP, aimed at channeling the flared gas into gas-to-power projects for rapid utilization and monetization and already implemented by government include: Domestic Supply Obligation (DSO) regulation put in place to jumpstart gas availability; Scalable Gas Infrastructure Blueprint for backbone gas pipeline and processing infrastructure aimed at enabling flexibility in gas supply delivery; Commercial Framework Reforms in pricing and revenue securitization to enable sustainable investment in gas supply. The reforms are aimed at revisiting domestic gas pricing to ensure it tends towards export gas parity.
Domestic demand for natural gas
Domestic demand for natural gas has been on a surge over the last couple of years. The rise in demand can be attributed to recent developments in the power sector, increase in feedstock to gas based industries, increase in domestic use of cooking gas and natural gas supplies to neighboring West African countries.
The Nigeria power sector is mostly powered by natural gas thus, to a large extent therefore, the total volume of gas available for power generation determines the maximum power generation expectations. Despite having abundant natural gas reserves, Nigeria has one of the lowest net electricity generation per capita rates in the world, with total available power generation capacity far short of demand. In providing a lasting solution to the country’s electricity generation woes, the Nigerian government plans to increase power generation from fossil fuel sources (natural gas and coal) to more than 20,000 MW by 2020. This may not be a realistic target though.
Although there have been significant investments in power generation through the NIPPs, lack of gas supply has seen most of the completed and commissioned NIPP power generation plants operate far below their potentials. Same situation also affects the recently privatized PHCN successor thermal generation companies namely Egbin, Geregu, Sapele and Ughelli. Over 2,500 MW is estimated to be stranded generation capacity as a result of inadequate gas supply to power generation plants, particularly on the western axis. Interestingly, in the Eastern axis, there is stranded gas as a result of a number of power plants that are yet to be completed and commissioned, and the non-completion of the 127km Obiafu/Obrikom – Oben (OB/OB) gas pipeline to move stranded gas in the eastern axis to the western axis.
Although Nigeria’s gas production has increased steadily over the years, the country’s production still ranks low amongst other gas producing nations of the world.
Gas Supply Challenges to the Power Sector
Supply of gas to the power sector is currently hindered by a number of factors and challenges, which we consider as medium term in nature. These challenges are summarized are: Incessant vandalism of gas pipelines; Inadequate gas infrastructure – gas pipelines and processing facilities; Uneconomic and non-bankable gas-to-power pricing framework; Reluctance of upstream Oil & Gas Companies to invest in gas production for the domestic market (exploration and development of dedicated gas reserves for the domestic market); Limited commercial funding of upstream gas development and gas infrastructure projects; Inability of the NNPC/NPDC to make cash calls for JV upstream work programmes, including natural gas development; Poor project management and delivery – contractor performance, community issues all continue to affect performance and delivery of gas projects; Outstanding power sector debt to gas suppliers remain a huge disincentive to investment in the gas sector; Host community issues leading to community interruptions during projects; Stalled passage of the PIB thus no clear fiscal policies on upstream and midstream gas development; Lack of activated gas contracts between Gas Suppliers and Gencos – Gas Supply Agreements, Gas Transportation Agreement, Gas Sale and Purchase Agreements.
Optimizing gas supply to the power sector
While gas supply to power generation plants is indeed important and is presently a challenge to the power sector, it is possibly the easiest weak link in the power sector value chain to resolve.
Four factors affect natural gas development projects, including gas–to–power projects; proven and producible gas reserves; gas transportation network; commercial gas pricing framework; credit worthy off-taker under a long term gas supply agreement.
A lot of attention is being paid to building gas transportation infrastructure without also addressing the issues of producible gas reserves (which entails natural gas exploration, development and production activities); establishment of bankable gas pricing framework that supports upstream gas E&P investment decisions and ensuring the credit worthiness of Gencos to enable them become credit worthy gas off-takers. The West African Gas Pipeline (WAGP) serves as an expensive reminder of the folly in this thinking.
A number of strategies aligned to these four factors are proposed to optimize gas supply to the power sector and will address the challenges to the sector.
Government policies towards gas development, production for power generation
Natural gas exploration, development, production, transportation, marketing and sale activities are the exclusive preserve of the Ministry of Petroleum and not the Nigerian Electricity Regulatory Commission (NERC), nor the Ministry of Power. The suggestion by the Chairman of NERC to make gas development the purview of NERC may have been borne out of NERC’s frustrations with the situation of gas supply to the power sector rather than practical reality. Due to the stalled passage of the Petroleum Industry Bill (PIB), government’s policies, particularly fiscal policies, towards gas development is presently unclear and uncertain. In the absence of the PIB, it is important that the present government under President Buhari and the leadership of the National Assembly urgently articulate a clear gas development policy for gas-to-power projects that will spur power generation and drive economic growth. Such gas development policy should ideally provide incentives (fiscal or otherwise) for gas-to-power developments that come on stream in the short to medium term (or within a defined period). The fall in oil prices is a blessing in disguise and the opportunity to develop a domestic gas industry because of the drop in oil prices should not be lost.
Establishment of a commercially bankable gas-to-power pricing framework
Under the last administration, natural gas prices for power generation were increased from US$1/Mscf to $2.50/Mscf and gas transportation pricing from US$0.30 to US$0.80. The intention behind the increase in gas prices was to bring gas-to-power pricing to export parity per natural gas liquefaction for LNG exports. However, there is a fundamental flaw in this thinking as evident in the reluctance of major gas producers to invest in new gas-to-power developments or meet their domestic gas obligations at this price. The new pricing is still lower than international spot prices for natural gas, thus provides no incentive for gas producers to consider the domestic market to produce gas into. The chart below shows spot prices for natural gas. At US$3/MMBtu using Henry Hub prices, it is still more profitable to export gas as LNG.
With regards to the export parity price benchmark, it is believed that the price of US$2.30/Mscf for natural gas sold to the NLNG is artificial, and has been deliberately kept low, as there may be certain benefits to the gas producers who produce gas for export to the NLNG. Such benefits possibly include lower hydrocarbon taxes, corporate income taxes and royalties on their gas production as well as offsetting the cost of gas development against their oil production. Also, losses from their natural gas production activities at this set price are offset with super normal profits from the marketing and sale of LNG. Given that the costs for E&P activities in the Niger Delta region are the most expensive in the world (outside of ultra deep water environments), it is absolutely not possible for natural gas, specifically non associated gas (NAG), to be produced at US$2.30/Mscf for the domestic market and it would be unrealistic to maintain an artificial export price as a benchmark for pricing gas production for domestic utilization.
It is recommended that the existing gas-to-power pricing framework be reviewed to make gas-to-power pricing attractive to gas producers. Gas-to-power prices should be benchmarked against international markets, typically Henry Hub (which is the price that global LNG exports to America and Europe is benchmarked), with an additional premium to incentivize gas producers to deliver natural gas for power generation within an agreed timeframe. More importantly, the gas-to-power pricing framework should apply to new gas development projects, particularly the development of Non-Associated Gas (NAG) reserves to encourage such developments to come on stream at the shortest possible time or within a defined period that the framework pricing will apply.
NERC, in trying to factor the price of natural gas in the electricity tariff model, seeks for an open book methodology to determine the price of gas at the wellhead, which would be inputted into the tariff. This approach by NERC is counter-productive, as it is adversarial and not realistic. Gas prices are benchmarked against international benchmarks, not local wellhead costs.
Activation of Contracts and Credit Worthiness of the Power Sector to off-take Gas
The first step to optimizing gas supply to the power sector is to activate and make effective, necessary contracts in the power sector, particularly gas sale and purchase contracts between Gencos and gas producers and gas transporters. Gas producers (IOCs and indigenous producers) and gas transporters require commercially bankable gas agreements with credible Genco off-takers. Such gas agreements typically are backed by credit worthy payment instruments and mechanisms (such as partial risk guarantees (PRGs) L/Cs, Bank Guarantees, etc) in the event of payment default on the part of the off-taker. The recently commissioned gas processing facility and gas pipeline built by Seven Energy in Akwa Ibom that will supply natural gas to the 564 MW Calabar NIPP is an example of this structure. However, international payment support instruments are very expensive to procure and add to the development costs for gas suppliers and IPPs.
Unfortunately, the power sector has proven not to be a credible off-taker for natural gas. The existing and lingering gas debts and continuing build up of additional gas debts in the power sector after the declaration of the Transitional Electricity Market (TEM) in February 2015 is a strong disincentive for gas producers to continue to supply natural gas to Gencos and make further capital investments in gas-to-power developments.
To this extent, it is important that the Federal Government ensure that the power sector is made credible in paying its bills to gas suppliers and transporters. The power sector intervention and stabilization facility by the CBN helps the power sector in this regard, as part of the CBN facility is to settle outstanding debts owed to gas suppliers. But beyond the CBN Facility, ingenious payment support mechanisms, such as developing a local partial risk guarantee (PRG)instrument(or similar type local payment support mechanism) to mitigate against non-payment for gas sold to the power sector is suggested to address the credit worthiness and bankability of the power sector. Such local payment support instrument that supports the power sector’s obligations to pay its bills to gas suppliers, makes Gencos and IPPs credit worthy off-takers to enter into commercial GSAs. The Azura IPP project in Edo State is a great example of this model, where a private gas company is investing millions of dollars in upstream gas production and midstream gas transportation infrastructure to supply natural gas to the Azura IPP, on the back of a commercially bankable GSA, which is underpinned by a Power Purchase Agreement (PPA), supported by a World Bank payment support instrument. In developing a local payment support instrument/mechanism for gas-to-power, the CBN can stand in the place of the World Bank in issuing such payment support instrument.
JV cash calls for gas developments
The prevailing low oil prices have seen very significant cost cutting in the oil and gas industry, particularly in the area of new investments in JV upstream gas development. Upstream projects have seen development budgets slashed by as much as 70% and in some cases, deferred to the future. It doesn’t seem likely that the National Petroleum Investment Management Services (NAPIMS) may have exempted new upstream gas development projects critical to the future supply of natural gas to the power sector, from being affected by the cost cutting and deferments. The effects of the cost cutting, budget reductions and project deferments, will become evident within the next two years as domestic demand for gas rises beyond 1.2bcf/day.
However, the Nigerian Gas Company (NGC) has been innovative in sourcing for financing through its collaboration with 3rd Party Investors to develop new gas projects aimed at addressing the gap in the gas availability, incentivizing NAG development and securing long-term gas supply for power generation.
Completion of key gas infrastructure
Completion of the127km OB/OBpipeline and the 342km Escravos Lagos Pipeline System (ELPS II) will increase gas supply to the power sector.These two projects have been in the pipeline (pun intended) for years! Completion of these two projects will cost $1.35billion and should be given critical attention by the new leadership of the NNPC.
Reduction of pipeline vandalism
Lastly, stopping and/or reducing pipeline vandalism will make gas supply to the power sector more stable. One method is to increase surveillance of the pipelines. Concessioning of the pipelines operations should also be considered. There have been cases where pipeline vandals are in cahoots with the contractors who are contracted to repair the vandalized pipelines. This criminality must be put to an end by government making an example of pipeline vandals and their sponsors as economic saboteurs.
Activated and effective gas sale and transportation contracts, underpinned by a commercially bankable gas-to-power pricing framework, and firm assurances of payment for any gas molecule delivered to the power sector, are the primary ingredients for enabling financing and capital investments for gas-to-power projects. In the absence of these key ingredients, financing for gas-to-power projects will struggle to reach financial close, further worsening current and future supply of natural gas to the power sector.
Wesley Odion Omonfoman is the CEO of New Hampshire Capital Limited, an energy consulting firm based in Lagos (orionomon@yahoo.com)
WESLEY ODION OMONFOMAN