New Global Oil Market and the Prospects of Nigeria’s PIB

The evolving global energy market dynamics suggest an urgent need to take a sober look at the Nigerian oil and gas subsector in particular and the energy sector in general. This is essential given the importance of the sector to the Nigeria economy. Despite the declining contribution to the nation’s Gross Domestic Product (GDP) –currently at 13.42%, the extreme dependence of government finances and external trade balances on proceeds from the sector exposes the nation to significant risks from oil price and production shocks.

The dwindling performance of the sector has been attributed to the structural gaps in its regulatory, fiscal and business practices which have supported high inefficiencies, a costly business environment to operators, and unchecked environmental disasters to host communities without corresponding restitution or compensation; thus promoting insurgencies and massive fiscal revenue losses. Unfortunately, the Petroleum Industry Bill (PIB) which was developed five years ago and adjudged the most significant attempt to address these challenges through the reformation of the governance and business structure of the sector as well as resolution of fiscal issues has remained stalled in political brinkmanship.

In our opinion, considering the key risks facing the sector in the face of the evolving global oil and gas market, the continuous delay in the passage of the bill is costly to the economy. We argue that while diversification of the economy from oil to non-oil is the ultimate solution to risks posed by the oil market scenarios, this is only attainable in the medium to long term; a luxury that the country may be unable to afford at this time. Hence, the quick passage of the revised PIB, following a review and resolution of the grey areas that affect the sector’s competitiveness is the short term solution.

Dwindling Oil Performance
In the last fifteen quarters, contribution of the oil sector to national output has continued to decline
From 18.89% in the first quarter of 2009, the year after the PIB was first presented to the national Assembly, oil contribution to GDP had fallen to 13.42% by the third quarter of 2012. The sector’s contribution to GDP in 1999 was 35.3%. Although the sector’s output was expanding during the period, it did not keep pace with other sectors of the economy. Divestments and declining new investment levels are largely responsible for the stunted growth.

As existing and potential investors await the outcome or the reform process, the sector experienced divestments from domestics oil assets (especially on-shore assets) as well as a decline in new investments. The Nigerian National Petroleum Corporation (NNPC) reported that Nigeria loses over US$287m from Production Sharing Contracts (PSC) monthly due to the delay in the passage of the PIB. On the aggregate, the sector may be losing an estimated US$18 billion in annual investment due to this constraint as International Oil Companies (IOC) continue to divest from on-shore assets in favour of off-shore assets pending the outcomes of the PIB among other factors.

Another important contributor to the disincentives for investment in the sector, particularly onshore, is sustained losses to theft and vandalisation of operators’ assets. This is an addition to the security threat to doing business in the sector as a result of restiveness in the oil-producing areas. The Coordindinating Minister of the economy and Minister for Finance, Dr. Ngozi Okonjo-Iweala reported that the economy lost about 20% of its revenue to oil theft in the first quarter of 2012. This assertion was corroborated by the Chief Executive Officer of Shell Production and Development Company Plc (SPDC), Mr. Mutiu Summonu who started that the country may have lost over  US$5  billion between 2011 and the first quarter 2012 due to the  activities of oil thieves and vandals. He put the average daily loss to theft at about 400,000 barrels per day. The Minister of Petroleum Resources; Mrs. Diezani Allison-Madueke put this figure at US$7 billion. The CBN statistics indicate that in 2012, oil production fell short of the budget benchmark of 2.48mbpd by an average of 376,000bpd in the first three quarters of the year for the same reasons.

Global Oil Market
The risk of a glut in the global oil market; potentially detrimental to Nigeria.
The international oil market landscape is changing very fast and eroding the competitive value of Nigeria’s oil and gas. First, the number of countries discovering oil and gas reserves in their national boundaries is increasing; thus expanding the supply base of oil and gas products into the international market. Secondly the increasing exploration of shale gas via a technique called fracking is weakening the competitive advantage of crude oil and gas resources as global energy sources. Finally, improvement in refining technology is helping to eradicate the difference between the Nigeria light crude and the other types of crude oil; a characteristic that conferred on it the price premium it has commanded for many years.

Oil and Gas Everywhere
Countries in East Africa and West Africa including Ghana, Liberia, Sierra Leone, Kenya, Uganda and Tanzania have discovered large oil reserves and have started oil production. Vast natural gas resources have also been discovered in South Africa, Mozambique offshore, Namibia and Botswana. Additional Discovery in an offshore oilfield in Angola has been forecasted to make the country the largest oil producer in Africa, ahead of Nigeria. Furthermore, oil exploration in Madagascar, Seychelles, Ethiopia and Somalia is under way. Outside the African continent, Israel discovered natural gas reserves off its Mediterranean shores in late 2010 which triggered the discovery that the entire eastern Mediterranean is endowed with huge untapped oil and gas reserves.

West African Oil
Shale gas is displacing West African oil in the USA.
US Energy Information Agency (EIA) forecasts the US oil imports will decline to 6mbpd, roughly a third of what it uses, by 2014 as the country moves closer to oil independence by 2035. Shale gas production account for 46% of U.S. natural gas production. Based on the recent forecast by US EIA, analysts at Citigroup Global Markets predict that the US may stop importing West African light sweet crude into the US GULF Coast by the second quarter of 2013. Over the fifteen-month period to July 2012, US crude oil imports from Nigeria dropped to about 330,000bpd from over 1.1mbpd. Displacing West African Oil from the US  market will probably put downward pressure on price due to greater competition. It is believed that US$90 per barrel might be the new cap for oil prices rather than the floor in the short to medium term.

The decline in US imports of crude oil is due to the increased availability of shale gas, of which the US is estimated to have one of the biggest reserves globally. The development of shale gas has become a “game changer” for the US natural gas market with an estimated 862 trillion cubic feet in reserves. Europe and a number of Asian countries are also investing in shale gas. The above suggest that oil futures are likely to trade lower going forward and could drive spot price of oil along. This is likely to reduce investment in oil and gas globally as players begin to play safe in the face of expanding supply of substitutes.

PIB to the Rescue
The PIB to the rescue, especially at indigenising the oil sector.
The passage of the Petroleum Sector Bill (PIB) and the resulting reforms will represent a total overhaul of the sector landscape. It borders on a new vista of governance, institutional, corporate and competitive structure of the entire value chains of the oil sector-upstream, midstream and downstream. Experts have estimated that the implementation of the reforms will guarantee at least an additional N3 trillion (US$18 billion) in direct annual revenue to the government of the Federation.

This additional revenue would come from any sources?? What do you mean. In addition to increased revenue from higher royalties and taxes on exploration, especially from deep water wells, more revenue will also accrue to the government- operated National Oil Company, an operator in the sector. A complete integration of the oil sector to the national economy via the complete implementation of the Nigeria Oil and Gas Content Development Act, 2010 (Local Content Act) is also expected to boost economic activities; leading to increased tax revenue to the government in the long run.

Indigenous companies are expected to benefit extensively from the reform of the oil sector as the bill provides for such companies to be given first consideration in the award of oil blocks, oil field licenses and oil lifting licenses, and in all projects in the Nigeria oil and gas sector. Indigenous service companies in petroleum engineering and engineering support services, engineering designs, fabrication, manufacturing and installation, seismic data processing, drilling and exploration services, maintenance services, finance and insurance, health, safety and environment etc. will also also be direct beneficiaries of the Local Content Act. These provisions should ensure a steady growth in Nigerians´ participation in the sector as well as increase local capacity, industry knowledge and expertise in addition to a boost in employment creation. It has been estimated that over three million jobs could be delivered in the first five years of the implementation of the law.

Unattractive and Less Competitive Bill
The proposed fiscal policies in the revised bill are unattractive and less competitive to other country
The PIB is expected to enhance government revenues through better tax codes and restructure joint ventures between the Nigeria National Petroleum Company (NNPC) and the international oil companies (IOCs). However, the PIB has been criticized by sector players, especially the IOCs for vesting aggressive ownership and control of petroleum resources on the government which could scare away investments in excess of N8 trillion (US$50 billion) from Nigeria. Royal Dutch Shell Plc, a major player in the sector has indicated that it is highly unlikely that the company would invest in offshore and domestic gas projects on the terms included in the PIB.

The fiscal regime in the revised PIB increased the resource rent tax from30% to 80%, and royalty payments from 7% to 12.5% for big producers and the minimal tax allowances for investment incentives on gas. The resource rent tax and royalties of 80% under the PIB is slightly tougher than the world average although the cost recovery limits are sufficiently high. With more competitive fiscal regimes available, such as Brazil with a government take of 60-65%, or Ivory Coast with as low as 49% government take on deep water activities, opportunities for incremental investments are discouraged by the proposed tax regime.

In addition, public control in the new bill appears excessive and may expose the sector to heavy political manipulations and interference. The presidential power to grant licenses and leases without competitive process or any other process is an issue in this regard. In addition, there is already discord about the significant power of the Minister of Petroleum, including the power to determine rentals and royalties by regulation, board appointments, make regulations without public hearings and non-application of fiscal responsibility and public procurement acts for many agencies. In our opinion, these issues need to be reviewed and resolved before the bill is passed into law. Nigeria cannot afford to make the sector less competitive at a time when it faces a tougher market outlook ahead.

Fiscal Sustainability
The greatest risk to the economy would be through fiscal sustainability.
The domestic and international issues facing the oil and gas sector pose both risks and opportunities for the Nigerian economy. The greatest risk is the potential shock to fiscal sustainability if the global oil price slumps when Nigeria has not expanded the sector’s output. The oil assumptions- oil price and production- in the 2013 appropriation as well as those contained in the medium term expenditure framework for 2013-2015 may be overly optimistic considering the domestic production challenges and the evolving international oil market dynamics. Fiscal sustainability would be significantly threatened if the international oil price becomes volatile and or domestic production falls short. The potential to the national buffer would also reduce significantly. The risk may not be a distant possibility; hence we need to act quickly.

Diversification is the Solution
Diversification is the solution in the long term; increased domestic participation in oil and gas activities would protect the nation against the impending market glut.
While the long run hedge against the impending oil market glut is substantial diversification of the economy away from oil to non-oil, particularly government finances and external trade positions, it is a solution that is only achievable in the medium to long term. In the short term however, enacting a competitive, inward looking Petroleum Sector Act that factors in the evolving global oil scenario is the ideal solution.

While we note that the passage and implementation of the PIB will not eliminate the problem, it would expand investment in the sector while increasing indigenous companies’ participation. This is expected to result in domestication of a significant portion of revenue, including taxes to government on the oil and gas value chain. In this regard, we advocate for the conscious creation of a domestic market for crude oil as an extant action to the PIB to facilitate local trading in the commodity at different scales. It is also important to fully deregulate the refining subsector and allow a multi-level participation as long as the final end products meet the standards required by the government agency. This way, the existing illegal refineries in the country can be licensed to operate legally.