Nigerian Oil: The Further From The Mainland, The Safer For The Investor

Ambivalence is one of the first words that comes to mind when thinking about the state of Nigeria's oil sector. Endowed with a truly tremendous resource base, it seems that Nigeria's deficiencies do not grow smaller with time and only become cluttered with even more complex dilemmas. Take, for instance, Nigeria's elections this year which have propelled a relatively pro-market Petroleum Minister Timipre Sylva, eager to increase foreign direct investments into the Nigerian energy segment by decreasing the state's participation there. Upon the face of it, seems a very welcome development, yet given what happens simultaneously with the Energy Ministry's trust-building utterances, one cannot help but notice that the whole government sounds rather out of tune.

Let's start with the one development which is undoubtedly positive - Petroleum Minister Timipre Sylva announcing this week that he would seek to reduce the government's stake in joint ventures with oil majors from the current 55-60% to a more reasonable 40%. Sylva sees this step as one of the preconditions to kickstart new output and bring the Nigerian total output volume to 3mbpd, a long-coveted aim given the African nation's dependence on these JVs - some 90% of the aggregate national production originates there. Concurrently, however, another branch of the Nigerian authorities is intent on reaching a different kind of deal.

The same day that Minister Sylva detailed his future plan, Nigeria's attorney general stated that Nigeria is claiming "colossal sums" from international majors present in the country. This announcement was predated by a prolonged legal battle between the federal government and oil-producing states, the latter suing the government for not acting out the Deep Offshore Inland Basin Production Sharing Contract Act (DOIBPSCA). Section 16 of the above act requires the Federal Government to review its share in existing PSCs whenever the price of crude oil surpasses 20 per barrel. It should be noted separately that the Bill has been up to now linked to 1993 real terms - Brent averaged $17.1 per barrel that year, hence the price levels of the day are completely irrelevant in 2019.

This new initiative creates a whole plethora of problems for everyone, government and oil producers alike. First of all, the Nigerian government failed to comply with its own legislation and it is by no means the majors' fault. Second, despite the backing of the Supreme Court, advocates of raising the government's PSC intake would find it hard to retroactively revisit the terms of cooperation. Nevertheless, Nigeria's attorney general Abubakar Malami wants to recover "what is due" - according to local media reports ExxonMobil, Shell, ENI, Total, Chevron and Equinor were each asked to pay the federal government $2.5-5 billion to settle the dispute out of court, something which all of them refused to do.

The fact that on the same day two top-ranking Nigerian officials put forward two completely contradictory stances is certainly a bad omen. One need not dig deep to find the root cause of such a phenomenon - Nigeria did not once reach the pro rata budget level of oil revenues this year (and last year, too, for that matter). Even though this year's budget was only signed off in June 2019 by President Buhari, it presupposes a rather unrealistic average monthly crude output of 2.3mbpd which was not once reached since late 2014. As crude oil still accounts for roughly 60% of government revenues in Nigeria and non-oil revenues failing to impress lately, the Buhari Administration is seeking ways to boost government coffers.

The pressing need for more liquidity is further deteriorated by one of the most astounding court cases of 2019, the "P&ID case". P&ID was contracted in 2010 by the Nigerian government to build a gas refining facility in Adiabo, Cross River State to which Nigeria would have had to send "wet gas" to be refined into "lean gas" applicable for power stations. Fast-forward into 2019, nothing constructed, P&ID claims that it failed to build the processing plant because the Nigerian authorities did not build the proposed pipeline to the site. The London arbitration on the issue sided with the claimant, ruling that Nigeria's reneging on its obligations resulted in a $6.6 billion loss to P&ID. Nigeria refused to pay so interest payments started to kick in, pushing the overall sum of damages to $8.9 billion. Needless to say, losing 20% of the nation's foreign reserves on just one horrendously botched contract is an unsavory prospect.

Against the chaotic background of the above, it should not come as a surprise that oil theft remains one of the most burning issues of Nigeria. According to governmental statistics, some 22.6 Mbbls (around 120kbpd) of oil were stolen from pipelines across the country at a total value of $1.3 billion. Sudden force majeures are by no means an oddity in Nigeria - another one was declared this week on the Bonny Light export pipeline - however the supply disruptions do not merely end there. The smuggling of gasoline to neighboring countries, especially those with porous borders such as Benin, is widespread and despite the government's best intentions would be very hard to stop given the current shaky price environment.

Tangible improvements could be reached in the downstream sector where Nigeria has sufficient assets (three refineries in Warri, Port Harcourt and Kaduna) yet which are mired in a similar quagmire. Despite wielding a total refining capacity of 445kbpd, the 3 refineries run at a mere 2 percent of their capacity and Nigeria is primarily supplied with products thanks to its DSDP crude-for-products swap programme. The Nigerian government claims it intends to bring back Nigerian refining to 90 percent of nominal capacity by the end of 2019, yet international investors are loathe to invest in downstream refurbishing unless stringent guarantees are fixed that insulate them from red tape, smuggling and corruption.

Italian major ENI (which has unsurprisingly a very robust position in Nigeria's DSDP swaps) is already engaged in the rehabilitation of the 210kbpd Port Harcourt Refinery yet unless the federal government guarantees that there will be no further attacks on the pipeline system around the refinery and that regular power outages would not jeopardize its performance, ENI's expertise applied to the best of both sides' intensions would be meaningless. Thus, Nigeria's brightest downstream prospect is the 650kbpd Dangote Refinery, a private project that has been remarkably for such a grand-scale project in Nigeria constantly within schedule. In an ideal world this might also prove that the less government involvement in Nigerian oil affairs, the better off everyone would be.

Perhaps the worst realization for those with the Nigerian cause at heart is that all of this takes place against the background of remarkably favorable external conditions. The drone attacks on Saudi oil infrastructure have palpably heated up market interest in Nigerian grades, which despite an adverse Dated Brent structure (backwardation did not narrow even though crude prices stabilized around $63-64 per barrel) and genuinely high freight costs. Moreover, with IMO 2020 lurking around the corner Nigeria, with a crude slate that is overwhelmingly low in Sulphur, is ideally positioned for this change in regulation. Yet all the positive trends notwithstanding, the only part of Nigeria's oil sector that sees some development going forward is offshore - the further from the mainland the safer for the investor.