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Long to-do list in Nigeria

NNPC has expansion plans for its lucrative upstream, and hopes to stem losses in the downstream, as the company awaits major restructuring

The Nigerian National Petroleum Company (NNPC) is clearly focused on reducing the country's vulnerability to supply disruptions in the Niger Delta and increasing its crude oil reserve base. Over the past year, despite problems with the terrorist group, Boko Haram, NNPC has invested significantly in exploration in the Chad basin. During the most recent seismic expedition there, however, the exploration team and their security detail were attacked by Boko Haram fighters.

Following that incident, NNPC has shifted its exploration efforts to five other Niger Delta basins: Anambra, Benue Trough, Benin, Sokoto and Bida. The likelihood of success in those basins is lower than that in the Chad basin, where Shell made the Kolmani River discovery, although it turned out to be uncommercial. The Bida Basin looks promising following an announcement of the existence of possible crude oil reserves by researchers at the Ibrahim Badamosi Babangide University Research Centre, using new technology.

Exploration in the Benue Trough, where Total, Chevron and Shell had previously explored with no success, is driven by the belief that those firms didn't drill deep enough. This has obvious cost implications. Thus NNPC is likely to concentrate on gathering and processing seismic data.

NNPC's focus on further exploration is, however, at odds with the global trend to view oil as a fading energy source, to be replaced with natural gas and renewables. Although most of the reduction in oil demand is expected from 2030 onwards, the rapid development in battery technology could make it happen sooner. This could leave NNPC and its strong focus on exploration behind the curve, as most of its oil discoveries would be coming into production and peaking just as oil was fading away. Against this background, the prospect of investing in onshore exploration in unproven basins becomes less attractive, forcing NNPC to finance exploration efforts.

NNPC's refining business faces a mixed future. The three major refineries—Port Harcourt 2, Kaduna and Warri—need major overhauls and repairs. Despite plans to ramp up refinery capacity utilisation to over 60% in 2017, the facilities have performed at a declining level since January when they averaged 37%. More importantly, there's been a change in refineries' tolling methods. In the past they simply charged the Pipelines and Products Marketing Company for processing its crude oil into products. Now they purchase crude oil at export parity prices.

Thus, the refineries require financing not only for the crude oil they purchase, but also for repairs and maintenance to ensure they maximise the value of the oil they process. Although the original construction firms, Chiyoda Corporation of Japan and Snamprogetti of Italy, have agreed to undertake the necessary repairs and maintenance, NNPC has had difficulty raising the funds for the work.

Products oversupply

Fixing the refineries would boost the country's hopes of cutting oil imports and conserving dollars. However, the existing facilities will have to compete with the Dangote 0.65m-barrels-a-day refinery being built in the coastal Lekki Free Trade Zone in Lagos State. The Dangote refinery is expected to come onstream in late 2019; but it's likely to begin test-trading via its jetty to establish a marketing structure before then. Considering the demand for fuel in Nigeria, estimated at 320,000 b/d and shrinking, the market is bound to be oversupplied. This could create opportunities for exports to the West Africa region, but these would face competition from European and US refineries.

Further downstream, the outlook for NNPC's retail arm is also mixed. At present, NNPC imports almost all of the petrol and kerosene required by the country via the Direct Supply, Direct Purchase (DSDP) programme. This is a reverse swap scheme where traders are contracted to bring in products first before receiving payment in commensurate levels of crude oil barrels. The programme has been successful, enabling NNPC to end the frequent fuel shortages, while also building up almost 70 days of petrol consumption in storage.

The problem is that NNPC continues to bear the full cost of selling the petrol at a fixed ex-depot price of N130 ($0.36) per litre, despite the landing costs having risen above this level. This has resulted in an under-recovery from the sale of the products amounting to over N100bn in the seven months to August 2017. Oil prices have been on the rise since mid-June and have recently climbed to over $60 a barrel. With no commensurate appreciation in the naira, NNPC has had to shoulder a higher subsidy bill to ensure pump prices remain unchanged. So while NNPC's upstream revenues are benefiting from the increase in oil prices, subsidies in the downstream business are likely to continue to drag profits. Furthermore, vandalism of fuel pipelines is back on the rise.

The government could thus be pushed into considering a full deregulation of the downstream market. With the success of the fully deregulated diesel market, the higher subsidy bill could push the government to make the necessary adjustment to enable NNPC to recover its full costs from products sales.

However, there are major pricing risks from full deregulation. Without efficient pipelines to deliver fuel to the furthest parts of the north, fuel prices in those regions could rise significantly. In a deregulated market NNPC is, however, the best party to prevent this from happening by ensuring its network of depots and pipelines remain functional and efficient, reducing the distribution costs. Other petroleum marketers using the distribution network would pay the NNPC sufficient transit fees to cover the cost of maintaining the pipelines. Selling at a market-based price would also ensure the retail outlets are profitable and reduce the drag on upstream profits.

Finance question marks

NNPC has the dubious distinction of being the country's richest loss-making government agency—but one that's facing controversial restructuring. The Petroleum Industry Governance Bill (PIGB), currently before the National Assembly, aims to split the company into two separate entities, one a commercial operator, the other an industry regulator. At present, NNPC is both, and it also collects revenue for the federal government from oil companies operating in the country. With oil being the mainstay of the Nigerian economy and over 90% of exports, NNPC over the years has become rich.

However, until the current Minister of State for Petroleum, Emmanuel Ibe Kachikwu, was made NNPC's Group Managing Director, very little was known about its internal workings. This made its loss-making streak over the years all the more intriguing. Corruption allegations in respect to fuel imports or crude oil lifting have also helped to colour the public impression of the corporation. However, since some light has been cast on the corporation's finances, via its monthly business performance reports, it's obvious that there are critical challenges that need to be faced. Some aren't likely to be addressed by merely splitting the corporation into two. They require an examination of its finances and business operations in full.

While NNPC's upstream revenues are benefiting from increased oil prices, subsidies in the downstream will continue to drag profits

NNPC's current business performance records are reported broadly according to the divisions within the corporation: upstream, midstream and downstream. The upstream businesses are extremely profitable, while the rest of the businesses tend to constitute a drag on performance. The area operations covering the corporate headquarters and its ventures is the largest loss-making segment of the corporation, losing billions of naira every year. But financial reporting doesn't provide an adequate explanation of the nature of the businesses incurring these losses.

Furthermore, NNPC has several subsidiaries, such as Duke Oil Company, Nikorma Transport, Nidas Marine, and Hyson Nigeria, which aren't covered in the financial data. In some cases, it might be argued, this is because of the absence of any major business activity. But in others, such as the Duke Oil Company, this isn't the case. NNPC intends to trade more of its own crude oil from 2017, mostly through Duke Oil. Nidas Marine played a key role in supplying crude oil to the refineries when the Forcados Pipeline was closed. These companies are either subsumed within others with no explanation, or altogether left out of the books. NNPC also reports on its payments into the government's Federation account, in two main categories: crude sold as exports; and crude destined for refineries. Most of the crude oil for the refineries ends up being exchanged for products via the DSDP programme, or exported as crude oil directly to purchase products. The financial records don't provide a breakdown of the payments from the various companies or which subsidiaries of NNPC receive the money.

The payments into the Federation account are meant to reflect all funds earned by the country through its joint ventures administered by NNPC and other energy sector businesses in which the government has an interest, such as Nigeria Liquefied Natural Gas (NLNG). Joint venture companies, where the government owns over 55%, pay royalties and recover a portion of their costs spent on field development before paying their taxes and handing over to NNPC its share of profit oil.

The government only owns about 49% of NLNG, thus it receives taxes and dividends from the company. Taxes are paid to the Federal Inland Revenue Service, while NNPC collects the dividends, royalties and profit oil on behalf of the federal government. Several independent audits into the NNPC's records of payment into the Federation account have found gaps in the payments. But, after cursory investigation, these gaps are often left unexplained.

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