21 December 2013, Lagos – An announcement has been made by the government regarding the privatization of national refineries whose implementation is slated for 2014. No doubt, the announcement has received mixed reactions from the public, depending on relative perception of would-be ultimate winners and losers from this exercise. There are some citizens who believe that a clique of individuals is about to buy up national assets based on their selfish interest. Similar views were expressed by a section of the populace when telecommunication licenses were awarded, and when moribund power stations were privatized. However, when infrastructure and systems operate efficiently everybody wins. A McKinsey report (2003) reveals that privatization results in significant operational and financial improvements; access to finance; ownership stability; access to technical skills; and a shift in accountability from public sector to private sector.
The Nigerian experience with running state-owned enterprises and infrastructure facilities has been poor. For example, Eleme Petrochemicals was operated (as one of the NNPC subsidiaries) at low capacity utilization levels until Indorama bought the process plant, and it now operates at over 90% of installed capacity. The National Fertilizer Company (NAFCON) was run down and later sold. The new owners have revamped the plant and ramped up production. It is doubtful if the NLNG could have remained as efficient as it is today if it were operated solely by NNPC.
Quite frankly, few, if any, industry analysts will dispute the fact that our refineries have not been operating efficiently in the past 15-20 years. Consequently, the country has been importing massive volumes of lighter petroleum products (i.e. petrol, diesel, and kerosene) for nearly 20 years. There are several reasons why the operations of our ageing national refineries should be run by the private sector. The cost structure of our refineries is high owing to salaries, administrative costs, and overheads not being co-related to profitability, and so these refineries are financially unsustainable. Personnel structure is top-heavy, particularly at the managerial levels. The plant integrity is frequently compromised by equipment failures and irregular turn-around maintenance (TAM). The poor state of supply and distribution infrastructure (pipelines and pumps) has led to unreliable feedstock supply to the refineries. Likewise, irregular product evacuation results in frequent downtimes. The decision making process for funding is extremely slow and so urgent repair work cannot be carried out on ‘just-in-time’ basis. There is also a lack of maintenance and performance culture.
Perhaps, the worst nightmare confronting the refinery managers is the lack of control over their business because they operate a flawed business model. Refinery failures arise because the major causes of refinery shutdowns are out of the control of the managers. Another subsidiary of NNPC, the Pipelines and Products Marketing Company (PPMC) act as the single crude oil supplier, single products off-taker, and sole products seller. The refineries only get paid a processing fee based on volumes of products refined, and so are volume rather than value driven. The consequences of this aberrant business model are high transaction costs and cost control / profitability risks. Given this situation, it is obvious that the efficiency of our national refineries has ‘gone south’ and the decision to privatize these refineries is the correct call and that this exercise can be concluded in six months to one year ‘tops’.
Therefore, the aims of this privatization exercise will be to increase capacity utilization, optimize the yield for lighter products (i.e. petrol, diesel, and kerosene), and to achieve profitable operations. It is also noteworthy that privatization exercises have been a veritable source of government revenue, particularly governments facing financial pressures. To achieve these aims will entail rehabilitation and debottlenecking (i.e. expansion) of existing refineries, enhancing operational capabilities, and a radical change in the business model. Realistically, these can be better achieved under a private sector setting.
A McKinsey report (2012) identifies six models of partnerships that are equally applicable to privatization of Brownfield refineries (i.e. existing refineries) and the design of Greenfield (i.e. new refineries) refinery partnerships. First model: the National Oil Company (NOC) owns and operates the refineries. This is the current case with Nigerian refineries, whereby NNPC has 100% ownership of all the national refineries and operates them.
Second Model: Joint Ownership & Operatorship of the refinery between the NOC and an International Oil Company (IOC) or an Independent Oil Company. For example, the Melaka II refinery in Malaysia is jointly owned and operated by Petronas (45%) and ConocoPhilips (50%). The government retained ‘golden shares’ of 5%.
Third Model: Joint Ownership, but the IOC or independent acts as the operator. For example, SPRC refinery in Thailand is jointly owned by PTT (state-owned and the largest oil company in Thailand) and Chevron based on 36%: 64% split respectively. Chevron is the operator.
Fourth Model: Formation of a Joint Venture Refinery Company, whereby the NOC and IOC or Independent jointly form a separate Special Purpose Vehicle (SPV) that owns and operates the refinery. For example, SATORP refinery in Saudi Arabia is a joint venture company owned by Saudi Aramco (62.5%) and Total (37.5%) and is jointly operated. SASREF of Saudi Arabia also operates a 50/50 JV with Shell.
Fifth Model: IOC or Independent obtains a refinery license, builds, owns and operates its refinery. For example, CHEVREF in South Africa is 100% owned and operated by Chevron.
Sixth Model: Service Contracts, whereby the NOC has 100% ownership of the refinery but appoints a service contractor that operates and maintains the refinery under a long-term contract. For example, Dong Quat refinery in Vietnam is owned 100% by PetroVietnam but the refinery is operated and maintained by SK Energy (Korea’s largest refinery) under a 5-year contract, renewable.
Most of these models would suggest a role for either an IOC or Independent in the privatization exercise. However, there are pre-conditions attached to attracting the requisite IOC or Independent. A prospective foreign ‘core’ investor will consider the attractiveness of refinery economics, funding security for partnerships, country perception, access to markets (domestic / foreign), and autonomy to balance domestic sales / export marketing of products. In the Nigerian context, price regulations and subsidies exist but the forecast for domestic and West African demand growth is significant. Nigeria has a relatively stable business environment, but licensing regulations incur significant upfront costs. Government intends to achieve self-sufficiency in petroleum products supply, but it is unknown whether investors’ choice on end-market (i.e. domestic versus export sales) would be subject to government intervention. The balance would likely tilt towards government intervention, if new refineries are not constructed and existing ones not expanded. From an investors’ perspective, perhaps the most depressing factor is that existing refineries are operating below par in terms of capacity utilization and availability, have high personnel levels, and with aged infrastructure.
All relevant factors considered, the preferred model of privatization for Nigerian refineries will be a kind of joint venture between NNPC and a ‘core’ foreign investor (NOC or Independent) and other private investors. NNPC should have the minority shareholding (between 40-49%). The core investor should have the role of operator, and should have considerable financial and technical capability and strong operational experience in refinery management. Other private investors will include other refiners, major petroleum products marketers, independent petroleum products marketers, depot owners, and the investing public.
From the get-go, it should be expected that refinery workers and associated staff unions would be restive as soon as this announcement was made. The refinery labor force is an important stakeholder in the business of crude oil refining. In technical terms, refinery technical workers are treated as part of the fixed costs of refinery operations because it takes a considerable length of time, and expenditure to train a competent technical refinery staff. They are part and parcel of refinery operations, difficult to replace when retrenched, and almost impossible to operate a refinery when they go on strike. Therefore, it is imperative to design and execute a model of privatization that secures the buy-in of top refinery management (the change agents) and which earns the acceptance of refinery workers as well. Successful negotiations with the industry labor unions will entail provision of safeguards for engineers and technician, and also with due regard to staff disengagement matters (e.g. staff pensions, gratuities, and other incentives). However, technical refinery staff will only be temporarily retrenched should the government decide to embark on the construction of major refineries in partnership with IOCs or Independents.
McKinsey report (2012) emphasized that even if Nigeria “pulls out all the stops” on existing refineries and achieves an unlikely capacity utilization of 90%, the country will not be self-sufficient in petroleum products availability. The table below clarifies this position. Therefore, if existing refineries are privatized and rehabilitated, the demand for products will still outstrip the supply if new refineries are not constructed. This has critical implications for continued products importation, fuel pricing, and overall competitiveness of the refining business and marketing of products. The market structure for refining will shift from a monopoly to oligopoly (competition among few players) and anti-competitive forces such as price-fixing and collusive behaviors will likely manifest. Prices of products may be higher than otherwise could have been, if more refineries were brought on stream.
The table below is based on very optimistic assumptions. For examples, current domestic supply for existing refineries was estimated at 32% capacity utilization; anticipated product supply (post-refineries rehab) was put at 90% capacity utilization; and the surplus product supply by 2016 was also based on achievement of an average capacity utilization of 90% for all refineries. Nevertheless, the table reveals that Nigeria needs more refineries (small, medium and large). Small refineries (50,000 bpd or less) are basically private refineries. Medium refineries (50,000 – 150,000 bpd) could be privately-owned or of the public-private partnership (PPP) type. Large refineries (> 150,000 bpd) could be privately-owned but most likely of the PPP type, requiring government involvement.
Refining Capacity Gap in Nigeria 2010 (Billion Litres per Year)
|Total Demand||Current Domestic
|Supply from 3 New
Refineries (200k bpd)
Supply by 2016
(9.5 million litres/yr)
(5.51 million litres/ yr)
(25.29 million litres/yr)
(40.33 million litres/yr
Source: NNPC, “Executive Brief on the NNPC Greenfield Refineries and Hydrocarbon Park Project”.
In developing countries, with fragile regulatory structures (i.e. high risk of regulatory capture), low per capita income and high corruption index, private ownership of large refineries has huge national security implications and should be discouraged by the government. Rather, government should be proactive in the construction of large refineries in partnership with IOCs, and at later stages off-load bulk of its shareholding to indigenous private sector operators and the investing public. Foreign investors are also more likely to invest in larger refineries, in partnership with government.
However, there is a role for smaller private refinery projects (particularly those that operate the modular model of refining which is neither labor nor capital intensive). The Dr Kalu Idika Kalu led National Refineries Special Task Force evaluated the potentials of applicants for, and licensees of, private refineries in Nigeria. There were 35 companies under these categories. Four of these (Total Support Energy, Orient Petroleum, Antonio Oil, and NSP refineries) were considered to have relatively higher potential for successful project completion. The reasons for the failure of majority of these companies to demonstrate seriousness in their projects were attributed to funding challenges, inability to obtain crude supply agreement, and inadequate operational and technical capabilities. Therefore, in addition to spear-heading the privatization of existing refineries and the construction of new large refineries, government should design incentives to encourage the four identified private refinery projects as well as encourage even more private refinery proposals.
Dr Chijioke Nwaozuzu, a petroleum expert wrote in from Abuja. Email: email@example.com. Tel: 070 6874 3617 (SMS only).