Incentivizing & energizing the construction of greenfield refineries in Nigeria

Dr. Chijioke Nwaozuzu04 February 2014, Sweetcrude, Port Harcourt – Nigeria has been particularly dependent upon imports for light products (petrol, diesel and dual- purpose kerosene / aviation kerosene), and long on dark products (fuel oils, etc) for nearly two decades. An estimated $12-15 billion per annum is expended on importing light petroleum products at present. Meanwhile, it would cost about $2 billion to construct 100,000 barrels per day (b/d) refinery plant. It is also estimated that there is a 650,000 b/d refining gap over the next ten years. The current name-plate capacity of national refineries is 445,000 b/d, but capacity utilization is below 30% and should increase after the turn-around maintenance is completed.

Nigeria requires at least a million b/d refining capacity to meet current and projected petroleum products demand. Increasing existing refinery utilization to even 100% would not meet this demand. For a country with a population of nearly 170 million people, this situation is quite dire. How do you drive industrialization and provide a boost to economic development when capital that should be channeled towards developing infrastructure for refining, production of petrochemicals, power transmission, transport systems, agriculture, etc are instead diverted to importation of refined petroleum products?

In most oil producing countries, government enters into partnerships with the oil majors or large independent oil companies to construct large-scale refineries. In the case of Nigeria, we chose to go it alone (i.e. NNPC monopoly of refineries) and have made a huge mess of it. But, it is not too late to make amends. We can privatize existing refineries in such a way that one of the oil majors would be the operator, and with significant shareholding. We can also encourage a joint venture between the government and one or some of the oil majors in constructing new mega-refineries and petrochemical complexes. There is also a role for small-scale private refiners, because it is government policy to encourage indigenous participation in all aspects of the oil and gas value chain in Nigeria. Another ‘royal fuck-up’ would be to allow private individuals (domestic or foreign) to construct mega-refineries. We can ill-afford private individuals threatening our national security or determining political outcomes to the latest generation with the colossal cash flows that attends such business. The present circle of petrol importers can even now hold up economic activities in this country, let alone when you allow some of them to own 200,000 – 400,000 b/d private refining capacity (i.e. a mega-refinery). There are anti-trust issues to be weighed and considered here. The American government was not stupid when it broke up the Rockefeller and Bill Gates monopoly, and yet America is the world’s most advanced free market economy. There is no OPEC Member State that has adopted this model. Not even the ‘all- mighty’ Gaddafi of Libya owned a private mega- refinery in Libya, Saddam Hussein did not own a mega-refinery in Iraq, nor were the Arab oil Sheiks allowed to own private mega-refineries in Iran, Saudi Arabia, Egypt, United Arab Emirates, etc. In all these countries, the model adopted were a partnership between the government and one or some of the international oil majors with the latter being the operator. Let’s keep it that way!

Nigeria’s value proposition for investors is import parity pricing, 60% crude oil availability, ample regional demand, a deficit local product market, and demand barrel alignment. However, investors decision not to invest in Greenfield refineries appear to be driven by the regulatory environment particularly the policy of regulation. According to Segun Akpata (GM, Total Nigeria), “multinational oil firms stay away from acquisition of stakes in Nigeria refineries and the establishment of new, private refineries because the conditions set by government for owning and operating refineries are unclear. There is no specific guarantee by government that it is possible to recoup investment made in private refineries”. Mike Mullier (Shell Global Leader, Crude Trading) also has this to say “Shell has no intention of developing its downstream portfolio in Africa…….low returns on downstream investments and peculiar situation in some African countries where government regulates prices of petroleum products are part of the constraints which have necessitated the decision”. Ed Johnson (CEO, Sirius Petroleum) opined that, “besides security considerations, there is no incentive for companies to invest in the downstream as they know the regulatory laws makes refining unprofitable”.

The critical issue, it would seem, is not just regulation of petrol prices but ‘right pricing of crude oil’ for domestic refining and consumption to ensure profitability for investors. OPEC’s rule for Member Countries is that crude oil pricing for domestic consumption should be based on local cost of producing crude oil in a Member State, not on international spot crude oil prices as quoted daily in Platt’s. Finding and Development (F & D) costs for crude oil in Nigeria varies depending on the location of operations: onshore ($2.5 – $7.5 per barrel); shallow water ($7.5 – $15 per barrel); and deep water conditions ($15 – 30 per barrel). However, under domestic allocation quotas NNPC does not lift crude from the more expensive shallow and deep water sources. These are marked for export. Domestic crude for local consumption is drawn from the old (Brownfield) onshore fields from the Deltaic region that were produced within 1960 – 1990. Average F & D costs of these onshore fields are about $3.5 per barrel!

As a country, we chose the opposite pricing model as advocated by IMF (i.e. adopting the economic concept of opportunity cost). The logic here is, what price will government obtain if the refined petroleum products were exported instead of being sold in the domestic market? Then sell the product at that export price, otherwise it is being subsidized. I personally resent this logic because even our budgets are not fully tied to the international spot price of crude oil (else there will be no excess crude account), nor are domestic wages aligned to international free market prices for labor. If our government can offer discounts to some crude oil traders and some ECOWAS countries, it follows that government can offer special discounts for domestic refining. The difference here is that government will be subsidizing local production of refined petroleum products instead of subsidizing imports of light refined products. Some have argued that domestic refiners may capitalize on the discounts and sell the crude oil instead of refining it. This argument factors in the corruption factor, but it is rather too presumptuous and even if that should happen government can also take pre-emptive steps to discourage such behavior. What is important here is to create enabling laws and policies that will encourage domestic and foreign investors to invest in refineries in Nigeria.

Foreign investors are unlikely to invest in refineries in Nigeria, if the government charges international spot prices for crude oil for domestic processing and consumption. They will consider it more profitable to procure the same volume of feedstock at the same price in New York or Rotterdam and operate their refineries in Europe or in the USA, where refining margins are higher, markets bigger, institutional environment more stable, and social overhead capital more developed. Therefore, foreign investors and indeed domestic investors would require the right incentives (i.e. a guaranteed profit margin) to enable them venture into the Nigerian refining market.

Incentives to be considered would include the following:
Guarantee of 100% crude oil feedstock for all refiners for at least ten (10) years.
Discounted price of crude oil for domestic consumption.
Refiners should be given a minimum of 60 days credit for each cargo of crude oil, at least for the first five (5) years of operation.
Supply of crude feedstock should commence as soon as the Department of Petroleum Resources (DPR) can certify mechanical completion of each new plant.

Each plant should be granted tax exemption for at least three (3) years from date of commencement of operations.
New plant should be exempted from import and export duties, and value-added tax (VAT) for at least five (5) years. This would include imports of plant and machinery, maintenance spare parts, consumables used for construction and commissioning.
New refinery plant should enjoy accelerated capital allowance of about 95%, and the percentage of assessable profit for the purpose of capital allowance recovery should be 70% at most.

All Greenfield refineries should be exempted from all State and Local Government duties, taxes and levies for at least five (5) years from initial production.

All refined products from the Greenfield refineries should be exempt from export duties, levies, and taxes for at least five (5) years from inception of production.
Price regulation and application of subsidies should be implemented at fuel pumps, not at the refinery gates.

The mandatory payment of a refundable deposit to DPR of $1 million for every 100,000 b/d refinery capacity should be scrapped.
The cost of acquiring and leasing land for each refinery plant should be agreed with the appropriate State / Local Government authorities. This should either be considered as part of equity investment by the land owners or amortized in installments over 20 years.

Greenfield investors should qualify as preferred bidders for oil and gas block allocations.
A refinery plant may be required, under domestic obligations to our country, to supply a portion of its products to the Nigerian market. In this case, any additional costs of meeting such an obligation should be borne by the government.

From the foregoing, it is crystal clear that Nigeria needs to ‘up its game’ in the crude distillation business and / or introduce alternative fuels for vehicles. The introduction of alternative fuels is necessary even when we have enough refining capacity. This calls for a clearer and more transparent regulatory framework for the refining / downstream petroleum business in this country. Incentives are vital to encourage urgent action towards developing acceptable refining capacity to serve our teeming population and neighboring countries that depend on ‘big brother’ for their supply of fuels.

*Dr Chijioke Nwaozuzu, a petroleum policy expert wrote in from Port-Harcourt. Email: Tel: 070 6874 3617

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