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Nigerian Energy Sector: Inherent challenges, massive potentials

The on-going reform in the energy sector followed the radical transformations witnessed by sectors such as financial services, aviation, and security services after their various reforms in the late 2000s. The energy sector is critical to the sustenance of the political and economic system of Nigeria and in the realisation of the country’s economic growth ambitions. While the goal of being one of the top 20 nations by the year 2020 may be overly ambitious given the pace of the economic growth in the last 5 years, the potential to grow significantly is huge if the benefits of a successfully reformed energy sector provide the springboard.

Over-reliance on oil as the mainstay of the economy is creating huge structural challenges

Across the full energy stream, Nigeria has not performed badly in terms of exploitation and turnover, with the exception of the power subsector. The oil and gas sector contributes about 16.05% to Nigeria’s total GDP, and accounts for over 74% of the national budget revenue. It has however been unable to support major employment creation and skills building for other industries as skilled employees are largely imported.

Another major challenge surrounds the inability of the country to escape from the obvious Dutch disease which it has been bedevilled by since oil and gas exploration commenced. The discovery of the vast economically viable oil and gas reserves led to conflicts and marginalisation, and in the real sense, dependence on a single resource has led to the crowding out of other sectors, like agriculture, solid minerals etc. Annual budgets rely principally on income from the oil sector which often leads to extreme volatility, a lack of transparency in government spending of proceeds, and difficulty in capturing economic multiplier effects through reinvestments in appropriate sectors of the economy.

To tackle these challenges, the sector requires the provision of a stable and reliable environment, with proper dependable legislation. There must be a clear distinction of roles played by stakeholders, such as resource owners, operators and industry regulators, and consistent economic policies. These are sufficiently addressed in the proposed Petroleum Industry Bill (PIB) which is expected to be passed during the current fiscal year. In addition, the government should attract investments in the sector through incentives such as waivers and tax credits. Reforms should also be aimed at supporting a desperately under-developed area and remediating the unsustainable environmental degradation caused by countless spillages from petroleum extraction.

The Petroleum Industry Bill (PIB) to drive the reform

The basic purpose of the PIB is to reform the petroleum sector in order to align it with global industry performance and achieve 21st century standards. The bill intends to decentralise the industry and make it more efficient, result oriented and profitable. The major tasks in the industry are those of policy regulation, national asset management and commercial operations; these operations are conducted by the Nigerian National Petroleum Corporation, implying that dissolution of the NNPC into its component subsidiaries would be necessary. The key arguments on the PIB are the set of taxes to be paid by oil companies, defining penalties for gas flaring and improved metering.

The main laws that regulate the Nigerian oil industry were enacted in 1969 and a revision has become necessary. The current laws are fragmented, outdated and reinforce the unwieldy nature of the industry, for instance the NNPC acts as the customer, agent, regulator and policy driver, an abuse of its role.

The biggest wins in the PIB are the new set of guidelines which stipulate that licence sales must be open and transparent. Revenues from the industry that accrue to the government would improve from the current 48% from Production Sharing Contracts (PSC) and 82% from Joint Ventures (JV), to international rates which average 56% PSC to 90% JV. JV cash calls would be deducted at source; hence government would no more be responsible for NNPC commitments. 

International oil companies (IOCs) have lots of undeveloped fields, crowding out local companies who would have gone on small level production. The PIB instructs all IOCs to define what they will do with undeveloped fields, a process which might lead to them having to forfeit or sell them. Oil companies would now pay company income taxes to FIRS, which they are presently exempted from. The Bill also sets up a trust fund for communities where oil is explored which suggests direct payments could be made to indigenes.

The volatility in oil prices leads to unstable revenue and affects other fiscal responsibilities

The macroeconomic volatility in Nigeria has been occasioned largely by swings in oil prices which affects the nation’s revenue. Poor corporate relations with indigenous communities, vandalism of oil infrastructure, severe ecological damage, and personal security problems throughout the Niger Delta, Nigeria’s oil-producing region, continue to plague the oil sector. The oil industry has been scarred by political and economic conflict largely due to a long history of corruption and complicity of multinational corporations.

The gas sector is the next growth sector if we can quickly overcome the related challenges

Nigeria is known to have the 7th largest gas reserve in the world with about 184tcf gas reserve of high quality sweet-gas. Remarkable progress has been made in the Nigerian gas sector in the last few years in a bid to grow its Liquefied Natural Gas (LNG) capacity to about 30% of total Atlantic LNG capacity. This has led to a sustained shift in gas prices since 2004; a trend that is likely to be sustained in view of the current imbalance between global NLG demand and supply and the robust economic growth and energy demand in many emerging economies in recent years.

Considering the size of the nation’s gas reserves, the potential for huge investment and revenue inflow from the sector is enormous. Three factors that have been identified to help aid in delivering economic growth in Nigeria through the gas sector are: sustained investment inflows, stimulating growth of domestic labour and efficient institution and regulatory environment.

However, there are factors likely to inhibit the pace of growth of Nigeria’s gas sector and consequently, its economic impact. These include pricing, fiscal terms, institutional and infrastructural arrangements, legal and regulatory framework and financing.

The gas sector has huge potential as a full-fledged industry

In line with the proposed implementation of the gas sector reform act, significant progress is being made on various projects to ensure increased production of sweet-gas. The gas industry is still evolving considering that most of the gas discoveries in Nigeria were achieved through petroleum exploration. Yet, the country remains the number one gas flaring nation in the world. World Bank Statistics suggest that 40% of Nigeria’s annual gas production is being flared.

Reform of the Power Industry is  key to achieving Vision 20:2020

Through the Electric Power Sector Act of 2005 (EPSA 2005), the Federal Government began the unbundling of the power industry for the eventual deregulation and privatisation of the power generation and distribution in Nigeria in a bid to make it more efficient in meeting existing and prospective consumption demand. As a result, the Power Holding Company of Nigeria (PHCN) was established with an intended strategy to privatise core functions of the power company such as generation and distribution, whilst transmission operations would be retained by the government.

Despite accounting for over 85% of national revenue, the energy sector contributes only 16% to GDP

The sector is largely detached from the mainstream of the Nigerian economy, employing a mere 21,794 people directly. Driven by the petroleum industry bill when passed into law and supported by the local content act 2010, repositioned oil and gas industries could add substantially to national output via increased local job creation.

  • Written by The Analyst
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Government can remove fuel subsidy, but it must first win the trust of the people through action

Deregulation is a sensitive and emotional issue; it divides Nigeria into various ideological camps and could sometimes be as delicate as the country’s thin religious lines. Previous governments who have flirted with the idea of deregulating the downstream petroleum sector have hastily dropped it because of the lack of political will on an imminent Pandora box. As a stop gap measure, successive administrations in Abuja have resorted to increasing fuel prices and at a time erroneously ending the toll taxes on the inter-state highways as a bargaining chip with opponents of deregulation. As a result, the price of fuel rose over 12,000% between 1990 and 2005. Each round of increase faces stiff opposition from civil right groups and the labour unions.

Protagonists of the fuel subsidy argue that Nigeria by virtue of its generous supply of hydrocarbons should provide its citizens with cheap fuel even if it has to be subsidised. Nigerians are quick to brag about the country’s status as Africa’s biggest oil producer and the world’s tenth largest producer. They also argue that should Nigeria remove its fuel subsidies, it will be one of the few in the top OPEC echelon to deny its citizens this subsidy. According to AirInc, a company that tracks the cost of living in various places around the world, a few Latin American and Middle-Eastern nations, such as Venezuela and Saudi Arabia, keep oil prices low for the benefit of the nation’s citizens. These countries produce oil through government-companies which also ensure that citizens get cheap gasoline in the local market. On the other hand, many European nations tax gasoline heavily, with taxes making up as much as 75% of the cost of a gallon of gasoline.

“Fighting cartels is hard”

Amongst many factors, those who favour the retention of the petroleum subsidy insist that corruption is the major reason why deregulation is failing in Nigeria. They therefore argue that instead of removing the petroleum subsidy, the corruption that weakens the effectiveness of the subsidy should be addressed. Paradoxically, friends and foes of the subsidy agree that corruption is the problem; but even the propositions from the two camps on handling the corruption bit of the petroleum subsidy further polarises the groups. Talks of simply removing the corruption layer and getting the petroleum subsidy right appear idealistic and may not be far from utopian considering the depths of corruption in Nigeria. According to the authoritative Economist magazine “fighting cartels is hard”. Painting a graphic picture of the corruption around Nigeria’s fuel subsidy regime, the Economist explains that fuel importers “routinely falsify bills of lading, inflate the amount of fuel imported fivefold, then collect the government subsidy on all of it, and finally smuggle the fuel to a neighbouring country to sell at double or triple the price”. Reformers who favour the removal of the petroleum subsidy argue that the current system of subsidised petroleum serves as the nursery for the patronage system from where corruption blossoms. Eliminating this regulatory system which promotes rent-seeking will inadvertently check corruption. It will also help promote a free market and engender competition. Pro-deregulation reformers have local landmark testimonies to draw reference from. Nigeria has risen to become Africa’s biggest telecoms market in just ten years of embracing free markets. In contrast, the government owned telephone company could only supply half a million lines in over 40 years.

What is the cost of Nigeria’s petroleum subsidy?

Since 2009, the federal government has been hinting that the price of petrol would be increased. The then Energy Minister, Mr. Odein Ajumogobia, said by December 2010 that the bill for fuel subsidy over the previous two years would hit N700 billion (about US$5 billion). According to him, this is unbearable, as it is of no benefit to the ordinary people on the streets. Indeed, it has been argued over the years that the ultimate beneficiaries of fuel subsidies are the contractors who import the products on behalf of the Federal Government.

In June 2010, Nigeria’s Central Bank Governor, Mr Lamido Sanusi said “the subsidies will cost the government N520 billion (US$3.4 billion) in 2010, compared with N1 trillion in 2009”. That compares with a federal budget deficit of N1.9trillion in 2010. According to Senator Saraki, “an amount of N240 billion (N20 billion monthly) was allocated to fuel subsidy in the “Appropriation Act and in 2011.  Of the N20 billion monthly allocated, N11.2billion was allocated for domestic fuel subsidy (NNPC) and N8.8 billion for domestic fuel subsidy (market) as stated in the Appropriation Act 2011.” Senator Saraki posits that although N240 billion was appropriated for fuel subsidies in 2011, as at August alone, N931 billion had been expended on the subsidy; representing a shortfall of over 280%. Petroleum subsidy is a first line charge in the budget which implies that it takes priority alongside other spending on independent bodies like the Judiciary. Once again, there is need to ponder whether to reform the management of the petroleum subsidy or simply remove the system that promotes this corrupt rent seeking and waste of resources.

Local refining first, subsidy removal to be discussed afterwards

Is subsidy related to just importation? If Nigeria achieves self-sufficiency in local refining and importation stops today, would there still be a budget for subsidies? These questions are often taken for granted by government officials, whereas they may be at the heart of the debate. The focus has always been on the amount spent on importation of products without any attention to several other issues that are critical to answering the question. In opposing the pump price cut in January 2009, labour argued that basing local pricing on imported products is not a feasible way of calculating the subsidy. The first step is to achieve local sufficiency in refining in order to be able to determine the actual economic price of the products. This argument however is subject to criticism on two fronts. One, the major difference in the prices of imported and locally refined products will be the cost of shipping – which some say is negligible. For as long as the local refineries buy crude oil at the international prices, the prices of end products would be similar. Two, subsidy is defined in two ways, the first being the difference between the cost of production and sale price, and the second being “opportunity cost”, that is: at what price can I sell my product in another market? Therefore, the opportunity cost of providing subsidy is germane to the entire debate.

Building a refinery cannot be that difficult, can it?

Iraq, still smarting from an internal war, has managed to put a new refinery on stream despite its political and economic fragility and the climate of instability. This crude oil distillery unit at the Dura Refinery in Southern Baghdad was inaugurated on January 26, 2009. It will produce 70,000 barrels per day. At the official opening ceremony, Iraq’s Minister of Oil, Hussein al-Shahristani, said his country would increase its oil refining capacity to become self-sufficient in oil production by the end of 2010. Although due to growing local demand, the country is not yet self-sufficient in oil refining, it has announced the plan to build a fifth refinery that will be completed by end of 2012.  In spite of recently announced plans to end fuel importation by 2020, the Nigerian government still remains aloof on when it would achieve self-sufficiency as all refineries are not only down, but even when fully operational, their collective production output will be inadequate to meet increasing local demand.

To the public, government cannot be trusted to deliver on promises

At a town hall meeting organised by the News Proprietors’ Associations of Nigeria (NPAN) on Thursday 22nd of December, 2011, the Federal Government of Nigeria in an interactive session with stakeholders explained with a large degree of precision the consequences of continued subsidy payments. The issue of the petroleum subsidy has been much discussed over the years with subsidies subjected to progressive reductions over the years due to financial necessity, however this time around; the government seeks to abruptly remove the economic cushion enjoyed by the masses, because the huge financial burden is considered inefficient and diverts resources away from potential investments in critical infrastructure. The government estimates the total projected subsidy re-investible funds per annum at N1.134 trillion based on a probable average crude oil price of US$90 per barrel. Out of this, N478.49 billion accrues to Federal Government, N411.03 billion to State Governments, N203.23 billion to Local Governments. Each tier of government is expected to design its own utilization programme.

The subsidy removal policy should be a win-win situation for the government and the people.

We understand the government’s position and fears, which is mainly the potentially disastrous effect an unsustainable and continuously increasing subsidy bill would have on the economy.   Also current economic contractions across the Eurozone and the developed nations have intensified apprehensions. We also commend the government for actively interacting with the citizenry on such topical and important issues, steps which are novel and dissimilar from predecessor administrations.

However we feel the recommendations given in the town hall meeting should be taken on board such as subsidizing transportation for the masses, power generation for homes and the political will to ensure proper implementation whilst sanctioning erring officials. Also to build trust from Nigerians, we also think it would be wise to have an assessment period for projects execution before the total removal of the subsidy.

  • Written by The Analyst
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