National Assets: To sell or not to sell

 

Nigeria’s economy is in decline following the downward trend in crude oil prices beginning in July 2014. By the end of Q2 2016, the country slipped into recession, following consecutive negative GDP growth in the first and second quarters of the year. Low oil prices, exacerbated by militant attacks on oil and gas facilities in the oil-producing Niger Delta region, a lack of competent fiscal measures and adverse macroeconomic policies amongst other factors have combined to make a bad case worse. Nigerians unanimously agree that the country is faced with the urgent task to mitigate a growing recession, and ultimately guide the economy back to growth; the strategy to achieve this is the subject of diverse opinions.

The Nigerian Economic Council recently recommended the sale of state-owned assets to raise much-needed revenues. The Senate President, Bukola Saraki, and businessman Aliko Dangote, have both supported this view. However, most wholly state-owned assets have almost been run aground, making the literal interpretation of the proposal a reasonable one. But wholly state-owned assets, like the only three refineries in the country, a steel plant, amongst others, which the country would benefit from privatising or even outright sale are not the assets in focus.

The state-owned assets proposed for sale are government-owned interests in joint venture assets with oil and gas companies and the Nigeria Liquefied Natural Gas, which are the primary non-tax revenue generating assets for the country.

The begging question is: Should Nigerian shares in oil and gas assets be sold? We answer “Yes and No.”

“Yes, Sell”: The sale of several oil and gas assets would benefit the Nigerian economy in the mid-long term. All commercial assets in which the state has a controlling and operating interest should be scaled down. These include assets held by the Nigerian Petroleum Development Company, the exploration and production subsidiary of the Nigerian National Petroleum Corporation. Competent and efficient operations of several of those assets would lead to an increase in production from the respective fields, which in turn would translate to more national revenues. Many of these fields are currently capped or under-producing.

National assets under the NNPC joint venture  arrangements with the IOCs should also be scaled down. The NNPC owns 55 per cent of each JV with oil and gas companies holding the remaining 45 per cent (there are slight variations). With these assets, the NNPC reserves the right to become an operator, but a Joint Operating Agreement is signed which sets the guidelines for running the operations of the field, with one of the partners designated the operator. All parties are required to share in the cost of operation. Unfortunately, the NNPC is rarely able to meet its funding obligations, and one wonders why in the first place anyone expected the NNPC to be able to do so. This arrangement has also created a loophole for massive graft and an inexplicable waste of government funds at the NNPC through cash calls.

The economics of the JV assets would be greatly enhanced if the state ownership were reduced well below the statutory 55 per cent, to between 10 and 20 per cent depending on the specific economic conditions of individual fields. The optimal operation of these fields would provide requisite revenue through other means including Petroleum Profit Tax, Equity Oil (without cash calls based on 10-20 per cent carry and cost recovery models), Royalty, etc. Any strategy that optimises production from Nigerian fields would generate more revenues for the Federal Government, better so if the NNPC is removed from the equation.

Amongst Nigeria’s deep-water blocks, there are a few with oil and gas discoveries but are considered non-commercial for development under current economic terms. In a couple of these fields, a reduction in the state’s statutory interest of 50 per cent held by the NNPC, has the potential to tip the economics of scale towards commercial viability even under current oil prices. Developing just two of these fields would add approximately 150,000 barrels per day of secure crude oil production within the next 4-5 years.

The capital and operating expenditure required for the development of two of these fields exceed $10bn. While the NNPC owns 50 per cent of these undeveloped blocks, it is unable to contribute its share of 50 per cent of the required investment for development. Developing these fields requires the investors or operators to fund 100 per cent of the investment up to first oil, and depend on long-term production cost recovery fiscal-terms, invariably condemning these fields to non-commercial status.

In the cases mentioned above in deep-water assets, the NNPC owns 50 per cent of the blocks that do not generate income or economic activity. Thus, the economic benefit to the state is zero. In these blocks, the NNPC divestment, applied along with strategic incentives could lead to commercial viability. Development of these fields would generate billions of dollars in economic activity for local businesses, providing a multiplier effect and increase taxable income from service providers. As long as the assets are operational, there are several avenues for revenues to flow into government coffers from these fields; these include Petroleum Tax, Equity Oil, and Corporate Income Tax for all associated service providers to business activities deriving from the operations of the fields.

As for state interests in pipeline infrastructure, one wonders why the state retains these assets. Selling these assets would free the state of scarce resources expended in maintaining them. To optimise the benefit from relinquishing these assets through sales, legislation would be required to make oil and gas companies account for production at the wellhead rather than at export terminals.

If oil and gas companies were made accountable to pay Petroleum Tax, Equity Oil and Royalties on the volume of oil produced at the wellhead, companies would be more responsible towards eliminating pipeline breach and its accompanying oil theft. With the availability of modern pipeline technology, it is curious that Nigeria still grapples with crude oil theft from pipelines, a lot of which is intertwined and explained away as part of the actions of vandals and militant attacks.

“No Sale”:  The country’s 49 per cent interest in the Nigerian Liquefied Natural Gas should not be contemplated for sale. It is Nigeria’s single highest revenue generating investment. A consortium of private oil and gas corporations owns majority shares of the NLNG (51 per cent). They operate and make management and investment decisions, making the NLNG a global model for successful State/Public – Private partnership.

The reasons put forward by the proponents for the sale of state-owned shares in the NLNG include the need to raise capital for fiscal stimulus towards achieving the implementation of the 2016 budget. In the first place, the proposed objective is not tenable. Nigeria’s 49 per cent shares in the LNG cannot be sold and successfully closed on, with and funds received in the bank within the next 18 months.

In the case of the NLNG, due diligence, process formulation, board and corporate resolutions/approvals, etc., would take more than a year, and this is just the process preceding a formal approval of all shareholders for the commencement of divestment. The estimated timeline does not take into account public opposition led by unions and host communities against the sale of the asset.

The partners in the NLNG would also have the right of first refusal on any proposed sale, and negotiations between political interests and that of the Majority Private Shareholders would raise legal issues that would take some time to straighten out.

In the past five  years, annual revenue from the LNG to Nigeria has been between $1.5bn and $2.5bn. Applying a simple valuation model, taking into account current market conditions and an estimated potential growth of 25 per cent over the next ten years, the present value of Nigeria’s interest in the LNG is between $13.8bn and $23bn.

This amount cannot be banked in cash in a sale transaction within one year, under current market conditions. In consideration of political risk, an astute investor would spread out payment at a highly discounted value for as long as possible, considering a sale could be rescinded by future governments as was the case with the sale of Nigerian state-owned refineries in 2007.

The NLNG is a great investment for Nigeria; this benefit is not optimised because of the structure of the NNPC, which holds the shares of the asset on behalf of Nigeria. Revenues from Nigeria’s shares in the LNG have to pass through the NNPC, which is wholly owned by the state, and the mismanagement of the dividends occurs at this point. The NNPC has become more of a liability than an asset to the country. Dealing with this and other related issues, require legislation.

There is no justifiable long-term benefit in selling Nigeria’s shares in the LNG, a quick sale as proposed is not feasible.There is also no realistic path to raising funds for Nigeria’s 2016 budget through oil and gas asset sales at the end of 2016; it is also unlikely that this can be achieved even for the 2017 budget.

For Nigeria’s shares in the NLNG, it is “no sale.”