Downstream Oil & Gas at a Crossroads and Due for Favourable Policy Steps

A recent survey conducted by REACH Technologies, a Nigeria-based fintech, on behalf of FBNQuest, indicates a substantial decline in household spending on transportation. According to respondents, spending on all forms of road transportation – private and public modes – declined by around -20% y/y. The decline in aviation fuel consumption is even more severe given the closure of the international airspace to passenger flights and halting of commercial domestic flights, the survey did not extend to gauging spend on air travel during the pandemic for obvious reasons. Given relatively softer petroleum products demand in H1 2020, the near term outlook for the sector is certainly subdued. However, long term prospects appear more promising.

The downstream oil & gas business is typically a low margin one. However, other factors, mainly constraining policies, have led to historically low investments in the sector over the last decade. In our view, the fortunes of the sector could change with the growing possibility of full pricing deregulation. We believe the re-introduction of a market-friendly pricing template for gasoline in March and the central bank’s current attempt at unifying foreign exchange rates increase the prospects of the end of mandated gasoline price ceilings.

The newly adopted pricing template takes into consideration several factors such as the petroleum product cost and the foreign currency conversion rate at which oil marketing companies import petroleum products. We expect the recent adjustment of the Naira official FX rate from N306/US$ to N380 to test the durability of this template within this quarter. Assuming all other inputs remain constant on the most recently published PPPRA gasoline pricing template, an adjustment of the FX rate assumption to current levels raises ex-depot prices by approximately 20%.

Competition within major marketers is growing with new ownership/management. Ardova (formerly Forte Oil, not covered) and 11 Plc (formerly Mobil Oil, not covered) are leading the charge. In Q1, Ardova and 11 Plc became the leading distributors of gasoline (23.8%) and aviation turbine kerosene (27.2%) respectively, positions previously occupied by Total Nigeria (Total). In the event that the FG decides to continue with the new pricing template, effectively deregulating the sector, we see competition intensifying over the long term. Under this scenario, reach and distribution will be a key competitive advantage. As such, Total and Ardova are presently in the best position to capture growth.

In the near term, we expect the industry to take a hit from measures adopted to stem the spread of the COVID-19 pandemic. The implementation of a total lockdown, followed by a partial economic re-opening in key states – Lagos, Ogun and the FCT – should result in declining gasoline consumption in Q2. We estimate a gasoline consumption contraction of between 40-45% in Q2 even though product importation grew 8% y/y to 5.3 billion litres in the prior quarter.

For Total, we forecast sales and earnings declines of -6% and -70% respectively in 2020E. Our projections are driven by both relatively lower petroleum product demand and a double-digit decline in product pricing year-to-date. Our forecasts assume a mild rebound in COVID-19 cases and that economic activities are allowed to continue under such circumstances.

Uwadiae Osadiaye, CFA, Oil & Gas, Industrials and Agriculture Analyst, FBNQuest