Salami: To Boost Revenue, FG Should Explore IJVs in Upstream Oil Subsector

Partner and Head, Energy and Natural Resources, KPMG Professional Services, Mr. Ayo Salami, harps on the need for the federal government to explore the option of Incorporated Joint Ventures model provided for in the Petroleum Industry Act to shore up revenue from the oil sector. He spoke with Peter Uzoho

What is your take on the need for the federal government to explore Incorporated Joint Ventures (IJVs) model in upstream oil sector to shore up revenue, especially given the revenue crisis that is inherent in the 2023 budget?

Clearly, the country is revenue-challenged, not only for the current year but it has been a trend for the past number of years. Specifically, if you look at the 2023 budget, the government expects to earn N10.5 trillion. By the same token, they expect to spend over N21.8 trillion. That will translate into a budget deficit of N11.3 trillion for the year. Clearly, that’s big, and the government needs to do something different this year to ensure that they don’t fall short of revenue, otherwise, that budget deficit level will worsen. 

And that’s where the idea of Incorporated Joint Venture (IJV) model might be very useful. It’s not a strange concept in the Nigerian oil and gas industry. It’s been a model that has been proposed by operators in the past, but somehow, we never got to explore it. It’s a model that has worked. It has worked for the Nigeria Liquefied Natural Gas Limited (NLNG), which is a flagship project done under the IJV model. If you look at the NLNG, it has delivered significant cash flow to all the partner shareholders – government inclusive.

But let me take you down the memory lane a bit to 2018. In that year, government actually had a revenue line item in the budget, called JV Asset Restructuring. What does that mean? It was thought that government would sell down its equity interest in the JV assets, realise immediate cash from the sale to the tune of N710 billion and, going into the future, reduce cash-call obligations of the government. 

Unfortunately, that didn’t happen that year, and subsequently, it didn’t. I guess government’s expectation was that the Petroleum Industry Bill (PIB) was in the works, and that with the PIB, those matters would be dealt with in the law. Fast forward to 2021, the PIA was eventually passed.

It was an omnibus law that consolidated the provisions of other pieces of legislation governing the oil and gas industry, and we have copious provisions around IJV in that law. For example, the law provides that the Nigerian National Petroleum Company Limited (NNPC) and its partners in JV operation could form incorporated joint venture (IJV) companies under the Companies and Allied Matters Act (CAMA).

Clearly, IJV is the way to go. It has the potential to solve the cash flow problems of government in that sector. And if you have IJVs, they can on their own seek funding for their critical projects. So, in essence, short, medium and long-term funding becomes easier for them on the back of their balance sheet, which was not the case before.

The other benefit is that the IJV itself is able to operate without government interference – they can operate outside the instrumentality of laws like the Fiscal Responsibility Act and the Public Procurement Act. These were laws that, in my view, hindered the effective operation of the then NNPC. So IJVs are not under the purview of those laws. And therefore, they can operate independently and more successfully like the NLNG. 

Again, I would say a note of caution: before we do the IJV model, I would expect the government to carry out an analysis of the potential gains under this model, which is, incremental cash flow to government devoid of cash-call obligations. So in essence, I’m saying, government needs to sit back, carry out a financial modelling that will depict the incremental cash flow accruable to the government post-IJV. Why this is important is that, we need to have a corporate governance structure in place to track those benefits post-IJV, so that we can see what IJV promises to deliver, and that actually, it is delivering. 

But, finally, those benefits may be elusive if the government does not deal with the big elephant in the room, which is the issue of oil theft. Therefore, government needs to solve this problem, so that the gains of IJV would become realisable. Otherwise, the much needed Foreign Direct Investment (FDIs) may not flow into the sector, if investors believe that ultimately, the return on their investment may be negatively impacted by the massive oil theft plaguing the industry. 

With the under-performance of oil revenue in 2022 (36 per cent of the budget), due to the dip in production level that averaged about 1.2mbpd in November 2022, do you consider the federal government overly ambitious to expect oil production level of 1.69mbpd at $75/bbl oil price? 

I personally think it’s overly ambitious and I will tell you why. But before I do, I must commend the government for trying to diversify the revenue base of the country away from oil. Why I say so is that we are seeing some positive results. In the last three years (2020 to 2022), we’ve seen non oil tax revenue move up from N1.1 trillion to N1.6 trillion, and last year to over N2 trillion. That is commendable.

In comparison, however, we’ve seen oil revenue under-performing. During the same period under review, we’ve seen oil revenue dwindle from N1.4 trillion in 2020 to about N970 billion in 2021 and to a paltry N587 billion last year. So, that is a significant drop, which of course, is a reflection of an under-performing sector. 

Now, this year, government hopes to achieve a revenue target of N2.3 trillion from oil sources, out of a total of about N10.5 trillion. That is significant – about 22 per cent of that amount, from oil. So, it’s going to be a tall order. But to answer your question directly, there are two parts to it. There is the part around oil price per barrel, which government has benchmarked at $75. And then, there is the oil production part, which is 1.69 million barrels per day. If I take the price per barrel, I would say, that is achievable. It’s reasonable, and the reason is not far-fetched. 

If you check the trajectory for the past three years, government has always exceeded in terms of actual price per barrel. So, I would say, that amount is realisable. Again, if you juxtapose it against what the International Energy Agency (IEA) and the World Bank are saying: they think oil price would exceed $90 per barrel this year. So, government is being conservative and I think, that price is realisable. 

The other bit of it is the production level of 1.69 million per day. That’s where I have a bit of challenge and my concern stems from the history. In the last three years again, I’m not sure we’ve met our production targets, both OPEC and self-imposed one, we’ve never met it. Last year, the budget was predicated on 1.6mbpd, we eventually achieved about 1.3m. And at some point last year, Angola surpassed Nigeria in oil production. As of November, we were doing only 1.2mbpd. So, I ask, how easy would it be for us to simply move from 1.2m in November 2022 to 1.6mbpd in 2023? So, it’s going to be a tall order for government to achieve that target. 

On an overall basis, I think it’s overly ambitious. Of course, I know the argument of the Director General of the Budget Office of the Federation, Ben Akabueze. He did say at some of his public commentaries on the budget that the revenue figures shown in the budgets are determined by certain mechanisms and that those figures are actually net of oil subsidy. He noted that on the balance, the N2.3 trillion expectation from oil this year already considered the fact that oil subsidy will stop in June 2023, and that on that basis, it is realisable. 

Again, I come back to the issue of volume. The volume of 1.69mpd is challenged if we do not fix the issue around oil theft. So, for me, the price is okay, but the volume is a big problem, and that, of course, puts a big question mark around how feasible the expectation regarding oil revenue is.

Do you think government’s plan to remove fuel subsidy in June this year is feasible, considering the fact that there are challenges around underperforming refineries and exchange rate instability? Will the removal of subsidy eradicate the incessant fuel scarcity that was rampant in 2022 till date, and won’t marketers use that as an opportunity to engage in anti market practices?

I think that the removal of oil subsidy come June this year is feasible. However, there are factors that have to be in place for it be successful. You’ve talked about two of them already: we need to fix the exchange rate problem; we also need to basically work on the under-performing refineries. 

Beyond the two points above is also the issue around public enlightenment. I think ordinary Nigerians on the street do not understand the dynamics around petrol subsidy, because they don’t know the devastating impact it is having on government revenues, and except that ignorance is completely dealt with, we might still see some hesitations on the part of Nigerians toward the removal. 

But, again, if you check the trajectory, right from when we started this oil subsidy, you would notice that the resistance is more from the point of view of ordinary Nigerians feeling they don’t even get its benefits – sometimes due to the scarcity and above-regulated prices at which it is sold in some parts of the country.

And mind you, we also hear the arguments around even the volume of oil consumption. There are arguments as to even the quantum of oil that is imported into, and consumed, in the country – are we not funding neighbouring countries consumption due to possible smuggling? So, those arguments are still out there.  You see, the real solution is that government needs to deregulate completely, and then provide some social safety net for the vulnerable people.

The beauty of deregulation is that it then encourages private investors to invest in new refineries and perhaps, also import the products. When that happens, you sell to consumers at competitive prices. With competition, prices might be up in a very short run, but ultimately, in the long run, equilibrium will be reached. There are fears as to whether prices will ultimately fall to affordable level. 

But, in my view, anti-market practices will only thrive in a regulated market. Once the market is completely deregulated, the likelihood of such practices thriving is remote.

How confident are you that the coming on stream of the Dangote Refinery will lead to an increase in local fuel supply and reduction in foreign exchange rate? 

For me, once production from Dangote Refinery starts, I think there will be ample supply of the products in the country. But whether that ample supply will then have a positive impact on foreign exchange availability in Nigeria is a different conversation entirely, and I will tell you why.

 Don’t forget, the country currently sells crude oil to third parties outside the country, from where we earn FX. If we begin to sell a portion of the crude oil to Dangote Refinery, it means our ability to earn FX from that source is curtailed, except Dangote Refinery pays government FX to buy the crude oil – we don’t know yet. So, that’s one angle to it. 

The other angle to it is that, since we currently import petrol, the haulage and transport cost of importation, which are mainly settled in US dollars, will be off the table, since the product is now being refined in the country. So, there will be a significant drop in that and the country might have some savings in FX from that angle.

 But the other bit, which is also critical to the conversation is that, if Dangote produces the end products, at what price will it sell to Nigerian government or private marketers in Nigeria, and in what currency? It’s very critical. If Dangote sells to us in Nigeria in USD because he pays USD for the crude oil, then, the likelihood is high that we might not realise the gain from FX perspective – the potential gains from the FX angle may wash off significantly.

So, the whole dynamic around the entire value chain: how the refinery gets the crude oil and what currency it pays for it, how it sells the end products to Nigerians and in what currency we pay for it and at what price, will determine whether the operation of that refinery in Nigeria will have a much more bigger positive impact on the economy or not. But as to whether to improve local supply of petroleum products, yes, it will definitely improve it.

What are your thoughts on how issues such as geopolitical tensions in Europe, energy transition and other issues affecting the global energy sector will impact the oil and gas sector in Nigeria?

The world is a global village, so whatever happens at the global stage definitely affects Nigeria. So, we’ve got the Russian-Ukraine War, which is yet to abate. We have the COVID-19 pandemic, which has, thankfully eased off. We also have the conversation around China and the economy picking up and all the conversations around Net-zero, energy transition, and the rest. As we speak, the impact of the Russia-Ukraine War has led to increase in food and energy cost globally, with imported inflation into Nigeria since we import most of our needs.

So, the way it would affect our economy is multifaceted, and I will start from the oil and gas upstream sector. In the last couple of years, we’ve seen a shift from our traditional markets where we sell our crude oil, from North America, Europe to Asia -India, Malaysia and the rest. We know for certain that India intends to replace all petrol and diesel fired cars with electric cars by 2030. So, the question is, what happens to the portion of our crude oil that we sell to India, by 2030? Clearly, that market might not be in existence anymore by that time.

Secondly, petrodollar will flow into regions that promise high rates of return on investment. So, with the Petroleum Industry Act that has been enacted, what is the government doing to maximize the benefits offered by this law to the country and to the citizens? In that sense, I will say that for instance, we know that deep offshore field operators are the greatest beneficiaries of the PIA because their tax rate has reduced from effective 50 per cent to roughly 30 per cent. So, what is government doing in the immediate to attract FDIs into the deep offshore arena?

 I know for instance that the Nigeria Upstream Petroleum Regulatory Commission (NUPRC) has put on offer seven deep offshore fields. We need to ramp up that very quickly to attract the needed FDIs. The other bit of it is also to say, we need to fast-track conversations with the IOCs around the conversion of current JV operations to IJVs, in order to enhance the capacity of the IJVs to unlock the value in their assets and improve government revenues through this means.

Thirdly is to say: since gas is seen as a transition fuel and beyond being a transition fuel, government has also declared the Decade of Gas. All these are steps pointing towards achieving NetZero by 2060, which is our sunset date. What incentives is the government putting in place now to attract investors into that sector – both for associated gas and non associated gas? Of course, there are copious provisions in the PIA regarding gas. But, there is still room for improvement, from an overall fiscal lever standpoint.

For example, only gas supplied to Generation Companies (Gencos) is Valued-Added Tax (VAT) exempt. Every other gas project is ‘VATable’. Government needs to neutralise that because if you are saying this is the Decade of Gas, you must encourage all gas projects, whether they are selling the output to Gencos, Transmission Companies or to industries, you must neutralise VAT and ensure that all these gas sales are VAT-exempt to encourage and incentivise investments to that sector. 

Lastly, we must ensure that the 20 per cent NNPC equity stake in Dangote Refinery is beneficial to both investors and Nigerians. So, these are what the changes in the global economy will have on us back home.