A Quick Analysis of the CBN Governor’s Proposal to Sell a Portion of  Government’s  Equity in Joint Venture Oil Companies in Nigeria

By

Dr. Emmanuel Ojameruaye

emmaojameruaye@yahoo.com

 

Speaking to the Financial Times of London after the recent Presidential Elections in Nigeria, the Governor of the Central Bank of Nigeria (CBN) advised the incoming administration of Mr. Buhari to give serious thoughts to scaling down the Government’s majority shares in the Joint Ventures (JVs) with major multinational oil companies operating in the country (The Street Journal, April 23, 2015). According to the reports, the highlights of the CBN governor’s proposal are as follows:

·         The government should shed at least 25 per cent of its equity in the JV oil companies to raise emergency funds for infrastructure development in key sectors of the economy.

·         The government may realize about $75 billion (N14.93 trillion) if it cuts its JV equity to only 30 per cent.

·         CBN officials have been directed to evaluate the prospects of the proposal. The outcome of the study will be presented to Mr. Buhari when he assumes office on May 29.

·         Private equity companies can be encouraged to take over the relinquished government equity.

·         Part of the proceeds from the equity sale could be invested in transport and energy developments projects to grow the economy and create jobs.

·          Government could adjust upwards, petroleum profit tax payable by the oil companies, to compensate for the reduction in government’s equity.

·         The equity cut back is one of the most attractive options available in view of the drastic drop in revenue due to falling oil prices and the need to avoid piling up more debts.

The CBN governor acknowledged that the proposal could meet stiff resistance from oil firms, politicians and their allies who depend on oil resources for patronage. However, it should be welcomed by those who support the unbundling of the NNPC and curbing corruption by increasing private participation in the oil sector. Some observers believe that the proposal is a response to Mr. Buhari’s promise during the presidential campaign that his party would “break up the NNPC but the ultimate answer may well be to divest the whole thing”. However, he noted that the immediate priority of his administration would be to stop leakages in the oil industry so that revenues that belong to the people get into the federation account. The governor’s proposal requires careful analysis because it raises some fundamental questions that must be addressed.

Firstly, why did the Governor not offer the same advice to outgoing President Jonathan who appointed him? After all, oil revenue started crashing almost a year ago when the price of Nigerian crude oil declined from about $114 a barrel in June 2014 to $48.57 a barrel in January 2015, although it has increased to $65 a barrel as of May 6, 2015.  One can assume that either this idea just occurred to governor or that he decided not to advise President Jonathan about it because he knew that his advice would be ignored because of interests vested in retaining Nigeria’s majority shareholding in the JV oil companies to guarantee the political patronage and revenue “siphoning” it provides. Perhaps, the governor thought that the slump in oil prices was a temporary phenomenon that would not lead to serious financial hardship for the government as we are now witnessing. Secondly, what is the overarching reason for the advice? Is there a hidden agenda? Is the governor fronting for the private equity companies who are waiting in the wings to grab the lucrative government stakes in the JV oil companies and deep their hands further into the pockets of the Nigerian oil industry? Is the governor offering this advice  altruistically and genuinely to solve the financial crunch the incoming administration will face in trying to meet the expectations of Nigerians for improved economic performance? I have no reason to doubt the governor is sincere about his advice and believes it is in the best interest of the government and people of the country. Thirdly, why has the governor recommended only a partial divestment, i.e. why reduce government stake to 30% and not to zero or convert the JVs to other forms of contractual arrangements such as production sharing contracts (PSC) or service contracts? I think the governor believes that it is critical for the government to continue to have an important stake in the oil industry in order to maintain some modicum of control of the “commanding heights of the economy”.

Fourthly, what is the benefits-costs ratio (BCR)? In other words, is proposal profitable to the government and people on Nigeria? Admittedly, it is almost impossible to come up with a BCR because some of the benefits and costs are non-quantifiable and cannot be ‘shadow-priced’. However, we can estimate the major quantifiable benefits and costs. The immediate reaction by some people to the proposal would be to dismiss it as dangerous and unprofitable because it could reduce future revenue stream into the federation account due to the reduction in  “equity oil” sales which may not be compensated by any reasonable increase in petroleum profit tax (PPT), royalties, rents, etc. As an empirical economist, I decided to conduct a quick “back-of-the-envelope” analysis of the proposal through the use of a simple economic model to estimate the likely loss in oil revenue, the possibility of realizing the $75 billion the governor expects the government to make from reducing its equity holding in the JV oil companies to 30% and the PPT rate at which government oil revenue will not fall if it decides to accept the proposal. In the remaining part of this paper, I will discuss the model, the simulation results and conclude with some recommendations for the incoming Buhari's administration.

The model I have developed to analyze the governor’s proposal (call it the OJV model) is made up of the following equations:

1.      G =  aQP –aC

2.      J = (1-a)QP – (1-a)C

3.      R = G + tJ = aQP –aC + t(1-a)QP – t(1-a)C =

4.      A = J -  tJ  = (1- t) J

Where:

G= Revenue of the Government from crude oil sales (of its share/”liftings”)

Q = Total crude oil produced by the JV oil companies in a year in million barrels. We will assume Q =420 million in model simulation which is about quantity of crude oil produced under the JV arrangements in 2013.

P = Average price of Nigerian crude oil during the course of the year, in US$ per barrel

a= Average ratio/proportion of government share holding (stake) in the JV oil companies (SPDC, Chevron, Mobil, Agip, Total and Texaco), currently about 0.57 (i.e. 57%)

t = PPT rate, currently 0.85 (85%)

C = Total cost of the JV companies (CAPEX and OPEX) in the year which must be funded by government and the JV partners in proportion to their share holding. We will assume C = $5,000 which is about the average annual JV cost between 2011 and 2013.

J = Revenue of the private JV partners from crude oil sales (of their share/liftings) = Pre-tax profits of the private JV partners

R = Total Government Revenue from crude oil sales and Petroleum Profit Tax

A = After-Tax Profit of the private JV partners

 

Equation 1 states that government net revenue from its crude oil sales (liftings) in a year (G) is the product of its equity holding ratio (a), quantity of crude oil produced by the JV operators (Q) and average export price of Nigerian crude oil (P) less the government’s JV cash call obligation (aC) which is the product of its equity holding ratio and the agreed cost of production by JV operators (C). Equation 2 states that the other JV partners’ pre-tax revenue (J) is the product of their joint  equity holding ratio (1- a), quantity of crude oil produced by the JV operators (Q) and average export price of Nigerian crude oil (P) less their cash call obligation. Equation 3 states that the total government revenue (R) is the sum of the net revenue from crude oil sales (R ) and petroleum profit tax paid the other JV partners which is the product of the PPT rate (t) and their pre-tax revenue (J). Equation 4 states that the after-tax revenue (profit) of the other JV partners (A) is their pre-tax revenue (J) less the PPT paid to the government (tJ).

 

Of course, like in most economic modeling exercises, we have made some simplifying assumptions. For instance we have excluded gas sales and other sources of oil revenue such as royalties and rents. However, the relaxation of these assumptions will not significantly change the results and inferences from the model. Using the above model, and assuming that Q =420 million barrels (1.15 million barrels a day) and C = $5,000 million (=$5 billion), we computed the values of G, J, R and A based on three crude oil price levels ( P = $50, $75 and $100) and three government equity holding ratios (a = 0.57 or 57%, 0.30 or 30% and 0.0 or 0%). Table 1 below (shaded area) shows the results of our computation.

 

Table 1: Computed Value of Government Revenue and other JV Partners Revenue from JV Operations based on three Crude Oil Price Levels and Three Government Equity Holding Ratios                                                                           

                                                                                                           US $m

 

Q

P

C

A

t

C

G

J

R

A

1

420

50

5,000

0.57

0.85

5,000

9,120

6,880

14,968

1,032

2

420

50

5,000

0.30

0.85

5,000

4,800

11,200

14,320

1,680

3

420

50

5,000

0.00

0.85

5,000

0

16,000

13,600

2,400

4

420

75

5,000

0.57

0.85

5,000

15,105

11,395

24,791

1,709

5

420

75

5,000

0.30

0.85

5,000

7,950

18,550

23,718

2,783

6

420

75

5,000

0.00

0.85

5,000

0

26,500

22,525

3,975

7

420

100

5,000

0.57

0.85

5,000

21,090

15,910

34,614

2,387

8

420

100

5,000

0.30

0.85

5,000

11,100

25,900

33,115

3,885

9

420

100

5,000

0.00

0.85

5,000

0

37,000

31,450

5,550

 

For example, row 1 indicates that at 57% average equity holding in the JVs and at P= $50 per barrel and at the current 85% (0.85) tax rate, government revenue from JV operations (R ) will be $14,968 million (or $14.968 billion or about N2.9 trillion) but when the equity holding is reduced to 30% (0.3) as proposed by the CBN governor (row 2), R will drop to $14,320million – a drop of 4.3% or a loss of about $648 million a year.  If the government decides to relinquish all its equity holding (row 3), R will decline further to $13,600 million– all coming from PPT. At P =$75 per barrel, R will be at $24,791 at 57% equity holding (row 4) but drop to $23,713million at 30% equity holding (row 5) – a drop of $1,073million or 4.3% also. At  P =$100 per barrel, R will be at $34,604million at 57% equity holding (row 7) but drop to $33,115million at 30% equity holding (row 5) – a drop of $1,499million or 4.3% also. Notice that the drop in government revenue from JV operations as a result of the reduction in its equity holding ratio is accompanied by an equal increase in the after-tax revenue of the other JV partners if the PPT tax rate remains unchanged. Also note that the magnitude of drop (loss) in government revenue is a function of the price of oil (P) – the higher the price the larger the loss. In fact, the model results indicate that for each $1 increase in the average price of crude oil, R will drop by about $17 million. Figure 1 illustrates the net government revenue from oil (R ) based on the three levels of equity holding and three crude oil price levels.

Figure  SEQ Figure \* ARABIC 1: Net Government Oil Revenue from JV Operations based on different Oil Price Levels and FG Equity Holding

From the above, it is clear that while the drop in government oil revenue (R ) appears small in relative terms (about 4.3%) , it is nonetheless large in absolute terms ($648 million at P=$50, and $1,073 at P=$75)  if government equity holding is reduced from  57% to 30% as proposed by the CBN governor. To prevent such as drop, the governor advocated for an increase in the petroleum profit tax rate (t) but he did not indicate the percentage point increase. The question therefore is to what level should the PPT rate be increased to prevent a drop in government future oil revenue stream? To answer this question, I simulated the model using different tax rates from 0.85 (85%) to 0.95 (95%) to determine where oil revenue at 57% government equity holding (R0.57) equals revenue at 30% equity holding (R0.30). Table 2 and figure 2 show the simulation results for PPT rates of 85%, 90%, 91% and 92%.  I have also shown the corresponding after-tax revenue of the private JV partners (A) and the results when government equity holding is reduced to zero.

Table  SEQ Figure \* ARABIC 2: Government Revenue from JV Oil Operations at $75 per barrel based on different PPT rates and equity holding ratio

 

       

         t=0.85

 

t =0.90

 

t=0.91

 

t=0.92

 

 

Q

P

C

a

R

A

R

A

R

A

R

A

1

420

50

5,000

0.57

14,968

1,032

15,312

688

15,381

619

15,450

550

2

420

50

5,000

0.30

14,320

1,680

14,880

1,120

14,992

1,008

15,104

896

3

420

50

5,000

0.00

13,600

2,400

14,400

1,600

14,560

1,440

14,720

1,280

4

420

75

5,000

0.57

24,791

1,709

25,361

1,140

25,474

1,026

25,588

912

5

420

75

5,000

0.30

23,718

2,783

24,645

1,855

24,831

1,669

25,016

1,484

6

420

75

5,000

0.00

22,525

3,975

23,850

2,650

24,115

2,385

24,380

2,120

7

420

100

5,000

0.57

34,614

2,387

35,409

1,591

35,568

1,432

35,727

1,272

8

420

100

5,000

0.30

33,115

3,885

34,410

2,590

34,669

2,331

34,928

2,072

9

420

100

5,000

0.00

31,450

5,550

33,300

3,700

33,670

3,330

34,040

2,960

                                 

 

The results show that in order for the government to receive the same level of oil revenue (R ) after reducing its equity holding from 57% to 30%, the PPT rate must be increased from 85% to between 90% and 91% (90.6% to be precise) as shown by the highlighted numbers in the table.  For example, at P = $75 and “a”= 57%, R = $24,791 million, but when “a” is reduced to 30%, R falls to $23,718million. In order to prevent this fall (that is, maintain R at or very close $24,791), t must be set at between 0.90 and 0.91 (precisely at 0.906). But will the government be able to find equity investors who will be willing to buy the 25% equity for $75 billion when the PPT rate is raised from the current level of 85% to 90.6%? In my opinion, this is very unlikely.

Fig. 2: Government Net Oil Revenue (R) from JV Operations at P = $75 per barrel and at four different levels of PPT Tax Rate and three Equity Holding Ratios

The CBN governor did not reveal how he arrived at the $75 billion which he expects the government to rake from private investors who will acquire the equity that the government will relinquish. The governor and his team may have conducted a valuation of Nigeria’s equity in the JV oil companies to arrive at this amount but the results of my model indicate that this may be very difficult to achieve. If the sale of 25% of government equity will yield $75 billion, as the governor has indicated, one can assume that 1% will yield $3 billion. Will private investors pay $3 billion to acquire 1% equity in the JVs? Let us go back to our model to see what the private investors can expect to make as after-tax profit (A) if they acquire the equity the government will relinquish. The model simulation results indicate that at P = $50 per barrel, the private investors who will acquire the 27% equity from the government (57% to 30%) will reap $648million as after-tax profit in a year. This translates to about $24 million for 1% equity acquired. At P = $75, the after-tax profit translates to about $40million for 1% equity while at P = $100, it translates to about $55million for 1% equity. Thus, assuming zero inflation rate, it will take between 55 and 130 years for the equity investors to recover the funds invested to acquire the equity if they decide to buy the 27% for $75 billion. The “recovery period” will in fact be much longer because of inflation, and if the government decides to increase the PPT rate (to mitigate the loss in oil revenue) as suggested by the governor. If the private equity investors do their due diligence (homework) it is very unlikely that they will be willing to pay a whopping $75 billion to acquire 27%, much less 25%, of government stake in the JV companies as suggested by the governor. In my view, based on the model, the amount the government is likely to realize from the sale of 25% of its stake will be much less in view of the likely increase in PPT rate as suggested by the governor, declining JV oil production and declining share of JV oil in total oil production.

Finally, let us assume that government can rake the $75 billion by not increasing the PPT rate in order to incentivize the private equity investors to acquire the equity. Let us further assume that government will use all the proceeds for infrastructural development and job creation as suggested by the CBN governor. Will the resulting “infrastructural development” and job creation bolster the federation account enough to compensate for the loss of revenue due to the reduction in government equity holding? Given Nigeria’s experience with infrastructural development/capital projects (e.g. in electricity, roads, railways) it is unlikely that these projects can generate additional $1,000 million in revenue each year (using the $75 per barrel estimate) into the federation account to make for the loss in oil revenue. The result is that all the tiers of government will face a reduction in allocation from the federation account. It is also important to point out that as in the case of the sovereign wealth fund, the federal government will be  challenged by some state governments over the sale of the government equity in the JV oil companies to private investors because the equity belongs to the “federation”, not the federal government only.

From the above analysis, we can conclude as follows:

1.      The proposal by the CBN governor to the incoming administration to sell 25% of government  stake in the JV oil companies operating in Nigeria to raise $75 billion for infrastructural development of key sectors of the economy deserve a careful analytical study. It should not be dismissed outright nor accepted hook-line-and-sinker without an independent study (in addition to the study by the CBN team) of the short and long-term costs and benefits, especially of its impact on the federation account.

2.      The sale of the 25% stake is unlikely to generate as much as $75 billion given the outlook of crude oil prices, decline in crude oil production by JV companies, decline in the share of JV oil production in total production, the likely increase in tax rates and the likely low rates of return on the equity. The sale will reduce revenue accruing to the federation account by between $600 million and $1.5 billion a year depending on crude oil prices. In order to avoid this loss of revenue, the government may have to increase the PPT rate substantially, from its current level of 85% to about 91%.   

3.      The sale may result in the loss of control of the oil industry – the “commanding height of the economy - by the government and this will mean a major change in Nigeria’s post-independence economic policy.

4.      The sale of government equity in the JV oil companies to raise funds for infrastructural development is a controversial policy at best. If the government is able to raise the $75 billion within a short period of time, managing the funds will be a very challenging task due to absorption issues and high corruption risk. The incoming administration should first put in place effective anticorruption measures before thinking of such a massive capital investment program. In any case, through proper management of its resources and reduction of its bloated recurrent and overhead expenses, the government can generate adequate funds internally for the needed infrastructural development without selling some of its stakes in the JV oil companies. The government can also explore other sources of generating revenue such as improved tax administration and gradual elimination of fuel subsidies.

5.      The management of the government’s portion of the JV oil operations has left much to be desired, but a partial or total sale of government equity is not the solution to the problem with the JVs. The NNPC must be unbundled and restructured as soon as possible. For instance, it should be relieved of the responsibility of lifting and selling the government equity crude oil. The JV operators should sell all the oil they produce directly, deduct the agreed “cash calls” and remit the government’s net oil revenue and their taxes, royalties, rents and other payments directly to the federation account. The local refineries should be made to purchase crude oil directly from the oil operators at market/international rates. Most of the current subsidiaries of NNPC such as the NPDC should become independent of NNPC and operate like private companies without any preferential treatment or support from government, and should be made to pay agreed profits to the federation account. The Boards and Management Teams of the companies should be given annual financial targets (with in-built reward and penalties including loss of appointment) by the Ministry of Petroleum Resources in conjunction with the Ministry of Finance.  

Finally, what I have done in this paper is more or less a “back of the envelope” analysis. It was conducted within a short time, but the results are very instructive. Given the critical nature and long-term impact of the CBN governor’s proposal, the incoming Buhari’s administration needs to engage an independent group of experts like yours truly -yes, I must market myself! - to conduct a more detailed analysis of the proposal and compare the results with those of the CBN team that has set up by the governor, before making a final decision on the matter and the whole issue of what to do with NNPC and the management of the oil industry in Nigeria .

Dr. Emmanuel Ojameruaye

President, Capacity Development International, LLC (www.capdevinternational.us)

Phoenix AZ, USA.    May 20, 2015.