On Oil and Gas (2)

Nasir Ahmad El-Rufai


Upstream activities - the exploration, production and export of crude oil are what Nigeria has become addicted to as the main source of its revenues. These activities provide three revenue streams - royalties, petroleum profit taxes (PPT) and sale of our share of crude. This week, we will look at upstream aspects and explain the jargon of the industry so we can understand this sector that has become a source of joy and sadness in our national lives.

Most Nigerians including those with only the most fleeting interest on the oil industry would have heard of the Bonga Fields and the massive reserves of crude oil and gas they produce. What most people do not know however, is that Nigeria earns no royalties from these wells because back in 1991, we signed an MOU with international oil companies (IOCs) forfeiting such royalties. So today, except from Petroleum Profit Tax (PPT), Nigeria earns little from Bonga and other deep offshore oil wells with a depth of more than 1,000 metres. This anomaly is just one of many in the oil industry that defy common sense. What have our regulatory bodies and legislature been doing?

Unlike other national oil companies like Petrobras of Brazil and Aramco of Saudi Arabia, the Nigerian National Petroleum Corporation (NNPC) and the Department of Petroleum Resources (DPR) have limited themselves to merely regulating the industry – and failing. For instance, what the IOCs do in Nigeria is in reality project coordination and management – by contracting out, outsourcing and subcontracting virtually all aspects of oil production from exploration to ‘fiscalization’. In return for these tasks, they repatriate billions of dollars in profit every year – money that would have helped to develop our human capital, infrastructure and create jobs.

And speaking of jobs, the relatively few Nigerians employed by oil services and related companies are engaged mostly through foreign companies who end up bringing in more expatriates than Nigerians – even in areas where there are many qualified Nigerians. Is this to say that the NNPC and the Petroleum Technology Development Fund (PTDF) cannot find or train Nigerian geologists, engineers, project managers and other skilled personnel required to ensure that at least 80 percent of workers in the oil and gas sector, like others, are Nigerians? Perhaps, we should not be too surprised, considering that until about 10 years ago, oil services companies operating in Nigeria were not even required to register in the country, and therefore paid no taxes to the Nigerian government despite the billions of dollars worth of contracts they have executed over the decades.

The Nigerian oil industry has been rendered unnecessarily complex, but in reality has less than 10 ‘major’ players – including Shell Exxon Mobil, Chevron, Texaco and Total. These IOCs only have a few thousand Nigerian employees, but produce millions of barrels of crude oil daily for export. Our oil exploration policy appears to be designed in the belief – or maybe the hope – that government will only regulate the industry while everything else should go to the IOCs since crude oil export was its main thrust. This environment means that our oil industry is skewed towards the dictatorship of the IOCs, including all kind of incentives, policies, agreements and MOUs with little or no positive impact on job creation and growth in the real sector in Nigeria.

To understand the workings of the sector requires an overview of the entire process – from exploration to exportation of crude and the meanings of some common and technical terms – the 'black box' of the sector. At the moment, the entire process is shrouded in secrecy and open to a wide range of interpretations, mostly to the detriment of our economy and environment.

Although oil and gas deposits are found in many areas of Nigeria, the process of exploration to production go through a similar sequence of activities. The differences lie primarily in the technology and sophistication of the process of the oil exploration/production companies involved. Our Constitution states that all minerals, including oil and gas legally belong to the Federal Government, so all oil exploration and production require licenses and approval of government. The Nigerian National Petroleum Corporation (NNPC) and the Department of Petroleum Resources (DPR) represent and coordinate government activities in the oil and gas industry. The standard process has some basic components.

The initial step is to ascertain whether there is commercial quantity of oil in a particular oil field. During this phase, the Department of Petroleum Resources (DPR) will issue an Oil Prospecting License (OPL) to a prospecting company. The second component comes when the quantity of crude oil in a particular oilfield is projected, and an Oil Mining License (OML) is issued to the company. The final step is when an Oil Mining and Leasing license is issued. At this stage, all relevant MOUs are signed between the Government and the oil companies. Bidding fees and signature bonuses in hundreds of millions of dollars are earned in the pre-exploration stages.

Petroleum production and exploration are covered under the auspices of Joint Ventures (JVs), Production Sharing Contracts (PSCs) between oil companies and the Federal Government, Service Contracts (SCs) or the Marginal Field Development agreements. Joint Ventures and Production Sharing Contracts account for approximately 95 percent of all crude oil output, while local independent companies operating in marginal fields account for the remaining 5 percent. As at 2007, JVs accounted for about 72 percent of oil production, PSCs nearly 24 percent while Independent Producers and Service contracts had 3.1 and 0.49 percent respectively. There is another operational mechanism tagged ‘Alternative Funding’ whereby the joint venture partners make no direct funding contribution, but instead incorporate an entity that raises the funds so bears the direct financial burden of the production and exploration.

Joint Venture oil exploration and production arrangements are modelled after partnership agreements. It operates as a form of partnership between the joint venture partners, which spells out the participatory interest of each of the partners and also designates one of the partners as the operator of the venture. The NNPC represents the interest of the Government in the joint ventures arrangements that are currently ongoing, whereas the respective oil exploration and production companies operate the different ventures with varying participatory interests. The NNPC owns 55% of Shell’s production JV and 60% of other IOCs' JVs. Between $4-5 billion is spent each year as FGN's contribution to JV financing.

The Joint Venture agreement (JVA) governs the relationships between the parties, including budget approval and supervision, crude oil lifting and sale in proportion to equity, and funding by the partners. In addition to the agreement, a Memorandum of Understanding (MOU) governs the manner in which revenues from the venture are allocated between the partners, including payment of taxes, royalties and industry margin. The income derived from the operation is also shared in proportion to the equity interests of the parties to the venture, with each party bearing the cost of its royalty and tax obligations in the same proportion. Allocations are also made from the revenue to take care of operating and technical costs.

In the case of PSC, the IOC bears all the technical and financial risks of exploration of the field which remains the property of the government. This form is modelled along the lines of share cropping in agriculture, where the owner of the land grants a farmer the rights to grow crops on his land and shares the proceeds with the farmer in agreed proportions after the harvest.

Under the PSC, the contractor bears the entire cost and risk of exploration activities, and only reaps the rewards after a commercial find. In the event of a commercial discovery, the contractor recovers its costs fully from allocation of oil, referred to as ‘Cost Oil’. Allowance is also made from production for royalties, after which the remainder of the production, called ‘Profit Oil’, is shared in agreed proportions between the company and the government. The Oil Company thereafter pays income tax on its profits from the venture. The oil and all the installations remain the property of the government throughout the duration of the contract.

The major operators in Nigeria are still largely the holders of the PSCs but there have also been new entrants, made up of independent foreign oil companies, which enter into partnerships with indigenous companies to bid for oil blocks, and thereafter operate it in line with predetermined contractual arrangements. In Nigeria, this form of contractual arrangement is relatively new but growing, and covers mostly acreages in the shallow and deep offshore areas and the inland basins.

Marginal Fields comprise small and abandoned fields which have remained undeveloped by their joint venture operators. Such fields contain reserves that are considered uneconomic when produced by the multinationals but might be profitable if operated by indigenous entrepreneurs due to their low overhead and operating costs. There are over 100 such fields with collective estimated reserves of about 1.3 billion barrels. The interested parties in the development of marginal oilfields are the Federal Government, the indigenous entrepreneurs and the major oil companies that were originally allocated the oilfield. The standard method that is adopted for marginal fields is by government acquiring such fields from the major oil companies and reallocating them to intending indigenous investors.

Analysing the Nigerian oil and gas industry invariably leads to the conclusion that our existing policies have hampered the optimal development of these vital resources and limited our ability to use it to develop Nigeria and reposition our economy, with adverse effects on our environment and the lives and livelihoods of people in oil producing areas. Incidentally, one of the commendable efforts of late President Umaru Yar’Adua was the initiation of the Petroleum Industry Bill (PIB) which would have completely structured and reformed the oil and gas sector.

It is no surprise that the IOCs are so vehemently against it, with reports of massive ‘lobbying’ of members of the National Assembly to dilute its key provisions and even block its passage. If there is no truth in this, how come the National Assembly is yet to pass such an important Bill – one that borders on our national economic security – nearly three years after it was first submitted? Nigerians are watching. And waiting!