Nigeria Reconsiders Its Oil Contracts

6 MINS READSep 24, 2015 | 09:16 GMT
Nigeria Reconsiders Its Oil Contracts
Worker communicates with the control room at the Port Harcourt refinery in Port Harcourt, Nigeria, on Sept. 16, 2015.

Nigeria is in a quandary when it comes to energy. Its onshore and shallow-water oil reserves are maturing, and increasingly being eclipsed by the potential of the country's deep-water oil reserves. Yet, having neither the technological know-how nor the finances to develop deep-water wells, the Nigerian government relies on international oil and natural gas companies such as ExxonMobil and Shell to exploit its offshore fields. Nigeria has been trying since 2008 to renegotiate its archaic contractual terms with the companies it has come to depend on. There are deep-seated concerns that the Nigerian government in Abuja is missing out on billions in oil revenues. Though keen to maximize its revenue share, Nigeria has historically faced difficult market issues that have constrained its ability to negotiate the best terms. 

An announcement last week by the head of the Nigerian National Petroleum Company (NNPC) that contract negotiations were underway is revealing, but perhaps premature. Speaking at a Nigeria-France business forum in Paris, general managing director Ibe Kachikwu said that contractual terms with international oil and natural gas companies (IOCs) were under review, especially those relating to deep-water offshore fields. Nigeria has been in discussions for some time, but will have to tread carefully to avoid alienating the very companies it so desperately needs, which will take finesse.

Nigeria has long been considering how best to reform its contractual terms with IOCs. Yet, any previous attempt by the National Assembly in Abuja to push through legislation supporting new fiscal terms has resulted in political gridlock and opposition from IOCs. Unfortunately, the Nigerians are not in a position to delay. Like the majority of oil producing nations, Nigeria is suffering as a result of low oil prices. The price of a barrel of oil is almost at $40 and is unlikely to recover in the immediate future. The corporate finances of the NNPC as well as the coffers of the Nigerian treasury are increasingly depleted. This depletion has led to widespread austerity measures throughout the country and a reinvigorated desire to increase revenue from oil companies operating in Nigeria.

But first, parliament must agree on how best to proceed, which is problematic in itself. The ill-fated Petroleum Industry Bill floundered for over six years before it was effectively nullified as a result of former Nigerian President Goodluck Jonathan's polarization of Nigeria's key energy stakeholders. Now it is unlikely to be considered in its entirety because of the serious complications associated with reforming Nigeria's oil industry as a whole. The NNPC is the conduit through which the government regulates energy production and interacts with the global industry. It is far from a transparent organization. Nigeria has also come to depend on the same coterie of oil companies to handle the bulk of its energy extraction. These are the same IOCs that are expecting to be called upon to develop the new deep-water fields.

Abuja is aware that drastically modifying or cancelling existing contracts is a good way to alienate the companies that Nigeria desperately needs to access its enduring oil reserves. Still, low oil prices will likely force Abuja to proceed on the contract reform aspect of the Petroleum Industry Bill separately. Nigeria relies on oil for over 70 percent of its overall revenues and wants to ensure a greater return, but any renegotiation of contracts will not come quickly or easily.

The Difficult Road to Change

Nigeria's oil production can be loosely grouped into three areas: onshore production, shallow-water production and deep-water production. Each area produces roughly one third of Nigeria's oil. However, onshore production is waning as the most important fields reach the final stages of their lives. As a result, IOCs are starting to withdraw from the depleted onshore developments. Royal Dutch/Shell finalized a divestment plan in March, and Total completed a similar plan in the same month, to the tune of $1 billion. In July, Eni announced that it was considering a divestment of its onshore fields in Nigeria. In response, the Nigerian government has encouraged the development of its indigenous oil and natural gas operating environment. Increasingly, Nigerian operators are partnering with 2nd and 3rd tier international companies to take the place of the supermajors onshore in Nigeria.

While more difficult to exploit than onshore and shallow-water deposits, the future of Nigeria's oil production lies offshore. Nigeria's strategy is to allow smaller, more flexible, Nigerian oil companies to cultivate the remaining onshore developments while IOCs concentrate on megaprojects offshore. The problem is that Nigeria's current deep-water contracts were drawn up and signed in the 1990s, when deep-water exploitation was a relatively new prospect, therefore difficult and expensive. Nigeria also did not have any proven deep-water reserves at that point. To offset the costs and complexity associated with the development of offshore fields, Abuja had no choice but to offer attractive contractual terms. Today, these terms are some of the most favorable in the world to IOCs. For example, the royalty rate charged to IOCs is dependent on the water depth. Anything deeper than 1,000 meters (3,300 feet) is charged at 0 percent. The profit tax rate for IOCs in profit-sharing agreements on deep-water ventures is 50 percent, as opposed to the 85 percent rate common to the joint venture contracts typically used onshore.  

In the 1990s, when the deep-water oil industry was still in its infancy, oil prices were low, around $20 per barrel or less. At the time, the country was still isolated from the international community, considered a pariah because of the excesses committed by then-leader Gen. Sani Abacha. Nigeria wrote highly competitive contracts, but did include a clause that allowed for their renegotiation after 15 years. Many of the contracts that were signed toward the end of the 1990s are hitting (or have hit) that 15-year mark. In 2012, it was estimated that Nigeria could gain around $5 billion in additional revenue through renegotiation of its deep-water contracts.

Under the Petroleum Industry Bill's proposed terms, the royalty structure would be overhauled so that Nigeria would increase its share in deep-water contracts. The entire bill is under review and unlikely to ever pass in its entirety, but Abuja is suggesting a combination of production-based royalties and price-based royalties — royalties that increase as the production rate and the price of oil go up — that would each top out at 25 percent. Most of these provisions were considered between 2008 and 2012, with higher oil prices in mind. Though they will likely attempt to negotiate production-sharing contracts along those lines, Abuja and the NNPC recognize the need for the continued IOC involvement. Before he became head of the NNPC — appointed last month by Nigerian President Muhammadu Buhari — Ibe Kachikwu was the executive vice chairman and General Counsel of ExxonMobil's Africa unit. He is well aware of Nigeria's investment climate and the specific considerations of IOCs.

It is in this regard that Abuja's negotiating position is weak. The NNPC, as the Nigerian partner in private-led oil and natural gas projects, lacks the ability to develop deep-water projects by itself. Beyond the issue of technological capability, the financial resources to develop the high-cost/long-term projects that deep-water resources require simply are not available. The participation of IOCs is not only a matter of necessity, but also a well known fact to all. Regrettably for Nigeria, several events have deterred long-term investment in Nigeria's oil and natural gas industry, as reflected by Shell's decision in April to delay its proposed $12 billion Bonga South West project. Besides low oil prices and the uncertainty surrounding existing contracts, there is the status of the Petroleum Industry Bill and how the country will continue to evolve politically under Buhari's tenure.

Nigeria must continue to walk the fine line between appeasing oil companies and increasing its revenue. This will require a lengthy negotiation phase with the IOCs. There have already been assurances that any renegotiation of terms will be carried out in consultation with the companies themselves. But with the NNPC's announcement that it is firm on the evolution of Nigeria's energy industry, it now appears that Abuja has taken the first direct steps toward reinvigorating the country's finances. There are margins for give and take on both sides. The major oil companies have made the best of favorable conditions in Nigeria for decades but recognize that news terms will be required going forward. 

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