Sustained Low Oil Prices: A blessing in disguise for Nigeria's Downstream Sector?

By Nkaepe Lisk-Carew 

 

Nigeria's downstream sector has always sat in stark contrast to what had always been a thriving upstream oil and gas industry. The downstream sector was very much the sick child of the Nigerian oil and gas industry, defined and plagued by chronic fuel scarcity. During such times of scarcity, the petrol stations across the country would be littered with never ending queues of cars while jerry-can carrying touts held court in the thriving black market, the price of petrol often selling at five times the going rate.

Nigeria has always focused on the upstream sector. With good reason too. It was, quite frankly, the breadwinner of the family with energy sales accounting for up to 80% of the Nigerian government's revenue and 90% of the country's export. In the first quarter of 2014 alone (obviously before the oil price plummetted), Nigeria realized N2.432 trillion in oil revenue compared to N299.2 billion realized from revenues from non-oil sector sources. This has meant that the current low oil prices has hit Nigeria hard because the government's income is not diversified. Between June 2014 and January 2015, oil prices fell by nearly 50 percent, and the oil price has remained low since then despite one or two upticks. Oil exporters are said to be receiving about 54% less than what they received in 2013.

In response to the continued low price of oil, Nigeria has had to revise its 2015 budget by adjusting the oil price assumption and cutting spending, especially capital expenditures. Currency depreciation and falling foreign reserves prompted monetary and exchange rate policy adjustments. The Central Bank of Nigeria raised the policy rate, and discontinued its reserve drawdowns to defend the naira. The naira has been devalued twice already. Inflation has accelerated. Overall, this period of low oil prices has meant a weak outlook for Nigeria. But what if the oil prices remain at its current level way past 2015 and 2016. What would that mean for an economy such as Nigeria that is so heavily reliant on Oil export revenues? Could there be a silver lining behind all of this?

While the upstream has been hit very hard by the current oil price,the downstream in a lot of countries, has enjoyed a boost in revenue. The low oil price environment has meant that the cost of feedstock has also fallen materially. Could this be the blessing in disguise? a signal from the market to cause Nigeria's ailing downstream sector to cast of the sack cloth and ashes to become the one who brings home the bacon?

 
Before I attempt to answer that question, let me profer my own opinion on why to date, the downstream sector in Nigeria has been addled with issues. I appreciate that this may be an oversimplification of complex economic issues (I am only a kitchen economist and so I dwell in the realm of simple). However, I consider that the root cause of the Nigerian downstream sector's travails can be traced back to high crude oil prices (and the weak Naira). This made it more attractive to export crude for foreign exchange rather than supply the domestic market. Further, high crude prices meant a higher cost of feedstock (which wasn't even readily available because most, if not all of the crude was exported). This invariably meant that it was easier to import refined petroleum product than to refine the crude in Nigeria. Let's not forget the eye watering amount of government subsidies made available to petroleum marketers for the import of refined product. With such a huge pay day available to importers of refined product, why go through the hassle of refining? As a result, Nigeria's refineries were brought to a grinding halt, operating far below capacity if not dormant for extended periods of time due to prolonged states of disrepair.

Now with the decline in government revenue as a result of the plunge in oil prices, the government has been finding it difficult to pay subsidies due to oil marketers. The month long fuel scarcity in May 2015 was as a result of non-payment of subsidies by the government. The new government has remained silent on its plan for the subsidy regime and the industry as a whole. The truth is that the new government can do without paying out huge fuel subsidies which is rumoured to be in the region of N2 billion per day. If the government where to put an end to the subsidy regime, a complete deregulation of the market would be required and this could lead to a tripling of the pump price of petrol (N87) if done when the oil price is high. This would ultimately lead to a significant hike in the price of goods and services, making life worse for the average Nigerian.

The truth is that the outlook for Nigeria's downstream sector has been bleak for quite sometime, prompting major players such as Oando to exit the downstream business all together. Oando in July of this year announced to its investors and journalists that it would be divesting its downstream business to focus on its upstream and midstream business. Without a doubt the uncertainty in the sector has led to this point.

 

 Ever the optimist, I am determined to find the blessing in disguise amidst all the low oil price woe. As I mentioned before, the logical effect of the fall in oil prices means that the cost of feedstock for refining has also fallen. For the purposes of this post I will focus on the refining segment of the downstream sector as I consider this segment to be the most critical to the average Nigerian. The decline in feedstock should hopefully signal to the downstream market to invest more in refining. That, and whether or not the subsidy regime will continue. The market should assume that the subsidy regime will not continue (because it is clearly unsustainable. Nigeria cannot afford to pay these subsidies if the price of oil persists at this level). Therefore, making imports less attractive to oil marketers. The market should realize that it is just as lucrative (perhaps even more so) to supply crude to the domestic market for refining instead of exporting.

Nigeria, with over 180 million people, cannot not be said to be lacking in demand for refined products. Nigeria consumed 305 000 bpd of petroleum in 2014. The fact that there is a problem of illegal refining is testament to the fact that there is a market there (albeit a black market. Personally, I think instead of closing these illegal refineries, the government should give them the platform to operate legally. There is some technology there that could be improved on. Take away the criminal element, tax their revenues, a win win for all, but I digress). Sustained low oil prices should signal investors to invest in the infrastructure required to provide the much needed supply to meet the demand for refined product.

 

 However, if these investors are reliant on upstream receivables (for instance if they are IOCs or NOCs), then the fall in oil prices could result in financial pressures which could cause them to reduce their downstream capital expenditure. For example Kuwait Petroleum Corporation (KPC) announced the cancellation of planned investment at its Rotterdam refinery. Marathon and Sinopec also announced similar investment cuts. This is the wrong approach in my opinion. After years of huge upstream revenues, there should be some money in the kitty to sustain capital investment. Instead of cutting back in the downstream sector, it should be positioned to take advantage of the opportunities that low oil prices present. Most commentators expect the oil price to stay low for an extended period of time. Therefore there should be a paradigm shift in strategy. Countries and companies alike should be thinking of how to continue making money while the oil price is low. One of the ways to do this is to grow their downstream business.

It goes without saying, that Nigeria should use this time to focus on diversifying its sources of revenue ( this point has been made and reiterated to death) but I consider, most important of all, that the Nigerian government should use this period of low oil prices to partially, if not totally, deregulate the downstream market. For example, in October 2014, taking advantage of the dip in oil prices, India announced the deregulation of diesel prices. Even a partial deregulation could lead to huge savings for the Nigerian government which in turn could be applied to fund more deserving projects. The subsidy was arguably necessary before because the high price of oil made the cost of imports high also. This argument is made redundant if low oil prices persist. Deregulation is more achievable now then ever before. Particularly if the market shifts from reliance on imports to domestic production of refined products.

The low oil price has changed the game so to speak. It presents Nigeria with a unique opportunity to set right what has been wrong with its downstream sector for a very long time. It should be seen as a blessing in disguise.

 

About Nkaepe

A legal professional with over 7 years’ experience in the profession, beginning in private practice in 2007 and making the switch in-house in 2010. Who during this period, commenced and subsequently completed an LLM in Petroleum Law and Policy. Nkaepe has garnered a wealth of experience in Oil and Gas matters and possesses a deep understanding of upstream legal issues. Nkaepe is the author of 5 articles published in the field of oil and gas law being on joint operating agreements, carbon capture and storage and on investment arbitration. Nkaepe is currently an Attorney with Schlumberger