ADDITIONAL REFINING CAPACITY; A VIABLE OPTION FOR NAIJA?

By Pagaebi Opuene

In Nigeria, the estimated growth rate in the demand for white products (PMS, DPK & AGO) is 5% per annum. Therefore, if current demand of 15.24 Million MTPA (Metric Tonnes Per Annum) is projected to 2015, it will result in a 2015 demand of 19.45 Million MTPA. If the existing refineries were able to achieve 63% of nameplate capacity and double production to 8.36 Million MTPA, the supply gap in 2015 would remain unchanged at 11.09 Million MTPA. If regional demand is taken into consideration, then the refining capacity will have to be increased.[1] A Greenfield Refinery Project has been proposed to be built at the Lekki Free trade zone in Lagos, Nigeria and will cost about US$5 Billion.[2] It is my objective to show through this article that an additional refinery capacity can be economically and financially viable; while pointing out that government must have clear-cut goals and objectives in eliminating all distortions- in order to ensure continuity, efficiency and profitability.

 Data presentation and analysis

Current Market Fundamentals of Petroleum products in Naira

PRODUCTS (per litre)
Cost components(N)	PMS	AGO	HHK	LPFO	ATK
Cost and Freight	88.63	90.75	93.04	72	93.53
Other charges	5.71	4.26	6.43	4.15	4.27
Total	94.34	95.01	99.48	76.31	97.80
Margins	13.20	13.20	13.20	11.71	9.50
Expected Price	107.54	108.21	112.21	88.62	107.30
Retail Price	65	110	50	75	85

Source:  www.pppra-nigeria.org

Assuming 1 barrel = 159 liters

Exchange rate of $1 = N151.60

Evaluation of the project and cost assumptions

I will conduct an annual revenue analysis on the Greenfield refinery project. Already identified cost and other cost assumptions will be made based on opportunity credible information and estimations by refinery experts.

Refinery project location and cost

The refinery plant has been projected to be built on a 16,000 hectare of land at the Lekki free trade zone in Lagos, Nigeria. A proposed investment of $5 - $6 billion for the refinery has been stated.[3]For the purpose of my analysis I would place the capital expense at $5.5 billion assuming that no further expenses will go into capital- which is not so in reality.

Plant capacity and output

The Greenfield refinery plant has been projected to have an initial production capacity of 240,000 bpd and 360,000 bpd at full capacity.[4] For the purpose of my economic analysis, an average production capacity of 300,000 bpd will be considered also allowing for downtime and unscheduled maintenance. The plant will also not be expected to operate everyday of the year, 360 days will be considered for the analysis.

The refinery is expected to have an average product yield of PMS-35%, HHK-20%, AGO-26% and other petroleum products grouped under 19%.

The refinery is billed to commence production in 2017,[5] with an expected lead time of four years, 2012 would be assumed as the year of commencement of the project. 2017 would be considered as the production year.

Operating and Maintenance Cost

Costs to be considered under this will be the equipment maintenance and repair cost, overheads, salaries and wages, equipment depreciation and other utilities. The cost of chemical inputs will also fall under this category.[6] The analysis will assume an average weighted operating cost of processing Nigerian crude of $35/bbl.[7] Which is inclusive of the opportunity cost of Nigerian crude (oil at international market based price as transfer cost to the refinery.

Other non refinery costs to be considered are cost of funds and finance, government taxes and insurance cost. For the purpose of this analysis only cost of funds would be used. The discount rate of 12% would be used to amortize the capital.[8] The other costs would be of great significance to the analysis but for the purpose of simplicity, they will not be included in the annual revenue model.

Price of Petroleum products and Project revenue

The average prices of refinery products adopted for the purpose of this analysis are PMS-$69/bbl, HHK-$53/bbl, AGO-$112/bbl and other petroleum products considered to be an average of $115/bbl. The revenue figure will be achieved by multiplying the product price and the quantity produced. These prices are expected to remain constant for duration of 30 years, which is the life span of the project- although this does not happen in reality. Especially with the introduction of the Petroleum Industry Bill and the deregulation of the oil and gas sector in Nigeria, it is expected that there will be competition and prices of refined products will be more realistic and huge savings on oil subsidy will be gained.[9]

Currently the price of petroleum products in Nigeria is still subsidized by the government as a negative tax incentive to the populace.

Model Description

The annual revenue model to be applied on the Greenfield Refinery project will be based on my prior assumptions. Although in reality this model does not exist, it however gives us an insight to how a proper analysis should be viewed. Analyses carried out on such projects in the real world are more complex than the analysis presented in this article.[10]

The net revenue of the project will be achieved by subtracting the capital and operating expenses from the total revenue to be received from the sale of the petroleum products. The capital cost would be amortized at the discount rate of 12% for the 30 years of the project’s life. From the excel sheet, the amortized cost will be added to the total operating cost and divided by the output to arrive at the average cost of producing one barrel.

GREENFIELD REFINERY PROJECT
Discount rate	12%
PRICE
PMS  ($Bbl/d)	69
AGO   ($Bbl/d)	112
HHK  ($Bbl/d)	53
OTHER PRODUCTS ($Bbl)	115
ANNUAL OUTPUT
PMS (Bbl/d)	105,000
AGO (Bbl/d)	78,000
HHK (Bbl/d)	60,000
OTHER PRODUCTS (Bbl/d)	57,000
COST
Capital ($)	5,500,000,000
Capex ($ amortised)	(682,790,116.54)
Opex($)	(3,832,500,000)
Total Revenue ($)	9,257,760,000
Total Cost  ($)	(4,515,290,116.54)
Net Revenue ($)	4,742,469,883.46
DECISION	PROJECT IS FAVOURED

Source: Author’s compilation

Findings and Decision rule

The project will be favored if it has a positive Net revenue. The Greenfield refinery project is considered very attractive as it promises high returns. It should be borne in mind that these conclusions have been reached using conservative figures.

Based on the revenue model used, the results show that the Greenfield refinery project is economically and financially viable because it gives us positive net revenue of $4.74billion.

Sensitivity Analysis

A sensitivity analysis with respect to changes in the price of the various petroleum products and operating cost is carried out to see the effect it will have on the net revenue.

Source: Author’s compilation

The sensitivity table shows us how sensitive the project revenue is to variations in the discount rate, operating cost and the product prices. The returns on were positive on all counts of variation. However, an operating expense of $50/Bbl and PMS Price of $40/Bbl produced the lowest net revenue. A discount rate of 8% produced the highest net revenue of N4.93 billion which is very relevant as the Nigerian Banking sector is facing new reforms.[11]

The model also showed us a payback period of 5 years which makes the project very attractive as it promises high returns on investment. Next are other determinants of the economic viability of the Greenfield refinery project;

Other factors that determine the viability of project

Refinery Location

In general, it is more economical for a refinery to be located close to its market than an oil field[12] as is the case of the Green field refinery project set to be built in Lagos, at the Lekki free trade zone, the economic nerve centre of the nation (Nigeria). The project has the advantage of being in close proximity to its market. Although it is far from crude oil source compared to Port Harcourt which has the both petroleum and petrochemical refineries, the project will be taken with the liberalization that comes with the free trade zone.

Foreign Exchange Savings

As at 2008, the NNPC alone imported petroleum products worth $5,660,940,164. It owns a share of 65% for PMS and 83% for HHK.[13]In view of these figures alone Nigeria is bound to make huge savings on foreign exchange with estimated net revenue of $4.74 billion.

This will in turn have a positive impact on the country’s balance of payment and exploit the benefits of exporting after and when domestic demand have been met.

CHALLENGES TO THE GREENFIELD REFINERY PROJECT IN NIGERIA

Government policies and their execution are perhaps the most important factors in the refining industry, since they shape the matrix of supply, demand and distribution of petroleum products. Consequently, they control the price and other economic indices.

Commercial Risk

Factors underlying this type of risk are; the possibility of changes in the market demand for petroleum products which will in turn affect the revenue and profitability of the project.

The project could also run the risk of fluctuations in interest rate. At higher interest rates the economics of the project would be at risk. Even with present crises of the banking sector in Nigeria[14], the project will have a financial risk of non availability of funds (If funded locally) between commencement and commissioning of the project.

Political Risk

Nigeria today is enmeshed in unpredictable political instability that makes foreign investment unattractive. Inconsistency in fiscal measures by the government could militate against the economic viability of an additional refining capacity.

NUTSHELL:

According to Pagaebi, the analysis carried out on the greenfield refinery project at Lekki Free Trade Zone has shown that- based on assumptions- the project can be financially and economically viable. From the sensitivity analysis it can be observed that discount rate and operating cost of the project will affect the profitability of the project, therefore caution must be taken in the management of these variables.

Although credible assumptions were made, the model (not an exact model in reality) analysis adopted, captured major variables of the project and gave an insight that the greenfield refinery project is viable.

She concludes by emphasising that; for growth and survival of this project, the government must have clear cut goals and objectives and eliminate all distortions to ensure continuity; efficiency and profitability in the operation of new and existing refineries to allow them reach their designed life span. The government should also focus on the full privatization and deregulation of petroleum products to attract premium values. Furthermore, an additional refining capacity can stimulate the nation’s export potential by shifting emphasis on crude exports only and maximize its petroleum resources.  


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