Power Sector: How PIB/Deregulation considerations dampens interest in mini refineries

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Thursday, July 30, 2015 11:38 AM / ARM Research


ARM continues their series of cut-outs from its core strategy document – The Nigeria Strategy Report, but directs their focus today towards developments in the domestic power space in H1 2015, outlining their views on policy trajectory for the sector in the second half of the year.


In February 2015, in the first and second tranches of the Nigeria Electricity Market Stabilization Facility (NEMSF), the CBN disbursed N57.79 billion to 11 power companies comprising 5 DISCOs and 6 GENCOs with the loan payable within 10 years of receipt. According to the apex bank, the funds were to support generation plant maintenance, transmission upgrades and distribution networks – including transformers and better metering for end consumers.


With this, stakeholder optimism for an eventual resolution of some power sector revenue monitoring challenges received a boost. In particular, the total sum rolled out in the first two legs of the scheme already outstrips the legacy debts of N36.9 billion owed to gas suppliers while the excess could be utilized to improve metering system – as highlighted by CBN – and positively reinforce NERC’s recent effort to clamp down on customers who tamper with domestic meters and crimp sector revenues in the process.


On other fronts, FGN’s formal provision of guidelines for efficient signing of Power Purchase Agreements (PPA) with Nigerian Bulk Electricity Trading (NBET) Company in January 2015 – aimed at fast-tracking the entire process of signing PPAs – appears to hold a few promises. Notably, the rules aim at improving clarity on issues relating to contractual frameworks for power generation, risk allocation, and tariff considerations. For its part, NBET continued to add to its long list of PPAs signed with GENCOs in 2015. It entered into PPA agreements with 10 new thermal generation companies (GENCOs) of the National Integrated Power Projects (NIPPs) late in H1 15, in furtherance of its quest to increase predictability and durability of expected returns from future power sector investments.


… but power value chain remains in knots
Despite the efforts of NERC and CBN, with the former providing incentives for adequate gas supply by  hiking benchmark gas to power price 67% to US$2.50 per thousand cubic feet (mcf) and the latter helping to stamp out pending debts to gas suppliers, gas supply for power generation failed to improve in H1 15. As noted by Ministry of Power, only an insufficient 8% of the entire five billion standard cubic feet of gas produced per day was directed to power generation in the period, with ~80% exported to foreign markets and the balance 12% used up by other industries. While explaining the improving preference for gas supply to industry relative to gas supply to power, the immediate past Minister of Power noted that gas suppliers’ reluctance to make gas available to GENCOs is largely underscored by fear of repeat of past experiences of delayed debt repayment. This underpinned suppliers’ insistence on long term letters of credits as guaranties for supplies to GENCOs which incidentally exposed the latter’s struggles as they largely failed to meet payment obligation. However, credit-worthiness was not the only concern as disturbances to Trans Forcados Pipeline (TFP), which reportedly accounts for ~50% of gas supplied to domestic gas market, and Escravos-Lagos Pipeline (ELP) further hindered supply. According to presidential task force on power generation, whilst the TFP reportedly suffered from oil theft and sabotage almost daily in the period, the ELP was blown up 4 times between January and March 2015 alone. Away from security-related concern, shutdowns in major gas plants such as Shell’s Alakiri Creek gas plants and 10 NIPP power plants – including Ihonvor and Geregu 1 & 2 – also affected gas supply in the period. These shut downs were particularly linked to strike actions by Petroleum and Natural Gas Senior Staff Association of Nigeria (PENGASSAN) and National Union of Petroleum and Natural Gas (NUPENG) – branch of Nigerian Petroleum Development Corporation (NPDC) which accounts for ~30% of gas used in generating Nigeria’s electricity – over transfer of rights over Oil Mining Lease (OML) 42 to two indigenous companies in the period.

Table 1: Recent Incidences of Vandalism & Impact on Gas & Power


Unsurprisingly therefore, whilst generation capacity is predicted to remain fairly stable at 7348MW in 2015 relative to YE 2014 numbers, the aforementioned gas supply challenges has restricted GENCOs capacity to raise actual power generation over H1 15. To buttress on the linkage with the aforementioned factors, Ministry of Power explained that a loss of 200 MMscf/d due to gas pipeline vandalisation could translate to ~700MW reduction in power generated while noting that pipeline vandalism led to a loss of 900 MMscf/d between January and February 2015 alone. This confluence of events led to decline in actual energy generated to ~2391.31MW in May 2015 from peak of 3,841.05MW in early February, before eventually recovering to 3655MW in June.


Figure 1: Generation, transmission, and distribution in 2015

 


The weak generation relieved transmission of being the key constraint on power supply, though YE 15 capacity is likely to remain flat from 2014 at 5,500 MW—clearly looking off the pace in reaching set target levels of 10,000 MW by 2017 and 20,000 MW by 2020. This is in spite of the reported deployment of ~ $2.7 billion of funds from World Bank, African Development Bank (AfDB), and French Development Bank, amongst others, into construction of new transmission lines and substations across the country. As has been the case in prior years, poor coordination with other players in the value chain i.e. GENCOs and DISCOs as well as bureaucratic delays in the execution of projects hampered power transmission in the country. Nonetheless, the very low generation meant current transmission capacity was able to support onward transmission of 98% of power generated in the last two months of H1 15.

 

For the DISCOs end, possibly reflecting the impact of CBN funding via NEMSF and the rise of several NIPP DISCOs, installed capacity is expected to jump 74% from YE 14 numbers to 16,050 MW in 2015. However, frequent meter tampering by consumers remains a significant weight on revenues. Importantly, while noting the entire value chain’s ultimate reliance on DISCOs for effective revenue collection, NERC recently issued a directive on meter reading, billing, cash collection and credit management to guide operators on the issue of revenue collection. In addition, the institution recommended disconnection and penalty – in form of a fine – to serve as deterrent to future offenders.  

 

 … will coal power Nigeria to the goal?

From the foregoing, the myriad of constraints, in particular, gas supply challenges remain a major clog in the wheel of progress on the power reforms. In addition, while measures such as NEMSF presented sparks of positives, the sheer size of the target yearly capital investment of ~ N520 billion earlier earmarked by Ministry of power for the realization of power generation capacity of 13,000 MW within a 3 year period and current economic realities necessitate the promotion of further partnerships with non-government institutions and pursuit of alternatives. To this point, FGN’s recent memorandums of understanding with Milhouse and One Nation Energy on the development of Enugu coal reserve and its subsequent utilization for power generation in March 2015 are pointers to newer efforts at galvanizing alternatives to gas-based power. This drive was further bolstered by African Development Bank’s recent pledge of US$200 million as Partial Risk Guarantee (PRG), specifically for coal-to-power projects. Interestingly, this development positively complements earlier plans for substantial investments in nuclear power plants in the country as both are geared towards reducing dependence on the erratically-supplied gas. In passing, we note that, on the urging of International Atomic Energy Agency (IAEA), Nigerian Atomic Energy Commission (NAEC) recently announced plans to commence detailed evaluation and characterization of the nuclear power sites for the proposed 4,000 MW power plants at Geregu and Itu – respectively in Kogi and Akwa Ibom states.


In our view, coal to power looks a relatively easier path in terms of managing environmental and regulatory constraints. Whilst the use of coal for energy generation could also engender some concerns about environmental hazards, the case for its suitability in the country is supported by Ministry of Power’s resolve to seek out and encourage clean coal technology that would see possibility of emissions significantly reduced. In addition, AFDB’s PRG offers a measure of reassurance and backing for long term solution to incessant gas infrastructural challenges in Nigeria. Given recent accentuated investments in this area and the Ministry’s guidance for an expected 500 MW from planned coal-propelled energy generation from the South East over the long term, we see scope for significant gains in overall outcome of the current fuel to power campaign of the ministry.

 

That said, in the near to medium term, we expect disruption of gas pipelines and vagaries of production to continue to underpin erratic power generation in the country. Notably, after an assessment of potential impact of industry changes on key players in the sector, we note that sub-optimal power generation is likely to stoke shortages, narrow down the amount of power delivered to consumers and stimulate fear of possible re-appearance of cash flow worries for DISCOs. This, together with reported frequent meter tampering by end users, could impact negatively on fees and service charges collected and, ultimately, hamper revenue numbers in the near to medium term. Thus, with the earlier noted NBET’s PPA agreement looking likely to drive increased scope for faster cash returns to GENCOs in the medium to long term, these emerging revenue worries at the DISCOs end could return them as the weak link in the entire process going forward.  


PIB and deregulation considerations dampens interest in mini refineries 

Perhaps one fall-out of the controversial PwC audit report[1] is the new government’s apparent prioritization of NNPC and oil sector reforms over other restructurings. Interestingly, even as speculations that the President could eventually take on responsibility for the oil ministry underscores the weight of emphasis placed on the issues, the more recent dissolution of the board of NNPC on June 26, 2015 suggest political will to go even deeper to root-out traces of unaccountability in the institution. The need for a more transparent NNPC had already re-invigorated the long dragging debate over passage of the PIB, which was meant to revamp everything (i.e. from fiscal terms to the overhauling of NNPC, environment rules, and revenue sharing). However, whilst the lower chamber of the 7th National Assembly managed to pass the PIB on its last day of seating (June 3, 2015), the upper chamber – Senate – were unable to see the bill through.


On a positive note, work on Dangote Lekki refinery appears to be progressing, with the reported selection of Honeywell Technologies, whose sister company – UOP technology – has been championing the development of the refinery, as eventual facility operator upon completion. In turn, UOP recently disclosed that its process technology, catalysts and proprietary equipment would form the basis for Dangote refinery. Besides this, expected production from the facility was scaled up to 650,000 bpd (vs. 450,000 bpd initially planned) whilst planned capacity for the petrochemical plant project was increased by over four fold to 3.6 million tones. This would comprise 2 million tonnes for polypropylene and 1.6 million tonnes of polythene. Overall, whilst renewed political will on the part of the new government bolstered early hopes of a quickened pace in Nigeria’s oil sector reforms, concerns over policy framework means the Dangote Refinery represents the only potential game-changer with its benefits likely longer-term, suggesting frequent domestic shortages and reliance on importation of refined crude will subsist in the interim.


On other fronts however, DPR’s recent downward review of the $1 million (now $50,000) prospective modular refinery owners were supposed to deposit with it appears to have increased the ease of setting up mini refineries in the country. Specifically, the move reduces both the cost and time to completion of mini refinery projects. More importantly, DPR expressed hopes that the current affordability should forestall a repeat of past experiences such as in 2002/2003 when the issuance of 18 licenses for the establishment of private refineries was stifled by prohibitive requirements. Thus, with capacity utilization in Nigerian refinery at ~ 21%, given its small size and greater flexibility, mini or modular refineries are better able to adapt to meet dynamic local demand and clutch value from marooned hydrocarbons in remote locations and marginal fields. In addition, with importation of refined fuel constituting significant part of Nigeria’s import, a re-direction to modular refinery could lead to substantial forex savings for the country.


However, despite aggressive campaigns to stimulate interest in modular refineries, investors remain cautious of the impact of government’s price regulation of the downstream sector as well as that of the long-dragging debate on passage of the PIB on private refinery business. In particular, with government stalling on complete deregulation of the downstream sector, continued enforcement of price ceilings could make meeting cash and debt obligations difficult for potential modular refinery investors who might rely heavily on bank funding. 


In addition, while commenting on investors’ reluctance to pick up modular refinery opportunities in Nigeria, DPR highlighted lack of funding as principal restraint on investor interest. In particular, government’s insistence that modular refinery operators obtain local crude oil at international market prices while holding firm to the proviso of sales at the official rates (i.e. PMS: N87/litre) stokes fears of unattractive returns for would-be investors. The overall obscure commercial framework for both borrower and lender, with local banks having grown wary of funding oil-related businesses, appears to have underpinned stakeholders’ recent clamour for sovereign guarantee on foreign loans.


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