Written By: Ritarilla Barick Yusuf
With the discovery of oil in commercial quantity in 1956, the Nigerian government began to place undue reliance and focus on the oil and gas sector to the detriment of other key sectors like mining, agriculture, services etc.
Nevertheless, there has been a renewed emphasis on the need to diversify the economy in the recent past, and the Nigerian government has indeed taken some steps in this regard.
However, the advent of the COVID-19 Pandemic and the attendant restrictions, brought setbacks to some of the economic diversification plans.
Furthermore, the COVID-19 Pandemic exposed the vulnerabilities of the Nigerian economy, as the country suffered significant foreign exchange losses arising from the slump in the global prices for crude oil products. Many operators within the sector began to evaluate available hedging strategies because of the persistent challenges in the sector.
In this article, we examine the prospects of Nigeria’s oil and gas deposits vis-à-vis the role of legislative reforms in unlocking the inherent value before it becomes lost to the dynamics of the industry.
The Case for Cleaner Energy Sources
More and more, operators in the oil and gas industry are beginning to appreciate the drop in focus on energy from fossil fuels. This is because of the overriding strategic plan to explore the huge potentials of renewable energy as it is fast approaching price points that may be competitive with energy from fossil fuels. Moreover, broad international consensus is emerging that fossil fuels are damaging to the environment, and that governments must help accelerate a transition to cleaner energy.
Although investors do not typically take kneejerk reactions to trends, it is clear that they have started retreating from the oil and gas sector as the sector’s share of the S&P500 index has declined by about -4.57% over the last 10 years. The implication of this is that it has become a lot more difficult for operators to raise the capital needed to operate, and where the capital is available, operators must allocate some capital to position for the ongoing energy transition. As always, capital will pursue the best returns; thus, necessitating the need to evaluate the next steps regarding oil and gas development in an oil-rich nation like Nigeria given the various pointers towards diversification.
The Petroleum Industry Bill
One cannot overemphasize the role of legislative frameworks in the development of any economic sector such as the oil and gas sector because sanctity of contracts and consistency of regulatory and legal framework play a huge role in the decision making of investors. Some investors had considered the potential implications of the Nigerian Petroleum Industry Bill (PIB or “the Bill”) on their current operations and most importantly, on the huge investments being considered. However, the passage of the Bill has experienced various setbacks for over a decade.
Although the Nigerian government introduced some amendments to the fiscal aspects of the legal framework via some changes in the Finance Act and the passage of the Deep Offshore and Inland Basin Production Sharing Contract (Amendment) Act 2019, these changes are minute considering the huge challenges of the Nigerian Oil and Gas Sector. However, policymakers have identified some of these challenges, and either partly or fully, addressed them in the most recent publicly available version of the PIB.
As hope rises about the eventual passage of the Bill, it is important to evaluate some of the key issues in the current version of the PIB and their potential impact on the performance of the sector, as well as the ability of the sector to contribute to Nigeria’s economic growth even as global crude oil demand shrinks. For the purpose of this short talk, I have focused on some fiscal terms, which I believe have far-more reaching import for investors
Dual Tax Structure
Across the world, countries separate corporate income taxes from any incremental tax that is connected to the value creation from a natural endowment. The PIB in its current form provides an attractive Hydrocarbon Tax (HT) on new licenses and clearly exempts non-associated gas from HT. However, the complexity of the rules around deductibles poses a major drawback to the proposed scheme. Perhaps, this could result in varying interpretations between tax administrators and operators on the treatment of transactions for tax purposes. Thus, it may be better to use a flat tax structure of (X+Y+Z)% comprising HT (X%), CIT (Y%) and Education Tax (Z%). This would be similar to the new fiscal terms for significant investments in the oil and gas sector in Saudi Arabia. The other option would be the use of HT as a base rate, with CIT charged only after recovery of capital investments.
“As always, capital will pursue the best returns; thus, necessitating the need to evaluate the next steps regarding oil and gas development in an oil-rich nation like Nigeria given the various pointers towards diversification”
The Bill seeks to amend the sections on deductions allowed and deductions not allowed. One would expect that the PIB should not deny the deduction of legitimate expenses (e.g. seismic costs, capital improvement, and expenses incurred outside Nigeria with respect to international experts), if the costs are incurred in creating value because costs are critical in generating revenue. Thus, proper attention must be paid to the deductibility or otherwise of costs to ensure such restrictions do not constitute disincentive for investors.
Conversion Terms for New Production
The PIB stipulates certain cap to Cost Price Ratio, forfeiture of rights under existing contracts, relinquishment of large portions (c.60%) of existing acreage and removal of the options for value chain consolidation when converting to the new terms. These conditions seem to negate the few incentives for conversion of existing producing licenses to the new terms. As such, it is important to review these conditions critically to ensure that the gains of having a legislative reform is not lost.
Incentives for Commercialization of Gas Resources
Natural gas is one of Nigeria’s most strategic resources. First, it can lead to affordable costing of power generation leading to broad economic development and growth. Second, as feedstock for fertilizers, gas is critical for boosting the productivity of the agricultural sector which currently employs about 35% of Nigerians. Therefore, natural gas could have a transformative impact as an income and employment multiplier.
Government stakeholders have held that a key objective of the PIB is to unlock investments in the gas sector – creating additional revenue lines for the government and creating new job opportunities. However, the current proposals in the PIB have the potential to derail gains made in the pricing framework as well as the fiscal incentives for gas over the last decade. This is because prospective investors would typically evaluate the attractiveness of Nigerian fiscals in comparison with those in other jurisdictions.
Based on the above, it is important for the government to carry out a comprehensive benchmarking study that would assess investor returns and government take in the new proposals compared to countries similar to Nigeria. By so doing, the government would be able to avoid a situation where it is unable to attract sufficient investment, which could result in reduced government revenues in the medium to long term, amidst a swelling youthful population.