NIGERIA: OIL COMPANIES SHARE CONCERNS WITH DOE A/S

S E C R E T SECTION 01 OF 05 ABUJA 001575 SIPDIS SIPDIS PLEASE PASS USTR FOR AGAMA DOE FOR CAROLYN GAY DOC FOR 3317/ITA/OA/KBURRESS TREASURY FOR DAN PETERS E.O. 12958: DECL: 07/24/2017 TAGS: ENRG EPET ECON PREL SUBJECT: NIGERIA: OIL COMPANIES SHARE CONCERNS WITH DOE A/S HARBERT ABUJA 00001575 001.2 OF 005 Classified By: Economic Counselor Necia Quast for reasons 1.4 (b & d). ¶1. (C) SUMMARY: Gas exploration is necessary to meet supply commitments for both export and domestic use and the Government of Nigeria (GON) should provide adequate fiscal terms for international oil companies (IOCs) to invest in gas development for domestic use, according to IOCs Total, Shell, Chevron, and ExxonMobil. IOCs observed significant progress in building local capacity, but meeting Nigeria's ambitious local content goals would be difficult. Both Nigerian National Petroleum Corporation (NNPC) and IOCs advocated an increase in Nigeria's OPEC quota to accommodate new oil production capacity. Insecurity in the Niger Delta had increased cost margins and limited IOCs ability to find quality oil services contractors. The GON had pressured IOCs to invest in Nigeria's refining sector, but high GON subsidies for domestic fuel made private investment in refining uneconomic. END SUMMARY. ¶2. (SBU) U.S. Department of Energy Assistant Secretary for Policy and International Affairs Karen Harbert on July 17 met with the Nigeria managing directors of international oil companies (IOCs) Total ) Jacques Marraud-des-Grottes, Shell - Basil Omiyi, Chevron - Andrew Fallthrup, ExxonMobil - John Chaplin, and separately with Nigerian National Petroleum Corporation (NNPC) Group Managing Director Funsho Kuplokun and senior NNPC staff to discuss the oil and gas sectors in Nigeria. -------------- -------------- Gas Exploration Essential for Myriad Supply Commitments -------------- -------------- ¶3. (C) Meeting gas commitments would require comprehensive exploration for Nigeria's ample undeveloped gas reserves. A senior NNPC official indicated NNPC was considering gas exploration and told A/S Harbert that it would be difficult for Nigeria to develop its gas reserves as fast as proposed gas export projects, underscoring that Nigeria had previously only found gas when looking for oil and had never engaged in gas exploration. Kupolokun assessed Nigeria had 7 trillion cubic feet (Tcf) of gas, but 38% of this was restricted in gas cap formations and would not be extractable until their constituent oil reservoirs had been depleted. ¶4. (C) The task of committing gas supplies for both export and domestic use led some industry observers to question whether Nigeria would have sufficient gas to meet its supply obligations. Total rep Jacques Marraud-des Grottes dismissed this as a misconception, stating instead that the constraint would be accessible gas supplies. Just as Nigeria had implemented Production Sharing Contracts (PSCs) for offshore oil development, Nigeria needed a framework for gas exploration to determine how the GON and IOCs would share gas stocks and proceeds. ¶5. (C) The IOCs noted that developing Nigeria's gas resources, and subsequently the terms under which gas supplies were sold to the domestic market, would be a material factor in the long-term development of Nigeria's domestic power sector. As of July, IOCs had plans for four gas export schemes in Nigeria: new liquefied natural gas (LNG) terminals Brass LNG and OKLNG; the expansion of the NLNG project; and Chevron's gas-to-liquids (GTL) plant at Escravos. Given Nigeria's domestic energy crisis, however, both the IOCs and Kupolokun acknowledged that the GON might require IOCs to commit a percentage of their total gas supplies to the heavily-subsidized domestic market, which the IOCs assessed would affect the pricing structure of gas currently exported at world prices. ¶6. (C) An NNPC official suggested that the administration and legislature were working on implementing several key reforms including the Downstream Gas Act, a revision to Nigeria's gas fiscal scheme, and the Gas Master Plan. An IOC ABUJA 00001575 002.2 OF 005 suggested that IOCs had more allies in the new Nigerian National Assembly than in the NNPC. -------------- Fiscal Terms Key to Developing Gas -------------- ¶7. (C) The IOCs asserted that Nigeria's fiscal environment would impact heavily future gas investment. NNPC underscored that inadequate GON funding for joint venture (JV) oil project increased project costs, and the IOCs lamented that the GON did not understand their JVs' true funding requirements. Shell opined that the NNPC erroneously thought IOCs could cheaply supply gas to the domestic market. The IOCs contended that issues Nigeria's gas framework should address included securitization of GON payments for domestically-supplied gas, domestic energy pricing, accounting rules for gas investment, and incentives for developing deep water gas reserves. -------------- Securitization -------------- ¶8. (C) ExxonMobil rep John Chaplin reported that the real cost of power generation in Nigeria from many privately owned diesel power generators was very high, but lamented a perceived public unwillingness to pay incremental increases for electricity from the grid. He decried the GON's procrastination in gas and power sector reform and payment securitization. Shell defended the GON's financial position noting that the Nigerian Electric Power Authority's (NEPA) successor companies had inherited collection problems, citing an improving current collection rate of 60%. He believed the new government was committed in one form or another to carrying out former President Obasanjo's stalled plans to meet IOCs' securitization demands, but questioned whether the Nigerian public would pay market prices for power. One IOC noted that a lack of political stability in Nigeria made it more difficult for IOCs to secure credit for large investment projects. Delays inherent to operating in Nigeria meant deepwater projects that typically take 3 to 4 years to complete elsewhere take 10 years in Nigeria, requiring stability over several governments. -------------- Subsidies and Taxation -------------- ¶9. (C) While the GON's high subsidies for domestic energy consumption discouraged private gas investment, Shell estimated that limited capacity rather than the gas price drove the electricity tariff, advocating that the GON offer a declining capacity charge subsidy to replace the subsidized electricity tariff. Another IOC noted that while GON had gradually increased gas pipeline transportation tariffs, most IOCs could not develop gas economically at the subsidized rate. As of July, the Yar'Adua administration was in the process of formulating a more thoughtful process to increase the transportation tariff to encourage IOC gas investment ¶10. (C) For gas investment amortization and taxation rules, a senior NNPC official advocated departing from the Associated Gas Framework Agreement (AGFA) that allowed IOCs to recover 85% of gas development costs against upstream oil income. This practice amounted to selling subsidized gas abroad in the midst of Nigeria's domestic energy crisis. The official stated Nigeria must protect gas future revenue and apply any subsidies to the domestic market. Nigeria's new gas fiscal regime allowed the GON to collect additional taxes on gas investments, implementing an escalator provision when a gas project matured. One IOC asserted that despite the GON's negative attitude towards AGFA, IOCs would not consider investing in independent power projects (IPPs) without it. ABUJA 00001575 003.2 OF 005 -------------- -------------- Progress on Meeting Tough Local Content Requirements -------------- -------------- ¶11. (C) NNPC officials reiterated to A/S Harbert Nigeria's commitment to local content requirements in the upstream sector. The IOCs said Kupolokun's policies had boosted local content and significantly expanded local engineering capacity. IOCs were making progress on meeting GON local content goals; the GON had set ambitious local content requirements which pressured IOCs to "go as fast as possible," but probably realized they might not be met. Local content requirements were enforced inconsistently by different GON ministries and a lack of high level ministerial coordination made it difficult for IOCs to meet these requirements. -------------- OPEC Quota Allocation Insufficient -------------- ¶12. (C) Both NNPC and the IOCs contended that Nigeria's OPEC oil export quota was insufficient, especially as IOCs worked to meet Nigeria's oil production capacity target of 4 million barrel-per-day (b/d) by the end of the decade. This issue especially concerned IOCs who recently saw Nigeria reduce oil exports from 2.4 million b/d to 2.1 million b/d to shoulder OPEC production cuts. The NNPC was cutting production from offshore fields governed under PSCs as opposed to production from its JVs because GON revenues from JV projects were higher than those from the offshore PSCs, which enjoyed project cost-recovery against current oil revenue streams. NNPC officials said how to allocate production cuts and accommodate exploration and new production were a subject of bitter debate within NNPC and the GON. ¶13. (C) One IOC opined that Nigeria could either cheat on its OPEC quota or constrain deepwater development. The latter would cost Nigeria $10 billion in foregone oil revenues and send a major negative signal to potential investors. The GON previously had made a failed case for OPEC to increase Nigeria's oil production quota based on expected production capacity increases, but both NNPC and IOCs recognized that a stronger case should be based on socio-economic grounds. -------------- Concerns with U.S. Bill -------------- ¶14. (C) NNPC officials expressed concern with the "NOPEC" bill, which the U.S. Senate and House of Representatives had passed. A/S Harbert shared DOE's position that while the U.S. condemned cartel activity, it assessed the bill - which would deny sovereign immunity from U.S. judicial action to any foreign state engaging in hydrocarbon cartel activity - would have negative implications for the worldwide oil market. She assuaged fears that the bill's implementation was imminent. -------------- IOCs Shun Recent Bid Rounds -------------- ¶15. (C) IOCs had chosen not to participate in Nigeria's last two bid rounds for oil blocks. Firms who had offered huge signature bonuses in exchange for oil blocks would soon see it difficult economically to develop their blocks. It would take several years for the industry to recognize errors in the licensing process and IOC investment in new licenses would be dry in the interim. Both the GON and bidders expected unrealistic returns from new blocks and some bidders based projects' economic viability on target oil prices that were too low. ABUJA 00001575 004.2 OF 005 -------------- --- Niger Delta Insecurity Hits Contracting Capacity -------------- --- ¶16. (C) A/S Harbert inquired at what point IOCs would assess the increased security costs of operating in the Niger Delta to outweigh the benefits. Both NNPC and IOCs believed that decreased oil services industry contracting capacity in the Niger Delta was a significant indirect cost. NNPC observed insecurity had reduced competition amongst oil services providers; that production costs had escalated 50% to 60% above expected levels; and insecurity had exacerbated the effect of robust worldwide oil industry activity had on contractor rates. Shell sensed that NNPC knew the balance sheet costs of insecurity but downplayed it by using the below-market GON budgeted oil price to price losses in representations to the GON. ¶17. (S) All companies had experienced difficulty in finding qualified contractors to work in the Delta, and conceded that the quality of contracting work on its oil production facilities had suffered and could impact future production. While Total's relationship with local communities had been good, in January it tightened its security posture in response to an attack on one of its Port Harcourt-area housing compounds in December 2006. As a result, most dependents were evacuated. Total had previously only used security consultants and local police for physical security, but now relied chiefly on Nigerian Joint Task Force (JTF) forces. Chevron reiterated to A/S Harbert the deleterious effect of illicit oil bunkering on its operations and requested U.S. Government assistance in tracking bunkering barges and tankers. -------------- --- Fuel Subsidies Deter Capable Refinery Investment -------------- --- ¶18. (C) As of July, Nigeria imported all refined petroleum product as its refineries were not operating. NNPC, which publicly opposed the recently aborted sale of the Port Harcourt and Kaduna refineries to a domestic consortium, said domestic fuel subsidies remained an issue. One IOC opined the domestic consortium had offered a fair price for the Port Harcourt and Kaduna refineries, based on the GON taking off the domestic fuel subsidy. ¶19. (C) IOCs confirmed that NNPC wanted them to invest in oil refining and did not consider the domestic or Chinese companies who held concessions for Nigerian refineries to be capable of running them properly. The GON subjected IOCs to an economic double standard, looking for IOCs to shoulder refining projects that were uneconomic for other firms. The IOCs had agreed to study the possibility of investing in domestic refineries, but would only participate if the projects were economical. The GON as of July had awarded sixteen licenses for new refineries, but none of these projects had begun implementation, largely because domestic fuel prices are still controlled. IOCs would be loath to build a new refinery without considerable benefits; a 200,000 b/d refinery would cost $4 billion to build. The rep suggested some Chinese or Indian firms would be willing to bid for Nigeria's refineries if the GON lifted the domestic fuel subsidy, but potential labor, environmental, and community issues would deter IOC investment in existing refineries. -------------- COMMENT -------------- ¶20. (C) The GON is going full-bore on domestic energy sector reform, but has not yet provided the legislative or regulatory framework necessary to court IOC investment to develop gas resources for domestic use and power generation. ABUJA 00001575 005.2 OF 005 IOCs appear willing to invest in Nigeria's gas, refining, and power sectors given economic returns, but the GON struggles to provide the necessary incentives. Given Nigerians' perceived sense of entitlement for subsidized fuel and electricity, the GON is forced to serve two masters in implementing domestic energy policy. GRIBBIN