NIGERIA: NEW GAS POLICY MAY SLOW NATURAL GAS

C O N F I D E N T I A L SECTION 01 OF 03 LAGOS 000122

SIPDIS

SIPDIS

STATE FOR AF/W, INR/AA, DS/IP/AF
DOE FOR GPERSON, CHAYLOCK

E.O. 12958: DECL: 03/13/2018
TAGS: EPET ENRG PGOV NI
SUBJECT: NIGERIA: NEW GAS POLICY MAY SLOW NATURAL GAS
DEVELOPMENT

REF: 07 LAGOS 750

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Classified By: Consul General Donna Blair for reasons 1.4 (b) and (d)


1. (C) Summary: Nigeria's recently announced natural gas
policy will likely slow development of domestic and export
natural gas projects. The policy relies on cross-subsidies
from commercial and industrial users for development of
electrical power projects. The policy and regulation are
vague in details and contradictory in places, but establish a
new gas ministry, lay out a complicated government led
pricing regime, and create a natural gas clearinghouse that
is supposed to manage gas supply and demand. Long
established up and downstream actors have resigned themselves
to this new policy and are attempting to make the best of the
current situation while hoping and working behind the scenes
for future revisions, particularly since the new policy is
not economically viable. A window of opportunity exists to
assist in the development of a follow-on policy. End Summary.


2. (SBU) On February 7, President Yar'Adua announced a new
natural gas policy and regulation designed to spur
development of natural gas projects that favor domestic
industries. The relatively brief policy and regulation
documents (twelve and six pages respectively) are the result
of over a year of work by a Nigerian National Petroleum
Corporation (NNPC) group led by Dr. David Ige, NNPC's chief
natural gas planner. The two documents establish a new
Department of Gas within the Ministry of Energy, expand the
duties of the Minister of State for Energy (Gas),detail a
three tier domestic gas pricing structure, and create a
strategic gas aggregator to manage Nigeria's gas supply and
demand.


3. (C) The policy appears only tangentially connected to the
Gas Master Plan (GMP),Nigeria's all-encompassing plan for
developing its natural gas infrastructure. No reference is
made to the Gas Master Plan directly, although the policy
contains the same projected economic growth rates and gas
demand forecasts as the GMP.

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Natural Gas Pricing Structure
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4. (SBU) The policy calls for a three tiered domestic gas
pricing structure: a "regulated pricing regime" with a low
floor price of USD 0.10 per thousand standard cubic feet
(mscf) for gas destined for domestic power plants supplying
residential and light commercial users; a mid level
"pseudo-regulated pricing regime" that uses a net back price
for industrial users such as methanol or fertilizer producers
that use gas as feedstock; and a higher level "market led
regime" that references the gas price to low pour fuel oil
for large commercial customers such as steel plants and
cement factories. All upstream producers will receive an
aggregate price based on the weighted average of the total
demand of the three tiers, regardless of the customer mix of
an individual gas producer. So an upstream company that
principally supplies gas to power customers and upstream
company supplying commercial customers will both receive the
same aggregate price.


5. (C) The rationale for the pricing structure is
economically flimsy. The floor price for gas is based on
NNPC estimates of the current cost to develop natural gas
fields with the assumption that upstream producers can earn
USD 40 per barrel from natural gas liquids associated with
the gas. However, it does not take into account increasing
marginal costs to develop new gas fields. The three tier
structure forces commercial and industrial customers to
subsidize domestic power customers. The assumption is that
gas supplied at levels below the world market price will
stimulate investment in commercial and industrial sectors
that use natural gas and these sectors, while receiving gas
at lower than world market prices, will still pay enough to
raise the aggregate price of domestic natural gas. However,
given the myriad of other costs associated with operating in
Nigeria, it is not clear that cheap gas alone will be

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sufficient to attract methanol producers, fertilizer plants,
and steel foundries. Without these large commercial users,
the cross subsidies will never materialize and the aggregate
price upstream producers receive will remain stalled at or
near the lowest price tier. For that reason, upstream
producers are seeking a guaranteed aggregate price above USD
0.50 per mscf from the GON. A contact at a European natural
gas company told Econoff that IOCs will press the GON to
establish a securitized fund to ensure money will be
available to meet a minimum agreed upon gas price. In other
words, having been burnt by the GON's failure to make its
cash call payments in its oil production joint ventures with
the IOCs, those same companies are not willing to simply take
the GON at its word that money will be there for gas.


6. (C) An ill-defined mechanism for transitioning to market
prices is spelled out in the policy. Once the Minister
determines that a "domestic saturation" point is reached in
any one of the three sectors is reached, subsequent entrants
into the market will pay the next higher price for gas. For
instance, if the Minister determines enough fertilizer is
produced in Nigeria to meet Nigeria's domestic needs, the
next fertilizer manufacturer to enter the market will pay for
gas under the market-led price regime instead of the lower
cost pseudo-regulated regime. The policy does not elaborate
on why that theoretical marginal producer would enter the
market if faced with a higher gas price than its established
competitors.

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Strategic Gas Aggregator
--------------


7. (SBU) The policy also establishes a "strategic gas
aggregator" (SGA) that will ensure available gas supplies
meet projected demand, match upstream suppliers with
downstream customers, write purchase orders for gas, and act
as a financial clearinghouse for all gas purchases. Who will
comprise the SGA and how it will accomplish those tasks are
not defined. As part of the SGA concept, upstream producers
will be ordered to set aside part of their gas reserves
strictly for domestic use. The SGA will determine annually
the amount of gas reserves upstream producers must set aside
based on demand forecasts generated by the ministry of gas.
Failure to set aside those reserves or meet a gas call by the
SGA will result in fines of USD 3.50 per mscf.

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New Policy or Interim Step?
--------------


8. (C) It is not clear if the new policy and regulation will
replace the Downstream Gas Act that had been working its way
through the National Assembly or are simply an interim step.
The Downstream Gas Act was a substantial piece of legislation
that detailed rules for upstream, downstream and midstream
operators and oriented the domestic Nigerian gas industry
towards market based solutions. In a speech at an oil and
gas conference in late February, President Yar'Adua announced
he was pulling the act from the National Assembly and would
consolidate it into one all-encompassing piece of legislation
as part of the announced reform of the Nigerian National
Petroleum Corporation (NNPC) (reftel). Reform of NNPC will
be a hot button issue and legislation is expected to take at
least a year to wind through the National Assembly. In the
opinion of one senior oil company executive, even if every
legislator agreed with every word of the legislation from the
day it was introduced, it would still take eight months for
the legislation to be passed into law.


9. (C) Established upstream and downstream actors have
resigned themselves to this policy and are attempting to make
the best of the situation. The industry trade group
representing international oil companies (IOCs) recently met
with NNPC in an attempt to establish a price above USD 0.50
per mscf for gas destined for power plants. An industry
trade group representative leading the negotiations with NNPC
told Econoff that if the IOCs can get a price above that
level, government securitization on that price, and

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concurrent guarantees that the GON will transfer to a
market-based pricing then they can live with the policy "for
a few years." The contact thought the policy would not last
three years. When pressed he admitted that the IOCs were in
essence "hunkering down" and waiting until the flaws in the
policy became evident. Additionally, a representative from
Nigeria Liquefied Natural Gas (NLNG) told Econcouns and
Econoff that his organization could live with the policy and
the IOCs have no choice but to accept it. (Note: NLNG
already has supply contracts signed for its six LNG trains.
It clearly feels confident that those contracts will be
honored, even under the new policy. End Note.)


10. (C) The policy and regulation, with their caveats,
contradictions, and vagueness, favor parties experienced in
Nigerian backroom politics. For instance, in the
implementing regulation, one of the powers given to the
Minister of Gas is to "from time to time identify and
prioritize specific export projects that have strategic
impact on the development of the domestic gas market for
consideration and inclusion in the Domestic Gas Demand
Requirement." That single statement leaves the door open for
any number of export LNG or pipeline projects to be given
favorable transfer pricing treatment, providing the project
backers can obtain the blessing of the Minister. Another
article of the regulation gives the Minister the power to
"review or amend, alter, add to or delete any provision of
these regulations as he may deem fit" with the only
requirement being to "consult" with "relevant stakeholders".



11. (C) Comment: The weaknesses in the policy will likely
slow development of Nigeria's natural gas which is
unfortunate, not only for the world market, but for the
Nigerian people; getting the gas policy right is critical for
developing Nigeria's electricity generation, which is in turn
critical for developing the country's non-oil economy. While
established actors can wait it out, new entrants to the
market may hesitate to make bold investments given the
uncertainty in the policy and the knowledge it may change in
a few years. Given the scale, expense, and long lead times
required, natural gas projects demand, if nothing else,
policy stability and consistency. On a bright note, this
policy may give the USG an opportunity to engage the Nigerian
government on a workable follow-on plan we anticipate will be
needed to address the economic failure of this one. The UK
has expressed an interest in engaging the GON on this issue
and Norway already has a working relationship with the GON on
a range of hydrocarbon issues. End Comment.


12. (U) This cable was cleared by Embassy Abuja.
BLAIR