NIGERIA: CONOCOPHILLIPS POWER PLANT POINTS TO

UNCLAS SECTION 01 OF 03 LAGOS 000415

SENSITIVE
SIPDIS

DOE FOR GPERSON, CHAYLOCK

E.O. 12958: N/A
TAGS: ENRG EINV EFIN PGOV NI
SUBJECT: NIGERIA: CONOCOPHILLIPS POWER PLANT POINTS TO
WIDER ISSUES IN ELECTRICITY SECTOR

REF: A. LAGOS 318

B. LAGOS 302

C. LAGOS 143

SENSITIVE BUT UNCLASSIFIED BUSINESS PROPRIETARY INFORMATION;
HANDLE ACCORDINGLY


1. (SBU) Summary: Expansion of a 480 megawatt power plant in
Delta State, which would double the plant's capacity, has
stalled because the state power company consistently fails to
make payments while demanding the power supply contract be
renegotiated. ConocoPhillips, part owner of the plant in a
consortium with Agip and the Nigerian National Petroleum
Corporation (NNPC),will not invest in the expansion until it
is paid USD 135 million owed to it for power supplied to the
national grid, and until the power supply contract dispute is
settled. Furthermore, backsliding on the current power
contract has made ConocoPhillips less likely to accept GON
payment guarantees in future power projects. Compared to
other emerging market countries, with functioning
transmission and distribution grids, that generate 10-20
percent of their electricity from IPPs, Nigeria plans to
generate 40 percent from IPPs. Instead, Nigeria might be
better served by focusing its efforts on stabilizing the
power grid, reconditioning existing government-owned power
plants, bringing new government-owned plants on-line and
coming to some finality about the status of the transmission
and distribution companies. Alternately, the GON could push
for off-grid generation, transmission, and distribution
projects as stop gap measures to provide power to the
industrial customers who generate sufficient income to pay
for electricity without GON assistance. End Summary.

Payment Problems Hamper Delta State Power Plant
-------------- --


2. (SBU) The Kwale-Okpai Independent Power Plant is located
in Delta State and is a combined cycle, gas fired plant that
produces 480 megawatts of electricity, or 15-20 percent of
Nigeria's total electricity supply. It came on-line in March
2005 and is owned by the joint venture consortium that
includes Nigerian Agip Oil Company, ConocoPhillips and the
Nigerian National Petroleum Corporation (NNPC). (Note: The
joint venture is primarily an oil production joint venture
with Agip as the operating partner and ConocoPhillips and
NNPC as equity partners. End Note.) The joint venture has a
power purchase agreement (PPA) with the Power Holding Company
of Nigeria (PHCN) for PHCN to off-take all the electricity
produced at the plant. Natural gas to fuel the plant is
supplied from the joint venture's nearby fields.


3. (SBU) Construction of a second phase to the plant, which
would add an additional 480 megawatts and was scheduled to
commence in 2007, has stalled. According to local press
reports and conversations with executives from ConocoPhillips
nether Agip nor ConocoPhillips have been paid in full for
electricity produced by phase one of the plant. A senior
ConocoPhillips executive in Nigeria told Energyoff that his
company is owed USD 135 million by PHCN, while Agip, which
owns a larger share of the joint venture, is reportedly owned
a proportionally larger sum (Ref A). Before phase one of the
power plant was constructed, ConocoPhillips and Agip
understood that payment securitization would be essential for
the deal to succeed. Accordingly, the PPA for phase one
includes an agreement by NNPC, as a state-owned company, to
securitize PHCN payments by forgoing its portion of the
profits from the power plant if PHCN failed to make payments
to the joint venture, thus giving ConocoPhillips and Agip a
superior claim on the cash flow from the plant. However, the
ConocoPhillips executive said PHCN consistently fails to make
timely payments and consistently under pays what it owes,
while NNPC has proven adept at finding loopholes and other
reasons not to make good on its promise to make the other
joint venture partners whole.


4. (SBU) In addition to not making payments, PHCN is
demanding the current PPA for phase one be renegotiated.
ConocoPhillips is open to the idea if it can get a guarantee
that the negotiations will settle the dispute once and for

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all and if the company is paid all it is owed from phase one.
However, the company refuses to even consider investing in
phase two until the issues surrounding phase one are settled.
Additionally, ConocoPhillips will be reluctant to accept
payment securitization from any GON entity in future
electricity projects. ConocoPhillips estimates it would need
to invest USD 500 million for phase two, with that amount
increasing if the project is further delayed. According to
the local press, negotiations with Agip on phase two have
broken down as the dispute over the current PPA drags on.

ConocoPhillips Uses Power Generation for Oil Access
-------------- --------------


5. (SBU) ConocoPhillips power generation business unit is
expressly designed to assist its upstream exploration and
production unit gain access to oilfields and provide a ready
market for its natural gas. ConocoPhillips expects nine to
eleven percent return on power projects and fifteen percent
on upstream oil and gas. While the company accepts lower
rates of return in power generation, the company does not
operate the unit as a "loss-leader". Okpai is not profitable
for ConocoPhillips and its local executives will not go back
to the company's headquarters and recommend additional
investment in the Nigerian electricity sector until the
problems surrounding the first phase of a Okpai are resolved.

Dilapidated Grid Raises Power Plant Operating Costs
-------------- --------------


6. (SBU) The ConocoPhillips executive also lamented the poor
condition of Nigeria's electricity transmission network,
saying power surges and grid outages have been problematic
for the power plant, increasing operating costs and damaging
some power generation equipment. (Note: Managers at AES
Nigeria's Lagos IPP have told us that the unstable grid has
caused equipment damage at their power plant as well. End
Note.) Additionally, he described the structure of Nigeria's
transmission and distribution companies as "baffling", noting
anecdotally that in a recent meeting with the Minister of
State for Gas, the Minister himself admitted he didn't
understand the structure of Nigeria's transmission and
distribution sector. (Note: The GON "unbundled" the state
owned power company into six generation, one transmission,
and eleven distribution companies under a single holding
company called Power Holding Company of Nigeria (PHCN). The
aim was to eventually privatize the eighteen companies, but
that effort stalled after the new Presidential administration
came to power in 2007. End Note.)

Comment
--------------


7. (SBU) We probably should not get too worked up over the
fact that Nigeria is seeking better terms on contracts. As
noted in a 2006 Stanford University study of independent
power projects built in emerging market countries in the
1990's and as reflected in both the AES and ConocoPhillips
cases, investors are not always adverse to renegotiating
power contracts. Power purchase agreements signed before a
complex IPP has been built are likely to require some
adjustment after the project is completed. The Stanford
study notes the inherent tension between the short term goal
of immediate investment in IPPs, which demands some policy
and regulatory consistency (but not necessarily ideal
policies or regulations),and the long term goal of
electricity sector reform, which is often an iterative
process that evolves over time in fits and starts. Nigeria
is at the beginning of what looks to be a long and probably
contentious process of reforming its electricity sector.
While laudable, that may in fact hinder significant foreign
IPP investment in the near term.


8. (SBU) Oil company-lead IPPs further complicate the
picture. Clearly, the primary goal of these projects is
access to oil reserves and not power generation, company
claims about corporate social responsibility not
withstanding. It is hard to see what is going on behind the
scenes in these power projects, but we wonder if the dynamic

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of oil is not warping the negotiations and sending the GON
the wrong signals about how to deal with IPP investors.
Given their quest for access to Nigeria's oil reserves and
their long experience dealing with the GON, oil companies
have been far more accommodating to the vagaries and whims of
the GON than pure-play, foreign IPP investors are likely to
be. In any case, elaborate power purchase agreements,
sovereign risk guarantees, and payment securitization schemes
may not be enough to attract sufficient numbers of IPP
investors to Nigeria if the existing electricity sector is in
a state of collapse and fuel supplies are sporadic and
vulnerable to militant attack. It's simply too risky for the
anticipated returns. Instead, Nigeria might be better served
by focusing its efforts on stabilizing the transmission and
distribution grid, reconditioning existing government-owned
power plants, bringing new government-owned plants on-line
and coming to some finality about the status of the
transmission and distribution companies. Alternately, the
GON could push for off-grid generation, transmission, and
distribution projects as stop gap measures to provide power
to the industrial customers who generate sufficient income to
pay for electricity without GON assistance.


9. (SBU) Worldwide, an emerging market IPP boom in the 1990's
ended in decidedly mixed results for foreign IPP investors.
Initial investor enthusiasm in the early to mid 1990's was
followed by a severe pullback in the IPP sector as the Asian
financial crisis hit, returns to equity investors proved
disappointing, and high profile IPPs in India and Pakistan
went bust. We note Nigeria's IPP plan is ambitious even by
the standards of the 1990s boom years, with an internal GE
document showing 40 percent of planned, new generating
capacity coming from IPPs. Other large emerging market
countries like India, Indonesia, Brazil, Turkey limited IPPs
to 10-20 percent of generating capacity and they added those
IPPs to more or less functioning transmission and
distribution grids. We are not aware of another large
developing country that planned to use IPPs as the
cornerstone for building a functioning electrical grid. End
Comment.


10. (U) This cable cleared with Embassy Abuja.
BLAIR