THE CHALLENGE OF PRICING DOMESTIC GAS UNDER THE PETROLEUM INDUSTRY BILL (PIB)

1. THE CHALLENGE OF PRICING DOMESTIC GAS UNDER THE PETROLEUM INDUSTRY BILL (PIB) Presented by OYETOLA OSHOBIAT THE GULF OF GUINEA CONFERENCE - GOG12November 2009 BABALAKIN & CO.

2. Outline • Background • Existing price regime • Change is imperative • The envisaged price regime under the Petroleum Industry Bill • Challenges • Thinking ahead • Conclusion BABALAKIN & CO.

3. Background • It has always been thought that Nigeria is rich in oil, it turns out it is ‘a gas province with a drop of oil.’ Therefore the Nigerian Government seeks to • Ensure that Nigeria derives as much revenue from gas as it does from oil. • Develop the nation’s gas resources to drive the goal of attaining a 10% annual GDP growth rate by 2010. • Maximize value from gas resources for Nigeria from both the domestic and export gas markets. BABALAKIN & CO.

4. Background • Attaining these objectives require significant investments • Over US$30 Billion required to develop the gas industry to meet domestic and export demands* • Insufficient know-how and resources • Nigeria has about 24 banks which are statutorily required to maintain minimum capitalization of N25 billion – approximately US$170 Million. • Some of the banks have liquidity problems • Capital market suffering from global melt down hang over • Clearly Nigeria requires private sector participation and international financing to bridge the funding gap. * Nigeria Gas Master Plan Presentation 26th November 2007 BABALAKIN & CO.

5. Background • Government’s strategy for attracting investment to the gas sector was largely based on granting fiscal incentives starting with • AGFA, • later incorporated into PPTA; • and later under the CITA: *Sections 11 and 12 BABALAKIN & CO.

6. Background • NLNG commenced production and export of gas in 1999 and rapidly expanded to the 6th train. Plans for the 7th train have currently been suspended. • The success of the NLNG and the rise in global gas prices and demand has stimulated interest in export oriented projects which are in various stages of conceptualization and development. • Limited investor interest for projects directed at supplying gas to the domestic market. • Conversely local demand for gas has continued to expand rapidly driven mainly by the considerable investment in gas fired power plants to increase the nation’s electricity generating capacity. It is projected that Nigeria should have 22 of such plants with a combined capacity of 12GW by 2013. • Electric power generation is estimated to account for 70-75% of domestic gas demand. • Nigerian domestic gas and power sectors are Siamese twins and what affects one invariably affects the other. • Already there is insufficient gas and inadequate infrastructure to meet the requirement of the existing power plants. • The demand for gas in the domestic market far outstrips the currently available supply. • The situation is compounded by the fact about 40% of current reserves are unavailable trapped in gas caps and are inaccessible until after production of oil this underscores the need for considerable investments in E & P for non-associated gas. • It is obvious that the fiscal incentives alone are inadequate to drive growth in the domestic gas market. BABALAKIN & CO.

7. Existing price regime • Until recently, the Minister was empowered to impose special terms and conditions on licences and leases including Government’s right to take associated gas, free of cost at the flare, or at an agreed cost, without payment of royalty. • PPPRA Act empowers PPPRA to regulate the price of petroleum products. • The only natural gas derivative classified as a “petroleum product” in Section 15 of the Petroleum Act is Liquefied Petroleum Gas. BABALAKIN & CO.

8. Existing price regime • No structure legal or regulatory framework exists currently for gas pricing. • The Minister has wide discretionary powers to demand, secure and fix the price at which gas is sold in the domestic market. • PHCN currently pays US$0.12/mmbtu of gas as opposed to US$0.50/mmbtu at the export market. • PHCN owes well in excess of N10 billion for gas already supplied. • Domestic gas prices are therefore uneconomic and unsustainable. BABALAKIN & CO.

9. Change is imperative • Stakeholders agree that there is a clear need for price change but disagree on mechanism • Government and producers seem to agree that a viable price must guarantee producers an IRR 0f 15% but disagree on what this price is • Government says between US$0.50/mmbtu and US$1.00/mmbtu. • IOC’s say US$2.oo/mmbtu • The Nigerian Gas Master Plan seeks amongst other things to balance interests of both sides BABALAKIN & CO.

10. Policy Reforms • Nigerian Gas Master Plan • National Gas Supply and Pricing Policy 2008. • National Gas Supply and Pricing Regulations 2008. • Pricing principles underpinning the NGMP, NGSPP and the NGSPR have been incorporated into the “Inter-Agency Memorandum” submitted by the FGN to the National Assembly in July 2009, proposing amendments to the gazetted PIB. BABALAKIN & CO.

11. Price regime under the PIB Management of the DGM • The PIB empowers the Agency: • To announce the Domestic Gas Supply Requirement for each calendar year necessary to meet the gas demand for strategic sectors as determined by the Government from time to time within the domestic economy for a specific period of time not exceeding 20 years. • Request the Inspectorate to allocate the Domestic Gas Supply Obligation to every PML. • Establish an Aggregate Gas Price for the volume of the DGSO which shall be based on the weighted average of the purchase price and volumes of the purchased gas and this shall be used by the Domestic Gas Aggregator as the basis for gas supply to the domestic market. BABALAKIN & CO.

12. Price regime under the PIB • Domestic Gas Aggregator (DGA) • The Agency is charged with the responsibility of establishing the DGA the functions of which shall include: • implementation of a gas management model for monitoring the demand and supply of gas for utilization within Nigeria • acting as an intermediary between suppliers and purchasers of gas in the domestic gas market and ensuring the supply of gas to the strategic sectors in accordance with the approved national gas policy framework; BABALAKIN & CO.

13. Powers of the DGA • Ensuring that the DGSR is met through the implementation of the DGSO • Ensure availability of adequate volume of gas for the strategic sectors • Open and manage an escrow account with an escrow agent approved by the Agency • Direct purchasers of gas to make payment into the escrow account in accordance with the payment schedule agreed by the suppliers, purchasers and the DGA. • Make payment to the supplier in accordance with the Aggregate Gas Price. BABALAKIN & CO.

14. Implementing the DGSO • Where a licensee has failed to fulfill its DGSO, the licensee may amongst other penalties be liable to a fine or be prevented from supplying gas for any export project during the default period. • Where the domestic and export gas market has attained a level of maturity that reflects fully competitive conditions. The Agency may suspend the issuance of new Gas Purchase Orders by the Aggregator. • The Bill preserves the rights of purchasers and suppliers to enter into GSAs for the domestic market on terms and conditions freely decided for volumes in excess of the DGSO without any discrimination in terms of access to midstream pipelines. BABALAKIN & CO.

15. Price regime under the PIB Wholesale Gas Market • The Agency is to make recommendations to the Minister to issue regulations defining the class or classes of customers that shall from time to time constitute wholesale customers under the Act and the qualifying criteria for such classification. *Section 385 IAM BABALAKIN & CO.

16. Price regime under the PIB Wholesale Gas Pricing • Wholesale gas in excess of the Domestic Gas Supply Obligations between a supplier and customer shall be negotiated directly between parties on a transparent arms length basis and the transfer price between an upstream producer and a midstream or downstream purchaser shall reflect the cost of transfer in line with the pricing principles stipulated in in the bill. *Section 393 IAM BABALAKIN & CO.

17. Price regime under the PIB Gas Pricing • The appropriate Regulatory Institution (Agency or Authority) is empowered, where it determines the following: • that a particular licensed activity is a monopoly service • that competition has not yet developed to such an extent as to protect the interest of customers • that a particular licensee is a dominant provider to regulate gas prices or revenues earned by licensees in respect of such activities in a manner consistent with pricing principles stipulated in the PIB BABALAKIN & CO.

18. Price regime under the PIB Gas Pricing • The bill requires the Regulator to consult with licensees, industry participants and stakeholders before undertaking a gas pricing review or establishing a methodology for regulating prices and revenues earned by licensees providing monopoly or dominant services. BABALAKIN & CO.

19. Price regime under the PIB Pricing Principles • The Regulatory Institutions are to be guided by following Gas Pricing Principles set out in the Act: (a) Gas prices shall be disaggregated into the component elements of the supply chain including costs of wholesale gas, transportation, distribution and supply. • Prices charged for each licensed activity shall reflect the costs incurred for the efficient provision of that activity. • Prices charged shall permit a reasonable return for licensees on their investments • Prices shall not discriminate between customers with similar characteristics such as similar size or consumption profile. BABALAKIN & CO.

20. Price regime under the PIB Approval of Tariffs and Pricing • Approval and publication of charging structures, tariff and pricing structure are required of licensees* 1.(a)Tariff and tariff methodologies in the downstream gas sector subject to the approval of the Regulatory Institutions (2) Tariff charged for use of gas transportation or distribution network shall reflect (a) efficient investments and capital costs (b) efficient operating and maintenance expenses and (c) a reasonable return for licensees on their investments. *Section 392 (1) BABALAKIN & CO.

21. Price regime under the PIB (4) Regulated customer prices shall reflect: (a) The reasonable costs incurred in the purchase of wholesale gas. (b) The transportation tariff. (c) The distribution tariff if the customer is connected to a distribution network. (d) Efficient supply charges covering billing, metering and other services relating to gas supply. (e) A reasonable return for the supplier. BABALAKIN & CO.

22. Price regime under the PIB Network Code • The Regulatory Institutions namely (NAMIRA and the PPRA) are to establish a network code* for the midstream and downstream gas network. • The Code will include provisions for connection charging methodology, the structure of charges and applicable tariffs for using the transportation network and distribution network. NAMIRA - National Midstream Regulatory Agency PPRA - Petroleum Pricing Regulatory Authority *Section 384 (1) (2) Inter-Agency Memorandum “IAM” p BABALAKIN & CO.

23. Challenges • Appropriate pricing of power. • Appropriate pricing of alternative fuels (petroleum products). • Need to strictly monitor the strategic domestic sector. • Investor already faces a number of risks in the market • Political risk • Market risk • Foreign exchange/inflation risk BABALAKIN & CO.

24. Challenges • Low purchasing power of Nigerian consumer. • Culture of government subsidy/Socio-political backlash. • It does not help that past governments have not been very accountable in use of public funds. BABALAKIN & CO.

25. Thinking Ahead • Dealing with the socio-political backlash • Petroleum products deregulation experience • Power reform experience. • Need for government to exert political will and to be prepared to be very unpopular • Need to adopt a carrot and stick approach BABALAKIN & CO.

26. Conclusions • Appropriate pricing of not only gas but power and petroleum products as well is an imperative for the development of a viable DGM and also for the long term sustainable growth of the Nigerian economy. • The present administration owes it to the current and future generations of Nigeria to take the very difficult and unpopular decisions necessary to actualize these objectives. BABALAKIN & CO.

27. Thank you. BABALAKIN & CO.