Saturday, February 02, 2008

Combustible mix

There were hopes this time last year that at least one Nigerian LNG liquefaction project would reach financial close in 2007. This has not happened, and the prospects of a deal closing in 2008 are also dim.

The main reason for the delay has been ascribed to a change of administration after presidential elections in April. As often happens with incoming governments, the new man in charge, President Umaru Yar 'Adua, who replaces Olusegun Obasanjo, wants to affirm his political identity with a change of direction. Consequently, project progress has stalled until the government's economic policies acquire greater definition.

Nigeria is in a similar situation over its gas supplies to that of Egypt – it has to strike the right balance between monetising its reserves through LNG exports and ensuring an adequate supply for domestic use. The government is also planning reforms of the Nigerian National Petroleum Corporation (NNPC), which given its status as a joint venture partner in the LNG projects will mean more delays before the projects are ready to launch in the debt market.

A further obstacle is the dire security situation in the Niger Delta, which despite a lull after the elections shows no signs of getting better. While violence has not stopped projects moving ahead in the past, and does not present an insurmountable obstacle to getting deals financed in the future, militants have proved themselves adept at disrupting oil production. The risk to investments in the region is still very real.

Despite these problems, however, the LNG deals will get done, eventually, for two simple reasons: in a world of $100 per barrel oil prices, international demand for gas is desperately high, and Nigeria has the proven reserves to meet it – around 180 trillion cubic feet comprising mainly associated gases that are currently wasted.

As things stand, most of Nigeria's gas is still flared – akin to burning money, and also a contributor to the environmental problems that have driven militants to take up arms. One way or another, developing the capacity to either monetise the gas or use it in domestic power stations is crucial for political as well as economic progress in Nigeria.

“An element of slow-down is inevitable while the new administrations beds in,” says a banker involved in one LNG project. “What is clear is that Nigeria needs to monetise its gas reserves in a way that makes sense for the country, as Qatar has done.”

There are two LNG liquefaction projects – the $7 billion Olokola LNG, also known as OK, and the $3 billion Brass LNG – already at the joint venture stage, with the Bonny Island LNG project also planned for further up the pipeline. Both Brass and OK are joint ventures that see NNPC teaming up with ChevronTexaco, BG Group and Royal Dutch/Shell Group on OK LNG; ConocoPhillips, Eni and Total on Brass. BG is an offtaker for both projects.

Flaring, Niger Delta

An optimistic view of Nigeria's future might focus on the fact that April's elections heralded the country's first ever transition from one civilian government to another, having for most of its post-colonial history been dominated by corrupt military dictatorships, punctuated by occasional democratic interludes. This view glosses over the fact that election monitors – both Nigerian and international – condemned the elections as lacking in credibility.

The challenge for Yar 'Adua now is to establish the legitimacy that the polls failed to confer on him through reforms that lift the country up from its regular placing near the bottom of international corruption tables and revive the country's productive base.

Reform of the country's energy sector is one of the key ways in which Yar 'Adua intends to pursue these goals, and to that end he appointed Rilwan Luxman in September as a special advisor at the head of a committee given a six-month deadline to come up with ways of reforming the country's oil, gas and power sectors.

However, beyond the rhetoric, achieving these reforms will not be easy. A chronic problem with NNPC is that its revenues go straight into government coffers with an insufficient amount finding its way back for new investment. Many personally benefit from the current system and oppose efforts to reform it. In December it was reported in the Nigerian press that members of Luxman's committee were considering fleeing the country after receiving death threats, a measure of how high the stakes are.

Meanwhile, some oil and gas operators are complaining that Luxman's committee is proceeding too slowly, and Luxman himself was quoted in November as saying that he would need a year or longer to complete his work. But Yar 'Adua, who regardless of the controversial nature of his election, before ascending to the presidency had a reputation for being one of the country's few non-corrupt governors, reiterated his determination to fight vested interests linked to the NNPC during a visit to Washington DC in December.

“In Nigeria, [the NNPC] is one of the most difficult agencies of government to tackle because of the vested interest of very powerful people,” he said. “But we are determined, knowing that when you break that up, it will help bring other agencies and ministries in line. NNPC will operate like any other company in the private sector and source funds for its joint venture operations from the capital market.”

The tension between political rhetoric and reality is greatest in the Niger Delta. Though attacks on oil installations is down from the heights of early and late 2006, little progress has been made in bringing lasting stability to the region, according to an International Crisis Group report released in December.

A key demand of militants fighting in the Delta was met in the summer with the release from prison of one of their leaders, Mujahid Asari-Dokubo – though shrewd observers had long anticipated his release, and his subsequent marginalisation. Soon afterwards another of the Movement for the Emancipation of the Niger Delta's (MEND) leaders, Henry Okah, was arrested in Angola, prompting members of his MEND faction to threaten a resumption of attacks on oil and gas installations.

The highly factionalised militant groupings in the Niger Delta have long been split between those taking up arms to pursue genuinely political ends and those that are essentially heavily armed gangsters. Ominously, the aftermath of elections in the Niger Delta are times of increased volatility as politicians lay off the gangs that worked for them, who then seek other uses for their newly acquired weapons. In recent months, there has been an increase in hostage taking, which has now spread beyond the targeting of oil company employees to members of their family.

In the summer the government set up a peace and conflict resolution committee headed by senator Devid Brigidi, but the Delta has been here countless times before, with reports issued and recommendations made. Until recommendations are implemented there is little chance of progress, and militant factions have already shown hostility towards Brigidi's committee. The danger is that once a sense of drift sets in, the opportunity to make headway under the new administration will be lost.

Insofar as Nigerian oil and gas projects are affected, some are a great deal more so than others, with offshore installations the safest despite some spectacular attacks in early 2006. OK LNG is not actually located in the Niger Delta – it is situated near Lagos – so security is a relatively small concern compared to Brass LNG in Bayelsa state. Attacks at the end of 2006 on installations next to Brass’s location highlight the greater security concern for that project.

Generally, however, there is consensus among bankers that whatever security concerns there are, though they pose obstacles they are not sufficient to prevent the projects being bankable. The feeling is that though the militants have made threats to completely shut down the country's oil and gas production, they have neither the organisational capacity to do so, nor is it in their interests.

Nevertheless, the militants should not be underestimated given that the 500,000 barrels per day reduction in oil production caused by their attacks of early 2006 has still not been reversed.

Yet despite these problems, investment is flowing into the oil and gas sector. Shell's upstream Gbaran/Ubie integrated oil and gas project will begin producing output in 2008, while Addax earlier this year tapped the syndications market for a $1.5 billion five-year reserve based loan, arranged by BNP Paribas, Natixis and Standard Chartered.

The concern is whether the investment is enough, as Nigeria's economic development plan under Yar 'Adua means soaring demand for domestic gas use. By 2011 domestic demand is projected to have risen from 1.2 billion cubic feet per day in 2007 to 6.2 billion cfd as 14,700MW of gas generated power is added to Nigeria's grid, while new methanol facilities add further demand.

Such a large increase puts a huge strain on the country's gas supply. Currently Nigeria exports 3 billion cfd through its NLNG facility, burns off 2.5 billion cfd that it is unable to use and keeps 0.5 billion cfd for the domestic market, which has enough capacity to consume over twice that amount.

As things stand, the country is not able to extract and keep the gas at anywhere near the rate required to balance supply and demand. This mismatch underlines the crucial importance of stamping out corruption from the NNPC so it can raise the capital required to finance its share in joint venture partnerships.

“The problem with investment is always that the government restricts how much funding it provides the NNPC for projects,” says one banker. “The company is expected to raise capital revenues itself, but for that to happen there needs to be reform of the NNPC.”

In November officials of the NNPC warned the national legislature that unless funding to the company significantly increased, it would not be able to meet its funding requirements for joint ventures in 2008, potentially resulting in the cancellation of ongoing oil and gas projects and the loss of billions of dollars in revenue.

Given this landscape, financial close for either OK or Brass in 2008 seems highly unlikely. However, the need to monetise a part of the country's gas reserves and the high enormous international demand for LNG means the projects’ long-term futures are not seriously in doubt. “At the end of the day, the country needs both a steady domestic supply and to monetise more of its gas,” says one banker. “But it will happen – if only because there's enough of it there to meet all these needs.”

This article first appeared in the December 2007/January 2008 issue of Project Finance magazine.

Photo: Gas being flared at a flow station in the Niger Delta. Nigeria burns off almost 2.5 billion cubic feet per day of gas, despite a massive shortfall in domestic supply. (Marcus Bensasson)