Nigeria's hunt for gas buyers
Pressure from government to meet domestic supply obligations (DSOs) remains intense in Nigeria. The current administration's policy is to not award or renew licences for companies that are failing to meet their DSO. Project approvals won't be granted unless operators have a gas monetisation plan, while even producers who re-inject gas to enhance oil production will face restrictions.
Nigeria's gas policy states that the government expects that producers will see the obligations as part of their contributions to national development and doing business in Nigeria. The government knows that the domestic market is unappealing, however it expects producers to do their bit regardless. A possible change of government in 2019 won't ease the pressure either.
Although Nigeria's DSO has been cut significantly in the last two years, the target has still not been met. In 2017 the DSO was double the volume actually delivered. However, the potential costs of DSO non-compliance has focused minds, particularly among the IOCs. All of them are prioritising supply to a market that is constrained in terms of infrastructure and credible buyers. Producers are desperately seeking customers, but are finding that their competitors are on exactly the same mission.
A low income is better than no income
But suppliers don't just want to find any offtakers, they want to find reliable offtakers who demand a steady supply of gas and will pay the regulated price of US$2.50/mn Btu.
Non-payment for gas remains a chronic problem and the power sector is the major culprit. The sector deficit from 2015 to 2016 was nearly US$2bn. In 2017, the government established a central bank facility of US$2bn over two years to ensure that generators are paid. This in turn should help them pay their gas bills. But the facility will need continual replenishment as long as the industry lacks electricity meters and below-cost tariffs are maintained.
To mitigate risk, some producers have experimented with pre-payment arrangements, but the on/off switching of supply is counter-productive for reservoirs and turbines alike.
So before producers can dream of accessing deregulated pricing, they would simply settle for getting paid by a reliable customer. Regardless of price, receiving income no matter how low, is preferable to receiving none at all.
Can you avoid the power sector?
The quick answer is not easily. Large resource holders will struggle to avoid the power sector if they want to market their gas. Not only because the power sector absorbs nearly two-thirds of domestic gas demand in Nigeria (around 650mn cf/d, but because the government largely controls who you sell your gas to, and the power sector is its priority.
Gas supply agreements under the DSO are brokered by the Gas Aggregator Company of Nigeria (GACN), a government middle-man which aggregates gas supply and provides a weighted average price to producers. It is a transitional body that is supposed to make way for direct contracting between buyers and sellers. But after 10 years, it's still going, even though the current administration views it as "largely unsuccessful".
The trouble is, there is just not enough transmission capacity to carry the available power in Nigeria. Although capacity is officially 7 GW, the grid still struggles with loads much over 4 GW. So power stations (of which 8 GW is available) cannot reach their full capacity. This has knock-on implications for gas suppliers even if they have a supply agreement with GACN.
Azura-Edo: extra capacity does not equal extra commodity
Azura-Edo near Benin City is Nigeria's first true permanent independent power project (IPP) that did not involve the IOCs. It started fully generating in May 2018 and is now operating all three turbines with a total capacity of 459 MW.
But Azura-Edo would not have happened without multiple guarantees. It is essentially backed by the government with multi-lateral donor support too, so that its private investors are protected from risks which would typically prevent a project like this in Nigeria.
Seplat supplies the gas, receiving an index-linked price of US$3/mn Btu, compared to the regulated US$2.50/mn Btu.
Azura-Edo's output has recently averaged 300 MW or 8pc of Nigeria's power, so it is already making a major contribution. But its output is not additive; there's yet to be any increase in total power on the grid.
Azura-Edo has displaced power elsewhere because of the grid's limitations. Power stations without Power Purchase Agreements (PPAs)—namely federal government-owned National Integrated Power Projects (NIPPs)—are the first in line to be stood down, which spells bad news for their suppliers.
But this does suggest that future projects which we expect to be fully contracted and supported like Azura-Edo (e.g. Qua Iboe IPP in the eastern delta) will be favoured over those that are not. Without dramatic improvement in transmission capacity (or rapid decline in Nigeria's ageing hydro-power generation), supply to risk-laden NIPPs will be squeezed-out in favour of privately-funded generation with binding PPAs.
So better quality opportunities for some producers could arise at the expense of others who are locked into uncontracted power plants with dwindling offtake. But access to such opportunities is not guaranteed unless of course producers are willing to build their own power plants.
Despite the welcome success of Azura-Edo and other IPPs that follow it, extra power capacity will not necessarily equate to more power delivery overall. So what are the alternatives?
Can suppliers find succour by targeting large industrial offtakers beyond the confines of the gas and power grids? Here, there are some signs of progress.
In 2017, Total signed a 74mn cf/d offtake agreement with Greenville LNG. Greenville will take gas straight from the Rumuji manifold near Port Harcourt where the high-pressure gas transmission system 1, 2 and 4 gas pipe-lines converge, so the volume risks are reduced.
This is a landmark deal because mini-LNG is a nascent industry involving LNG transport by road. Because liquefaction reduces the gas volume 600 times, mini-LNG offers decent scale for suppliers unlike compressed natural gas. But given the high costs of liquefaction and re-gasification, not to mention the state of the roads, it will be interesting to see whether Greenville proves to be a reliable offtaker for Total's gas.
Total also signed a supply agreement with Indorama of Indonesia. It will use its Northern Option pipeline-built at huge cost due to community issues-to supply over 100 mmcfd for its petrochemical plant expansion at Port Harcourt from 2021. Outside the oil compa-nies, Indorama is one of the biggest and most successful foreign investors in the Niger Delta, and should provide steady offtake for Total in contrast with its short-lived reliance on Alaoji NIPP.
Both of these deals were brokered by GACN under Total's DSO. Hence the aggregator has a major say on how and who gas is marketed to, even beyond the confines of the state-owned gas grid.
But attracting foreign investment into a country with major security concerns when there is competition from less risky locations in Sub-Saharan Africa will be tough. It may be local investment that drives industrial growth in Nigeria.
Free trade zones
The Lekki Free Trade Zone (LFTZ) is located on the Lekki peninsula to the east of Lagos. It is home to the largest industrial complex under construction in Nigeria including the Dangote refinery, petrochemical plant, a 570MW power station and a deep sea port. Constructed with private money, LFTZ should provide a much-needed new gateway for goods into Nigeria thus bypassing Lagos's clogged arteries.
The refinery is the lynchpin of the LFTZ, and Dangote Group will construct a short 20 kilometre gas pipeline from Lekki to tie-in with the Escravos-Lagos transmission pipeline, so there are opportunities for gas supply using existing infrastructure, although the possibility of secure supply by extending Shell's offshore gas gathering system (which has plenty of spare capacity) could be even more attractive.
Develop gas distribution
In 2017 Shell signed a US$300mn deal with Shoreline Power. It will finance and develop a pipeline network in the Lekki franchise area which Shoreline has owned since 2015. The 20 year franchise provides exclusive rights to distribute and sell gas in Lagos's commercial centres of Victoria Island, Ikoyi, Lekki and Epe. This includes LFTZ, which Shell is targeting. But as Lagos continues to expand along this eastern axis, Shell foresees opportunities to supply more commercial and industrial consumers on the peninsula, which has developed rapidly over the past 15 years.
Shell has been distributing gas on small networks in Nigeria since 1998, but the Lekki franchise is a significant step-up in scale and ambition. In 2017 Shell also signed an MoU with the Rivers State government which could see them develop a distribution grid in the greater Port Harcourt area.
Shell aims to displace some of the 18GW of expensive on-site diesel generation which it estimates is being used in Nigeria. This alone would absorb over 4,000mn cf/d of gas, so even 10pc of this would be a material share.
Gas distribution is not currently regulated in Nigeria, and distributors in Lagos make a healthy margin in this sector with some end-users paying around US$8/mn Btu (which is still far below the equivalent cost of running a diesel generator). There is significant upside here for early movers, provided the government resists its regulatory tendencies.
Because of the physical transmission constraints, there are opportunities to embed small gas-fired power plants into lower voltage distribution grids. Lagos has a few of these including Mainland Power (5.8MW), while others like Island Power (11.5MW) and Akute Power (12MW) have their own distribution grids or supply direct to local utilities.
But in 2017, the Lagos State government initiated the far more ambitious "Light-up Lagos" project to generate and distribute up to 3GW of off-grid power and design tariffs to support embedded generators (to put in context, this would be a 75pc increase in national power generation). It also passed its own power sector reform law in February 2018, and established a Lagos State Electricity Board, to develop new generation, transmission and distribution infrastructure beyond the national grid and distribution franchises.
If Nigeria stays on its current path, then domestic market growth will remain constrained well below its potential. The gas and power sector will continue to fragment away from the limitations and risks of the state-owned grids, and so diverging tiers of service quality will emerge.
Where state-control is dominant, the value chain will continue to suffer chronic illiquidity, non-payment, under-investment and intermittent supply. Long-suffering consumers are unlikely to see much improvement in power supply because the transmission grid will remain constrained.
Private investors will seek to minimise or avoid these risks wherever possible. Wood Mackenzie expects to see:
● More point-to-point supply and demand between gas suppliers and large private offtakers.
● More supply to clusters or 'islands' of private-sector industrial demand in the form of free trade zones.
● The creation of new islands of industrial, commercial and even residential demand for those willing to go downstream and build gas distribution networks where none exist.
● Smaller islands of gas demand from embedded generators powering small-scale private distribution networks outside existing franchises.
● State governments increasingly promoting their own grids to the private sector rather than looking to the federal government.
Those simply hoping that Nigeria will one day—willingly or otherwise—abandon its paternalistic view of the energy sector and embrace market forces are likely to be in for a long wait.
Serious players will be more creative and ambitious in their efforts to build their own markets beyond their upstream bases and ideally beyond the reach of regulation. The message is clear: if you really want to grow and prosper in Nigeria's domestic gas market, you are going to have to move downstream and do it yourself.
Gail Anderson is a Nigeria specialist at Wood Mackenzie