Swimming Upstream: Nigeria’s Economy Defies All Logic

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Nigeria’s petroleum industry is very peculiar. Despite producing 1.75 million barrels of crude oil per day(b/d), they only refine about 24,000 barrels into gasoline, leaving them 384,000 barrels short of meeting daily domestic demand.

This means, they must sell their raw materials to a refining country – effectively a ‘middleman’ – and buy back the finished product at a superfluous markup. This is an extremely illogical, impractical and shortsighted process, which has been artificially propped up in the past by the price of oil. Now that the price of Brent crude oil has declined by 52%, compared to 22% for retail gasoline in the last two years, the structural problems in the industry are beginning to manifest themselves. I propose a two-part solution involving government policy changes and private sector investments in the petroleum refining sector.

It is almost trivial to state that Nigeria’s biggest problem is corruption, Nigeria ranks 136/138 in the Corruption perceptions Index and rampant oil theft of about 100,000 barrels/day costs the country about $10 billion every year. With many public officials profiting from the “bunkered” oil, analysts have been doubtful about seeing any meaningful changes materializing in the country. However, a year has passed since the first Nigerian election where an incumbent president handed over power peacefully and the country now has a president that is generally highly regarded by Western governments; Nigeria finally has an administration with the political will to enact the necessary policies. This is not mere political rhetoric as the government has already begun to take tangible actions.

One of the most significant reforms was the landmark decision to deregulate the importation of petroleum in May 2016, considering the power of the vested interests fighting against this bill, this is an underrated indicator of the government’s volition to do what is best for the country. Nevertheless, much more work needs to be done.

First, Nigeria’s state oil company, Nigerian National Petroleum Corporation (NNPC) must be restructured, through the Petroleum Development Corporation and National Petroleum Investment Management Services it currently acts as both a market participant and regulator respectively. Such conflicts of interests indirectly resulted in PWC conducting a forensic audit and finding that $20 billion was unaccounted for from NNPC reserves. A restructure seems very likely as the biggest opponent to a restructuring was the last NNPC president, who is currently in the UK amidst pending corruption charges brought on by the current administration.

The Central Bank of Nigeria must also relax its capital control laws and maintain its floating exchange rate, the CBN had previously tried to fix the exchange rate but that simply caused the reserves to reach their lowest point in 11 years; 16 months later and $6 Billion poorer the governor finally gave up on the experiment and has publically declared a more liberal exchange market . Though the currency has slid 49% against the US dollar since 2014, this is a signal to foreign investors that Nigerian assets are effectively on sale and more importantly, the government will not excessively interfere with the free market.

Finally, the government must solicit investments from the private sectors through lucrative pro-business incentives. Currently, the only major investor looking to set up a refinery is Dangote PLC. The proposed Dangote Lekki Refinery will have a production capacity of 650,000 b/d, bear in mind that Nigeria has a domestic demand of 408,000. This means that one private company will effectively be producing all the gasoline for an entire country, with a surplus. It is almost trivial to point out why this is a bad idea, fortunately, a solution seems likely.

I proffer a strategy whereby the government submits an incentivised request for proposal (RFP) from foreign/direct joint ventures in the petroleum downstream industry. Potential bidders would be upstream companies with experience in the African market, including Canadian firms such as Oando PLC and James Bay Energy. The electricity subsidies will compensate for Nigeria’s expensive and scarce electricity and allow the companies to source power at profitable rates;Dangote was offered a similar deal in its Nigerian and Ethiopian plants. I project increased cash flows of $12,290,499 from foregone gasoline importing costs. The initial investment will be a floating rate, 3-year electricity forward contracts, priced at the difference between the subsidized cost and market price of electricity, using historical averages. Present valued at a discount rate of 11.76% . Resulting in a profit of over $10.9 million and a return on investment of 45%.

My calculations for expected value of the partnership.

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