Avuru: Why Private Refineries Fail

By MARCEL MBAMALU, TEMILOLUWA ADEOYE and IKECHUKWU ONYEWUCHI    |   24 January 2015   |   4:25 pm  

Avuru-1

• ‘I Did Not Call For Scrapping Of NNPC’

Nigerian oil companies are touted to shoulder huge responsibilities as multinational companies are giving way for indigenous participation. Managing Director (MD) and Chief Executive Officer (CEO) of Seplat Petroleum Development Company, Mr. Austin Avuru, in this interview with MARCEL MBAMALU, TEMILOLUWA ADEOYE and IKECHUKWU ONYEWUCHI explains, among other issues, the prospects of Nigerian businesses in the indigenous industry, challenges in gas production and why private refineries couldn’t take off.

Seplat will be five very soon. Given the fact that the company has grown considerably, as evidenced by its successful international deals, what factors would you say   are driving this growth?

    It can be attributed to a couple of things. First, we are focused. Our strategy has remained what was conceived from inception. We grew our business on three planks, through what we call an organic growth. This means creating optimum value out of any asset we own. We work on assets thoroughly to optimise shareholder value and all other stakeholders, including government and host communities, by paying taxes and other royalties. We supplement that growth by acquisition of assets — an exercise we describe as growth by acquisition. 

    When nobody was thinking of domestic gas business, about three years ago, we invested in it. I am proud to say that, in a very short while, we have doubled our gas capacity. We hope to increase our capacity by 60 percent in about 12 to 18 months. So, our strategy is: focus, acquisition and the gas business. We focus on those three; build the prerequisite human capacity to deliver on all three fronts and, by prudent management, build a balance sheet that would see us through trying times so as to implement our world programme. 

    Our world programme implementation figure in the last four years is over 90 percent each year. To summarise, our growth has been well-planned and sustained.

Considering your new deal with Afren, what are the bigger plans ahead?

     The preliminary discussion with AFREN and the refinancing package are all part of our growth through acquisition and interest in the gas business. To be able to make the huge investment in gas and associated facilities, and the acquisitions that are complementary to our business, we need a petty minimum war-chest. What we have done is to then leverage value in terms of production and sales and our balance sheet to tap the debt market to access debts that can enable us do business better. 

   This is a statement of two key things. If you look at the details you will discover that there are 12 Nigerian banks and a number of international banks. There is probably no other indigenous business today that can access this instrument. The three international banks put together $300 million out of the $1billion.

Why do you think this is so?

    I can tell you, and you can find out from indigenous companies, that there is a lot to say about corporate governance, about international confidence in a business model, in a balance sheet before a business can attract funding from international banks. The fact that we have gone through this international due diligence before we got listed shows that we belong to a different category of indigenous companies in terms of assessment by international credit providers and international investors. Hence, it is not surprising that we got about $300 million from foreign banks and $700 million from Nigerian banks, a total of $1 billion. It is a very strong statement on our balance sheet, in us as a company and on our corporate governance. That’s one key area. The other area is that it provides us with the war-chest to finance our acquisitions in the gas business.

 What do you make of the current gas price when weighed against demand?

      The current gas price is not as high as we want it. Domestic gas price today lifts at $2 to power plants, and higher than that to other industries. The one to industries are close to the market price. The one to the power plants could be flatly higher but we can live at $2.50 for now. We hope in the next few years, it will escalate to $3 to $3.50, which is more like it. But even that, is a far cry from where we were coming from. About four years ago, the price was at 20 cents, and then rose to a dollar and later to $1.50. So we are shifting closer to the market price. This is why we are encouraged to make the investments we are pursuing. The idea is that by the end of 2017, we should probably be responsible for 20 percent of the gas delivery in the west to the domestic market. That is our target as a company.

    How are you reacting to the issue of pipeline vandalism, especially in the Trans- Focardos pipeline?

    That’s bad for us. In fact, the biggest risk to our business is the Trans Forcados vandals. The thing with this is control. The pipeline system is critical to our business. And we have managed to keep those critical to our business safe from vandals for the past four years. But farther down south the biggest threat to our business is Trans Forcados lines. Anytime it goes down, our production goes down. 

    We have alternatives, though. We deliver volumes to the Warri refinery, financing the investment ourselves. Trans Forcados saves us some production cost. We deliver crude oil to the Warri refinery at zero transportation cost to them. That would be between $10 and $15 per barrel.

   We are also putting up storage facilities such that even when all of our production is down, we can deliver gas. We have sufficient facilities to meet up with cuts, especially with the Trans Forcados thing. We are hoping that the storage facility will be commissioned in the first quarter or early second quarter this year. We can deliver gas uninterrupted to our customers.

What are your future plans on gas, in terms of expanding to new markets?

    The domestic demand for gas right now is outpacing supply. We are struggling to catch up with supply. As I said, the pricing is not as much as we want it, but it is still good enough for us to make investments. Two things are driving our gas business. We are working hard to achieve the target we set for ourselves for 2017. As a company, we want to be known to be a critical support base to the domestic energy sufficiency drive. We want to be proud, to beat our chest and say we are a major contributor, in terms of domestic energy security. When we get to the point whereby 20 percent of gas delivery in the economy comes from us, then it doesn’t matter who is charge, people will take us seriously.

 Given the global oil prices, it would appear that Nigeria is not fully tapping into its gas potentials, even in production. What do you make of that, in terms of strategy for efficiency?

     It is largely true. Fortunately, locking down the domestic contract, even at $2 or $3, provides revenue stability, provided the customers are available. The biggest risk we have today is having our customers available. Hopefully, in the next four years, we would have crossed that hurdle and have very stable contracts where the customers are guaranteed to pay. It provides stable income, not as high as the income from oil, but stable enough to be a major dependable source of revenue. Again, as I said, the gas business doesn’t only position us as a serious contributor to the energy economy; it is a stable source of revenue, too.

 You talk about capital investments in the business but, going by what is the public domain, it is predicted that oil will run dry in about 30 years time. What do you think is the future of the oil business in this regard?

    Oil will not run out in the next 30 years. It all depends on how much they are discovering. It will stretch beyond that.

Our current reserves inclusive?

    Yes, it will still stretch to 30 to 35, even to 100 years. If we take current reserves and production ratios, the results show that there is still very much opportunity in the industry. We are making investments in the gas sector to make sure that the opportunity is fully harnessed.

The Organisation of Petroleum Exporting Countries (OPEC) regulates output in the oil industry, but there are no controls yet for gas; what do you think Nigeria should be doing to benefit from its abundant gas reserves?

   There is an association of gas exporting countries headquartered in Qatar. It is not as critical as OPEC, largely because volume regulation for gas hasn’t become necessary due largely to forces of demand and supply. But in Nigeria, it will take at least four years for supply to meet demand in the domestic market. The Liquefied Natural Gas (LNG) has been dominated by Nigeria Liquefied Natural Gas (NLNG). The other LNG plant has not managed to take off. And it is getting increasingly difficult for that plant to take off because the other markets in the West, the United States and the East are gone. It is difficult for a new LNG plant to take off in Nigeria. 

           There is an expansion of the NLNG and the huge expansion of the domestic market. The complementary nature of the NLNG and the domestic market has been such that by 2018 and 2020, total production of natural gas, both LNG and domestic gas, by the NLNG will be expansive.

There was this report about you calling for scrapping of the Nigerian National Petroleum Corporation (NNPC). What would be your clarification of that report?

   Anyone who understands this industry cannot ask for the scrapping of the NNPC. But you can ask for certain adjustments in the structures for efficiency. I talked about the NNPC having the courage to sell its refineries, privatise the down-stream, so that it will be more efficient, and concentrate on its activities in the up-stream. I said they should strive to form a share of all its projects in the up-stream sector and diligently collect all revenue due to government. The government, in turn, should manage the revenue well and start the building of the country’s Sovereign Wealth Fund (SWF). Those are exactly the things said. I stressed that Nigeria needs a healthy SWF to play during periods of downturn like this. If you have a healthy SWF, you can survive the downturn. It is the reason Saudi Arabia and Kuwait are matching on with the price war and are not dazed by it because they have a healthy SWF. I advocated that, as a country, we should strive towards achieving a SWF that is not less than 50 percent of our GDP. At that point, our budgeting can be stable. Those are the three critical things I talked about: privatising the downstream sector and financial security for the NNPC to fund its upstream activities.

What about OPEC?

  There was something I said that was not quoted. At that forum, I and two other persons, that is, former Minister, Ajumogobia — and that is the second time he spoke about it — and Mr. Kupolukun, argued that we cannot be talking about pulling out of OPEC. My reason is that we may think we are not benefitting as a country from OPEC, but that is not the issue. The issue is this: is OPEC as an organisation relevant in securing stable prices for producers of crude oil? The answer is yes. 

    OPEC has the capacity to intervene and secure favourable prices. What is happening now is a price war between OPEC and some other non-OPEC producers. The price war is aimed at establishing an equilibrium price below which high cost producers cannot play. Establishing that price could happen in the next three to six months. It is only at that point that OPEC can now use its machinery of reduction in production to reduce price.

   But, clearly, in the last 40 years, when it was needed, OPEC came in to stabilise prices. OPEC is a critical intervention agency on behalf of Third-World producers, whose economies depend on oil revenue. Now, if you kill OPEC, oil producers are, individually, at the whims and caprices of the consumers, which used to be the case before 1971. 

   Once you argue that OPEC is irrelevant, and I argue strongly that OPEC is very relevant, it will then be sensible to withdraw from OPEC. Once everybody withdraws from OPEC, including Saudi Arabia, the consumers will decide what gives. So, I think it is really short-sighted in terms of conceptual reasoning. It is shocking to think of anything that will kill OPEC. If you kill OPEC we are dead-meat. 

    There are even non-OPEC countries that depend heavily on OPEC to stabilise prices. Sometimes, OPEC works with Russia, Mexico and other non-OPEC producers to stabilise prices. If OPEC is not there, we are in trouble. I argued strongly that we have to be in OPEC for good reasons; that is the part that was not reported.

It’s strange that OPEC is not cutting oil production yet; isn’t it?

     No, they are not cutting production now because we cut production today to secure high prices for people producing at high cost. This is a long-term war. Shale oil producers in the United States, who have been responsible for an increase of overall output of about five or six million barrels per day in the last three years, are producing at the cost of $45 to $50 a barrel. When the prices are at $90 and above, it keeps them in business. Then, they flood the market and you withdraw your production and keep the prices high. 

    OPEC is saying that they are not going to pull back volumes to create a market for high cost producers in the US. You won’t see the effects immediately. At $45 per barrel, in the next six months, half of all the shale producers will have a shocker because they can’t be in business. When that happens, in the long-term, it will become clear that, at a price below $60, certain people cannot do business. 

    From that price, OPEC can then determine at what volume to pull out if they want a $70 or $80 price. The first thing is to throw out those who cannot compete out of the market before stabilising prices. That is what OPEC is trying to do.

The US has a huge stockpile from shale, how long do you think it will take before they budge?

    The US has shale oil or not, as part of their stabilisation policy, they will have a large stock-pile, whether they are importing or not. And that impacts on pricing. They will have a large supply, no matter the emergency, even without a barrel entering the US. 

Let us not forget that this is not the first time this has happened. In 1987, the US was producing 12.5 million barrels a day, before it declined to five million barrels a day; while their demand is 15million. 

   Shale oil is just another source of crude oil, just as we have had other sources in the past. In 1972, we suddenly found oil in the North Sea. It attracted over 10 million barrels of additional production into the market. There will always be old sources drying up, and new sources. What is important is that, globally, there is still a demand and supply balance for the next 40 years.

   Within the context of that demand-supply balance, what kind of price do you expect? That pricing will be determined by a mixture of cost of production, difference in geography and so on. So at $110, there will be some production that will enter into the market that would not have been in the market at $40. That is the dynamics we are looking at.

Are you saying the discovery of shale oil and other sources of renewable energy may not be real threat after all?

   Let me put it in context. First, renewable energy and all energy sources — except natural gas, coal and crude oil — still account for a little more than 20 percent of the total energy used by 2040. Fossil fuel will still account for little more than 80 percent of total energy by 2040. Renewable energy has its limitation in terms of volume, cost of production and others. When you come down to fossil energy, coal will reduce, crude oil will remain largely flat and gas will increase. That is the trend between now and 2040. 

   Overall, you want to ask, looking up to 2040, are we likely to see supply that can meet the projected demand? The answer is yes. This is thanks to these additional sources like shale oil, and shale gas. Shale gas will account for 17 percent of total gas production by 2035, from zero ten years ago. It will account for 13 percent of total crude oil by that same date. If that did not exist, we would have had a supply demand imbalance that would have tilted the price more towards the $200-$250 per barrel. So, it is not something to be afraid of. It is another source of natural gas just like crude oil. Over all, there is reason to be happy that there is enough secured supply of fossil fuel over the next 30 years.

Federal Government announced reduction in the pump price of petroleum products, from N97 to N87.; yet  about N2. 84 is allegedly being paid as subsidy. As a player in the industry, what would you say should be the right pricing for Premium Motor Spirit (PMS)?

      In third world countries, we try to place premium on the wrong priority. Subsidy does not serve any purpose. We have been flaring gas for the past 30 years because we decided not to allow the appropriate pricing of gas to take place. We come up with all manners of laws to punish gas flaring, which didn’t work. The price for domestic gas is about $2 to $2.50, watch the next three years, there will be a drastic reduction in gas flaring. If there is a market for it, why burn it? I was telling someone who runs a marginal field that gas that is being flared on his field, is $80 million revenue a year. That is huge to a marginal field company. 

   Subsidies don’t have any purpose. I do not believe that we should subsidise the product. We have been subsidising kerosene yet the ordinary person does not buy at subsidised price. But we keep paying subsidy.

   Usually, the best opportunity to remove subsidy is when prices are low, take away subsidy and let the market determine the price. Deregulate it, make your refineries work, and then over the next 12 to 18 years months, even if there is an increase in crude oil prices, the marginal increase in pump prices may not be felt, especially when supply is guaranteed.

    In any case, subsidy is not sustainable in this economy. Take it away and make the downstream efficient.

Some Nigerians think pump price of PMS should be less than N50 by now… 

    I don’t want to get into that calculation. The way to look at it is, diesel has always been sold at the market price. People do not remember that, for the past five years, diesel has been deregulated. We buy diesel at N155, when it is $100 a barrel. Now that it is $50 a barrel, people will want to argue that it should probably be more like N70, N75 or N80. Or we can make export price high. But whatever the case, the market determines the price. 

   First of all, it has to be more efficient. There is about 20 to 30 percent padded on the price just because of the inefficiency arising from the fact that it is not determined by market forces. I still believe that if it market determines, we will come to a decision among importers, marketers and refiners. And you will get the best price. 

Why has it been difficult for us to get private refineries to work?

    When those licenses were given seven years ago, I predicted that a lot of them wouldn’t work because there is a method to it. First, who were the people licensed? The most important element in the entire crude oil value chain is refining. If you refine crude without the right experience, or by getting mere license, you don’t need a soothsayer to tell you that nothing will come out of it. Two, when you are going into a capital intensive segment, it becomes even more critical — 150,000 barrels of crude oil per day will cost nothing less than $3 billion. If you go to bankers to borrow $ 2.5 billion and have equity of $500 million and the market into which your product will go is controlled by government fixed price and your only competitors are government refineries, you will never raise that money from any bank. So no serious refining has started. 

    The only one that has prospects is Dangote. He is raising money from an existing business, so he has the fund to build it. He is going to open doors, anyway. Once he builds his own, the existing ones will rather be sold off or will die. Once other players get that window, however, we, as a company, will like to be involved in the total value chain of the oil production such as actual gas processing and production, and crude oil production.

Is that the same reason why multinationals like Shell and Chevron, have thought of downstream investments?

    With all due respect, very few multinationals will investment in any segment of the oil and gas industry where the currency is domestic. Even in the natural gas industry, they are very reluctant. The currency instrument is what they don’t want to risk. You heard the argument in Uganda, you have crude oil in the country, but it is going to cost you a fortune to get the crude oil to the coast to export. With all the processes involved, you wouldn’t want to export it. The future of domestic business in Nigeria lies with the indigenous companies. In case of refining, Dangote will lead the way and hopefully, indigenous companies will come in. 

A final take on the pump price of oil, there has been drop in global prices; how, in your opinion, is this going to play out?

    Once crude oil prices drop, you cut down on the capital expenditure. It is the instrument that creates jobs, that provides contracts. When this happens, the revenue profile of companies is going to fall. It has already been announced that will be about 9,000 job cuts in 2015. These two things suffer. As a company, because we are still in our growth phase, we will not lay off staff. We will be very prudent in any new hiring — that’s the way we make up for it.  

    Even if it is fixed at 53, it strategically fits into our long-term domestic gas supply. That’s why it is priority for us. And then, there is also oil to be developed. It gives us critical gas reserves to meet that supply and also oil development. We will invest hugely into gas development in that bloc and monetise the oil. 

From a report in December, it was claimed that Seplat has very good debt-to-equity ratio; how does that affect you?

   It will go up. But that’s in court. It was that way because we had a low equity debt ratio. That is the headroom that we utilised. We will continue to balance our business to make sure that there is always headroom. As much as possible, we will build our balance sheet so that it would positively reflect on our debt equity ratio. 

Does that affect the cash at hand?

   You know, capital can either be debt or cash. The thing about it is not how much cash you have in the bank; it is how you deploy the cash to create value. In fact, if as a listed company, between one to two years, you have $500 million sitting in the bank, you won’t get value for it. Actually, there will be a discount for it. You must deploy capital optimally, that is why it is not about how much cash or debt you have, but how much value you are creating.

Seplat has done five years already, what should Nigerians expect from the company in the next five years?

    The next five years is for consolidation. After our first four years, which ended last July, the next four years should be in July 2018, will be consolidation. This means that by then we would have consolidated to a certain target of oil and natural gas production with sufficient reserves to march. 



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