PAPER : Gas Infrastructure Financing

SUBJECT : Challenges and Opportunities

AUDIENCE : Gas Aggregation Company Nigeria (“GACN”) – Buyers Forum / Stakeholders
Engagement
DATE & VENUE : 24th September 2018, PTDF Main Auditorium, Central Business District, Abuja
AUTHOR : Patrick O. D. Mgbenwelu

1) INTRODUCTION AND OVERVIEW:

Notwithstanding progress made on a number of fronts, attainment of Nigeria’s full gas potential remains
several years behind. This paper has been written in the context of the Nigerian financing landscape,
more specifically in relation to the challenges and opportunities across the gas infrastructure value chain.
It is based on developments over the last few years and also pulls upon lessons learned from gas
infrastructure financings closed, including transactions still on the drawing board. The contents of this
paper does not purport to or intend to contain all information in relation to the subject matter and may
therefore be subject to updating, revisions and or other amendments. As we all know the gas sector is
split into upstream, midstream and downstream segments with the upstream and midstream segments
being the most capital intensive. The gas sector constitutes a very important and increasingly critical but
yet constrained, untapped and unrealized sector, compared to other sectors of the Nigerian economy – it
is an integral element of the foundation for our struggling power sector, ambitious industrialization drive
and overall energy requirements. It represents a key feedstock component across various industries, has
multitude of linkages with other sectors and is the cornerstone / building block for the nation’s
industrialization, economic growth, equitable distribution to the commonwealth and job creation.

The importance of gas can be summarized below based on its direct contribution to other sectors:

 Transportation infrastructure (roads, sea ports, rail, airports) requires steel and cement - gas
feedstock is a key input for the production of steel and cement;
 Plastics are used as important components within households, factories and industrial plants – the
production of plastics depends on gas feedstock as a major input component;
 Exports of end-products from petrochemicals plants can be a major contributor towards the country’s
much needed foreign exchange – gas feedstock is a prerequisite for petrochemicals plants;

Despite the glaring importance of gas, it unfortunately has not been given the priority it deserves. There
remains a host of challenges and concerns noted by both onshore and offshore investors, project sponsors
and lending institutions as articulated below. In no particular order of importance, I have grouped these
challenges into primary and secondary buckets.

2) PRIMARY CHALLENGES:
A. ABSENCE OF SINGLE DIGIT, LONG TERM NAIRA FUNDING: development of gas infrastructure facilities
is extremely capital intensive (deploying significant amounts of capital) and takes several years to
complete. Projects therefore require unusually long grace periods on debt to fully complete
construction activities and achieve steady state, post commencement of commercial operations. In
view of the foregoing, the present 5 – 7-year tenor funding from Nigerian Banks at rates of between
18% to 24% will not “bank” any gas infrastructure financing, and in circumstances where these
features are “bolted unto” financings will naturally result in inevitable debt service defaults and

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 “tight” unsustainable cashflows. Except for Liquefied Natural Gas (“LNG”) projects with a secure, long-
term and credit worthy foreign offtaker, majority of other gas projects will have offtakers who’s
primary source of revenue will be denominated in local currency. We therefore cannot keep ringing
the bell for only long term and low cost US Dollar funding as we have seen the havoc that exchange
rates can have on company cashflows (I will speak on the issue of hedging products fairly soon) – it is
acknowledged that additional offshore capital will be required to plug the financing gap for most
projects, but notwithstanding, the Nigerian financing landscape needs to transition to one where
single digit and long term local currency credit can be accessed. As a result, the Federal Government
of Nigeria (“FGN”) needs to seriously and very quickly work towards opening up another Naira
denominated liquidity pools such as the capital markets, bonds and PFAs to provide long-term Naira
funding for greenfield gas infrastructure projects (i.e. the rules needs to be revamped). In parallel,
the Central Bank of Nigeria (“CBN”) working with the private sector should work towards catalyzing
the Nigerian banks so they are in a position to provide single digit local currency funding with tenors
of up to at least 20 years. Development of gas infrastructure in the country will remain challenged in
the absence of the foregoing.

B. LIMITED COLLABORATION / PARTNERSHIPS: with increasing pressure on public sector finances,

Nigeria cannot continue relying on its yearly budgets to meet the country’s growing infrastructure
demands. The recent efforts of FGN accessing offshore liquidity has been noted, however (a) much
more needs to be done to attract a wider pool of investors and (b) alternative “risk transfer” based
funding models needs to be pursued. Gas pipeline financing are excellent candidates for progressing
Public Private Partnerships (“PPP”) with investors to attract private capital for the accelerated delivery
of greenfield projects. As the scale of investments required cannot be met primarily from the onshore
debt and or equity markets, the responsibility is therefore squarely on the FGN to identify, develop
and “market” investment ready projects for investors, project sponsors, development financing
agencies and fund managers. However, as noted in several sections of this paper there are a number
of issues which FGN needs to address in order to attract private sector capital – one issue that clearly
stands out for investors is the fiscal bill (as contained in the Petroleum Governance Bill) for gas sector
development which has been a major area of concern for local and international investors, all of which
have now adopted a “wait and see approach” and also one of the reasons international investors have
not and will remain reluctant to deploy their cash into the Nigerian gas sector.

C. ABSENCE OF HEDGING PRODUCTS: project sponsors and commercial banks may include offshore
based liquidity providers, especially for those projects that are likely to benefit from the sale of their
end-products in overseas markets. In these circumstances, liquidity providers will expect the project’s
financing plan and structure to include appropriate risk mitigating products (i.e. commodity, currency
and or interest rate hedging instruments) irrespective of whether the project’s capital structure is
100% US Dollar funded, 100% Naira funded or a combination of both currencies. The extremely long-
term nature of such financings (and the natural uncertainties which the transaction will be exposed
to during the loan life) acts as one of the underlying reasons why such hedging instruments are
generally sought by liquidity providers. Efforts should be made for the development of such hedging
products to be available for Nigerian gas projects which are to be funded in either US Dollars and or
Naira.

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D. GAS AND POWER SECTOR DEBTS: despite this paper’s focus on gas infrastructure financing, we simply
cannot ignore the role, importance and positive economic impact of stable power supply. Gas
suppliers are naturally at the bottom of the power sector payment chain, and as a result, have been
and continue to suffer from payment defaults and liquidity constraints higher up the power sector
value chain. The entire power sector value chain continues to be chocked by liquidity constraints
which we are all aware of. Given that virtually all gas supplier debts are yet to be fully settled it will
be a futile attempt engaging with investors. Nigeria’s industry base which requires gas feedstock is
yet fully taking-off and power generating companies are at the present time one of the largest
customers of gas suppliers. Steps (driven and managed by FGN) should be taken to ensure full
settlement of all historic debts (especially those from government agencies) and also rolling out a
sustainable framework for the timely settlement of gas supplier invoices going forward. Two other
interrelated sub issues to be looked at are (i) ensuring that power sector tariffs are economic, market
driven, and investments made to reduce technical and commercial losses over time, and (ii), aligning
the foreign exchange components inherent within the gas and power tariffs.

E. OFFTAKER CREDIT STRENGTH: gas financing is essentially underpinned by the certainty, outlook and
robustness of the offtaker’s cashflows. Where the offtaker’s cashflows are in question then fund
raising will always remain a challenge – i.e. banks and equity investors will remain at bay. At the time
of presenting this paper, only a few offtakers in the country have operations which financiers will
“smile” at. Power generating companies which currently represent the bulk of gas offtakers at the
present time do not have acceptable credit quality and this has been directly as a result of ongoing
power sector specific industry challenges which they have been struggling with since privatization of
the sector. There has to be a “deep dive” into those fundamental issues which are negatively
impacting the operations of existing and new gas off-takers. From where financers sit what we see
are basic infrastructural, fiscal and regulatory anomalies and bottlenecks some of which have been
set out in this paper.

F. GAS TO POWER CHAIN: this remains unviable and unsustainable.

3) SECONDARY CHALLENGES:
A. APPROVALS, PERMITS, RIGHT OF WAY, RED-TAPE AND BUREACRACY: investors are still not clear or
fully aware of the various approvals required for projects. The challenge remains that there is no
“black and white” direction / policy in this regard. What we have found are that sponsors assume all
is in place only to stumble over a new set of unknown requirements (i.e. approvals, consents,
administrative red-tape and or permits) emerging midway or towards concluding the processing of
approvals. In addition to the foregoing, approvals take unusually longer than expected and the
number of government agencies from where approvals are required are simply just too many. FGN
should put in place “One Stop Shops”, Business Links or Development Agencies where investors can
obtain all the requisite approvals and paperwork required for moving their projects forward. In
summary, the timing for securing approvals should be significantly reduced and so do the layers for
the requisite approvals.

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B. GAS INFRASTRUCTURE (limited network): participants fully acknowledge that the FGN can only do
so much in terms of addressing the issue of limited pipeline network. However, the obligation rests
squarely on FGN to set the stage for attracting investments in this area. Although there is indeed a
long-list of what FGN should and can do, some of the immediate ones to be tacked are:
 the need to review and accelerate the introduction of incentives for private sector investment
(i.e. tax breaks, custom waivers, capital allowances, etc.) across all sections of the gas value chain;
 Expanding access to gas reserves;
 Ensuring a cost reflective gas pipeline tariff (see below);
 Addressing security challenges;

GAS INFRASTRUCTURE (monopolistic): the present ownership structure of gas pipelines

infrastructure is one that will continue keeping investors at bay, unless potential investors are
incentivized to construct their own pipelines and allowed to impose economic and market based
tariffs that must include components of gas production, gas processing and its transportation. At the
moment, existing infrastructure has monopolistic features which include elements of tariff regulation.
To the extent development of gas pipeline infrastructure will transition (i.e. whilst these monopolistic
features are in place), then the tariffs must be cost reflective and accommodate “acceptable investor
returns.

C. SECURITY CHALLENGES: this remains one of the biggest fears across all offshore investors as no
amount of financial engineering can address this issue. The solutions must include supporting project
sponsors navigating the terrain for job creation and addressing host community issues in the sensitive
areas to encourage project acceptance by the local communities and other key stakeholders.

D. FRAMEWORK ANOMALIES: The sector is governed through an outdated institutional, legal and
regulatory framework. The gas fiscal framework is seen to be outdated and needs to be revamped,
for example:
 Fiscal framework is such that oil projects essentially subsidizes those for gas;
 Gas is not legislated for as an industry and is therefore not seen as a commodity in its own right;
 Policies and regulations focuses more on oil than gas;
 The market needs to transition towards that of a willing buyer and willing seller;
 Domestic Supply Obligation (“DSO”) should be driven and based on credible demand;

4) THE OPPORTUNITIES:
a) Financing opportunities: The are a multitude of funding opportunities for the gas sector, some of
these are pretty obvious. Given the time restriction imposed for presenting this paper on gas
infrastructure financing, a comprehensive paper and detailed discussion on each of the below is
outside the scope of this discussion and will be undertaken at another time.
 Syndicated lending from both onshore and offshore financial institutions;
 Club deals driven by sponsor “house banks”;
 Prepayment financings;
 Emergence of greenfield project bonds;
 Public Private Partnerships;
 Reserve Based Lending;

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  Contractor Financing, as offshore banks tied to their EPC and O&M contractor clients follow them
into Nigeria;
 Expansion of the equity and debt capital markets;
 Increasing involvement of Development Finance Institutions; and,
 Hopefully, entry of PFAs and Insurance Companies;

b) Sectoral opportunities: growth of the following sectors will take off as liquidity gravitates towards
bankable deals:
i. POWER SECTOR: I am forced to state the obvious, “energy represents the catalyst for
development of any economy seeking to grow, and its absence is akin to running a car on a flat
tire”, secondly, use of the “ideal fuel will determine the long term and sustainable performance
of that car”. In this context, the Nigerian economy will only emerge from its comatose state once
there is steady and abundant power supply, including market based price(s) for gas feedstock for
power plants which is without question one of the critical building blocks for moving the country
forward. At the bottom of the power sector value chain are the gas suppliers without which
industries will not be able to operate. A brief snap-shot of key industries shows that over 90%
depend on gas as feedstock – i.e. cement, fertilizer, petrochemicals, steel, etc. The message
therefore is that unless a sustainable solution is found and implemented for the gas sector, growth
of the power sector and all other sectors that rely on stable energy will continue being hampered.

ii. INDUSTRIAL BASE: as already articulated, most industries from which improvements in
infrastructure depend on rely on gas as feedstock. We can therefore spend months discussing
the need to industrialize the Nigerian economy but will remain constrained achieving any tangible
progress unless focus and concrete steps are taken to build the foundation building blocks (i.e.
gas supply and its associated infrastructure) upon which accelerated industrialization can be
achieved.

iii. LNG: The demand outlook for Liquefied Natural Gas (“LNG”) remains very positive, and we have
tangible evidence of the positive financial, employment and social benefits that NLNG has
contributed towards the Nigerian economy. At the time of writing this paper, we understand that
NLNG is embarking upon increasing its access to gas feedstock and also expanding its trains.

iv. THIRD PARTY INVESTMENTS: we will witness a natural increase in third party investment
initiatives and the opening up of ancillary (even unrelated) commercial hubs across the various
corridors where pipeline infrastructure is rolled out.

v. GAS FLARING: the FGN has taken a notable step towards addressing gas flaring following the
release of the Gas Flare (Prevention of Waste & Pollution) Regulations 2018. The overriding
objective is to accelerate the pace for stoppage of flaring in Nigeria. The Regulations therefore
puts in place the following framework and opportunities:
 puts in place the commercial and legal framework for monetizing flared gas;
 widens access to Nigeria’s gas base, particularly for the gas midstream segment – i.e. there is
now outright prohibition of the routine flaring of gas when undertaking greenfield projects;

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  opens up a producer’s flared gas to third party potential investors seeking
“commercialization”;
 Extends a host of incentives to gas midstream operators (i.e. initial 3 years’ tax free period,
accelerated capital allowances post the tax free period, VAT exemptions, etc.);
The potential and opportunities from the above initiative can be summarized as follows:
 Increased power generation;
 Higher outputs from ammonia plants;
 Significant step-up in LPG production;

5) CLOSING REMARKS:
Notwithstanding the gas infrastructure challenges highlighted in this paper, it is worth noting that there
have been some positive developments in terms of the efforts being made for expanding Nigeria’s gas
infrastructure as follows: (i) advancement of the funding arrangements for the Ajaokuta-Kaduna-Kano gas
pipeline project by NNPC and (ii) NLNG formally moving ahead with its fund raising plans for train 7 and
gas supplies in this regard.

In closing, unless efforts are made to address the issues set out in this paper, greenfield gas projects will
continue struggling on bankability criteria and developments across the gas value chain will remain
constrained, stifle economic growth and national development. NLNG is however an exception – NLNG
remains the “darling” of the local and international banking community given its blue chip status, sound
credit strength and remarkable operational and financial track record.

 Entire value chain must be bankable to attract funding;

 Long term financing now an ever increasing component, amongst other factors;
 FGN must therefore take bold and audacious steps to “load up” incentives in order to attract much
needed investments and confidence;
The longer the country takes to resolve these issues and accelerate investment in Nigeria’s gas
infrastructure the further the country will lag behind and slowdown in terms of advancement. If we do
not act now, the country will slide further behind (by almost another decade) in terms of economic, social,
infrastructural and industrial advancement. “Although the train has almost left the station we must act
fast and jump unto the rear carriages if we are to have any chance of moving forward”.

6) APPENDICES:
a) AUTHOR CONTACT DETAILS:
 Patrick Mgbenwelu, Head – Investment Banking Division, FBNQuest Merchant Bank Ltd, www.fbnquestmerchantbank.com,
Patrick.mgbenwelu@fbnquestmb.com;

b) IMPORTANT NOTICE & DISCLAIMER:

This Paper has been prepared by FBNQuest Merchant Bank Limited (“FBNQ MB”) based on a combination of publicly
available data, engagements with existing and potential investors seeking to deploy capital into the Nigerian gas
sector and engagements with potential lenders seeking to consider financing gas related projects in Nigeria. On the
invitation from the Gas Aggregation Company Nigeria (“GACN”) FBNQ MB is sharing its thoughts to the audience
attending the GACN Buyers Forum / Stakeholders engagement without any obligation, duty and or liability. No
representation, warranty or undertaking (express or implied) is made and no responsibility is accepted by FBNQ MB,
or any of its respective officers, directors, or affiliates as to the adequacy, completeness or reasonableness of this
Paper or other information and documents provided to GACN by participating in this seminar / forum / conference.

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The information is therefore not a substitute for any recipient's own investigation or analysis and should not be
construed as a recommendation or not of any kind in respect of the Nigerian gas sector. The Information does not
purport to or intend to contain all information that a prospective lender, investor and or sponsor may require in
considering whether to participate in the sector and it may be subject to updating, revision and other amendments.
The information contained in this Paper is not intended to provide the basis for any credit or other evaluation and
should not be considered as a recommendation that any recipient hereof should participate in the sector referred
to herein. Each recipient is responsible for making its own independent investigation and appraisal of the financial
condition and affairs of, and its own appraisal of the creditworthiness of the sectors and or any project as described
in this document. Where the information contains summaries of law and of agreements and documents, these
summaries are provided for assistance only. They do not purport to be complete, comprehensive or accurate
descriptions of the law, agreement or document to which they relate, and are qualified in their entirety by the full
text of such law, agreement or document. Participants / attendees of the GACN Buyers Forum / Stakeholders
Engagement and or readers are therefore advised to undertake their own independent verification and due
diligence. The information does not purport to or intend to be construed as providing recipients with any legal,
business, tax or other advice. The delivery of this paper is based on information, experiences and feedback received
across investors, commercial banks, project sponsors and engagements with various organizations and does not
imply that the information herein contained is correct at any time subsequent to its date. Neither the author and or
his organization accepts any responsibility for updating the information contained in this document. The information
may not be reproduced or used in whole or in part for any other purpose. This document may contain forward-
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negatives of these terms or variations of them and similar expressions are intended to identify such forward-looking
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events or circumstances occurring after the date of release of this Paper. You are therefore cautioned not to place
undue reliance on these forward-looking statements, which speak only as of the date of this Paper. By their nature,
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concerns over the general economic status, environment and risks associated with doing business in Nigeria,
significant technological and environmental changes in our sector, as well as many other risks.

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