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Independent Analysis
For Energy Leaders

Outlook 2019

Gail Anderson
19 December 2018

Nigeria's hunt for gas buyers

Gas supply to the domestic market is a hot topic in Nigeria. Producers want to monetise their gas and
need to nd credible buyers
Pressure from government to meet domestic supply obligations (DSOs) remains intense in Nigeria. e 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. e 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 signi cantly 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 nding that their competitors are on exactly the same mission.
A low income is better than no income
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But suppliers don't just want to nd any o akers, they want to nd reliable o akers who demand a steady supply of gas and
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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. e sector de cit from 2015 to
2016 was nearly US$2bn. In 2017, the government establishedNO a central
THANKS bank facilityALLOW
of US$2bn over two years to ensure that
generators are paid. is 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 tari s are maintained.

To mitigate risk, some producers have experimented with pre-payment arrangements, but the on/o switching of supply is
counter-productive for reservoirs and turbines alike.

So before producers can dream of accessing deregulated pricing, they would simply se le for ge ing paid by a reliable
customer. Regardless of price, receiving income no ma er how low, is preferable to receiving none at all.

Can you avoid the power sector?

e 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 a er 10 years, it's still going, even though the
current administration views it as "largely unsuccessful".

e trouble is, there is just not enough transmission capacity to carry the available power in Nigeria. Although capacity is
o cially 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. is 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 rst 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.
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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 rst 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 be er quality opportunities for some producers could arise at the expense of others who are locked into uncontracted
power plants with dwindling o ake. 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 nd succour by targeting large industrial o akers beyond the con nes of the gas and power grids? Here, there
are some signs of progress.

In 2017, Total signed a 74mn cf/d o ake 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.

is 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 o ers decent scale for suppliers unlike compressed natural gas. But given the
high costs of liquefaction and re-gasi cation, not to mention the state of the roads, it will be interesting to see whether
Greenville proves to be a reliable o aker 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 o ake 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 con nes of the state-owned gas grid.

But a racting 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
e Lekki Free Trade Zone (LFTZ) is locatedWe'd like to send you notifications for the latest
on the Lekki peninsula to the east of Lagos. It is home to the largest industrial
news and
complex under construction in Nigeria including the updates.
Dangote re nery, 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.
e re nery 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 o shore gas gathering system (which has plenty of spare
capacity) could be even more a ractive.

Develop gas distribution

In 2017 Shell signed a US$300mn deal with Shoreline Power. It will nance and develop a pipeline network in the Lekki
franchise area which Shoreline has owned since 2015. e 20 year franchise provides exclusive rights to distribute and sell gas
in Lagos's commercial centres of Victoria Island, Ikoyi, Lekki and Epe. is 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 signi cant 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. is
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). ere is
signi cant upside here for early movers, provided the government resists its regulatory tendencies.

O -grid generation
Because of the physical transmission constraints, there are opportunities to embed small gas- red 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 o -grid power and design tari We'ds to support embedded
like to send generatorsfor
you notifications (tothe
in context, this would be a 75pc
increase in national power generation). It alsonews
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.

How will the market evolve? NO THANKS ALLOW

If Nigeria stays on its current path, then domestic market growth will remain constrained well below its potential. e 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 su er chronic illiquidity, non-payment, under-investment
and intermi ent supply. Long-su ering 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 o akers.

● More supply to clusters or 'islands' of private-sector industrial demand in the form of free trade zones.

● e 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

ose 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 e orts to build their own markets beyond their upstream bases and
ideally beyond the reach of regulation. e 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

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