Nigeria’s National Domestic Gas Supply And Pricing Policy

INTRODUCTION – Policy Aspirations GIVEN THE ABUN DANCE OF NIGERIA’S gas resources, Government has identified the accelerated development of the domestic gas sector as a focal strategy for achieving the national aspiration of aggressive GDP growth (10% increase per annum). Domestic gas is defined as gas utilized locally within the shores of Nigeria either for home, industrial and/or electric power use. Specifically for industrial use, gas used in value adding industries such as methanol, fertilizer etc. is considered domestic gas, regardless of whether the end product (i.e. fertilizer, methanol) is consumed locally or exported.

Gas export (LNG and pipeline) provide high returns to government through tax receipts and dividends for equity stake. However, it is recognized that beyond economic rent, there are broader strategic benefits to the economy that may be attained from the domestic utilization and value addition to natural gas. In essence, in addition to exporting of natural gas, Nigeria must develop strategies to ensure increased domestic utilization.

Rising gas prices in key international markets however continues to create a preferential pull for exports. Consequently, there is a disproportionate focus by gas suppliers in the country for LNG projects. This is creating an anomaly in Nigeria where there is now a significant shortfall in the availability of gas for domestic utilization. The continued shortfall directly threatens the economic aspirations of the nation which if unchecked may result in Nigeria supporting the development of the economies of the industrialized nations at the expense of its own economy.

The energy requirement to sustain an aggressive GDP growth is enormous. Currently, total demand (export and domestic) for natural gas far outstrips supply. The demand is driven by growth in the Power sector and other gas based industries such as Fertilizer, Methanol, LNG etc.  Gas demand is forecast to grow from the current level of 4bcf/d to about 20bcf/d by 2010. In the short term, the growth in the domestic sector is particularly most aggressive, growing from less than 1 bcf/d in 2006 to about 7 bcf/d by 2010.  This demand growth is underpinned largely by the power sector and by an increasing requirement by large industries such as fertilizer and methanol that require gas in high quantities. These industries which are unable to compete in high gas cost locations have expressed strong interest in relocating to Nigeria.

Nigeria needs to demonstrate availability and affordability of gas or else risk losing these industries to competing nations like Egypt, Trinidad etc. The scale of demand growth relative to supply growth creates an immediate availability challenge. In addition, is the challenge of price affordability and hence gas pricing. The domestic demand sectors such as electric power, fertilizer, methanol etc. have varying capacity to bear gas prices (Fig. 1). For example, the Nigerian Power sector has a lower gas price threshold than a Methanol industry. Government is however keen to stimulate the growth of all these sectors. Timely availability, affordability and commerciality of supply of natural gas is a critical pre-condition for realizing the government’s aspiration for the domestic economy.

In recognition of the urgent need for domestic gas availability and a pricing framework to drive and sustain a major gas based industrialization in Nigeria, this policy document seeks to:

l. provide solutions to the issue of gas pricing;

2. address domestic gas supply availability in a manner that delicately balances the need for domestic economic growth and revenue generation from exports; and

3. provide an implementation approach for the gas pricing that enables the full participation of all gas suppliers in the country in a manner that ensures sustained gas supply to the domestic market.

B) GROUPING OF NIGERIA’S DOMESTIC DEMAND SECTORS

The need for a pricing strategy that recognises the diversity in the ability of the various industrial sub-sectors to bear gas price cannot be overstated. Such strategy will not only enable and sustain diversity of the demand sectors, thereby enabling Nigeria to benefit from the industrialisation potential that is inherent in gas, it will also enable the selective maximization of net revenues for Nigerian gas from sectors that are most able to deliver that direct economic benefit.

From a gas pricing strategy perspective, Government has grouped the entire domestic demand into three broad groupings. This grouping is in recognition of the fact that the different demand sectors have different strategic benefits to the country and different pricing considerations. Fig. 2.1 below presents the three categories. Any demand sector will fall into one of these categories and where there is a lack of clarity, the Minister for Energy will determine the classification of such sector. Fig 2.1: Grouping of Gas Demand Sector

The groupings are:

• Strategic Domestic Sector — This refers to a very limited set of sectors that have a significant direct multiplier effect on the economy namely the Power Sector (residential and light commercial users) or other sector that the Honourable Minister for Energy may from time to time consider applicable. The strategic intent in gas pricing is to facilitate and ensure low cost gas access to these sectors in order to spur rapid economic growth.

Strategic Industrial Sector  – This refers to industries that utilise gas as feedstock in the production of value added products that are primarily destined for export or in some cases, consumed locally. Strategically, these sectors ensure that value is added to Nigerian gas before it is exported. The process of value addition ensures industrialisation, job creation etc. Typical projects in this group are Methanol, GTL and Fertilizer. For this sector, the strategic intent in pricing is to ensure that feedgas price is affordable and predictable in order to ensure competitiveness of the products in international markets in the face of competition from other gas producing countries such as Qatar, Trinidad etc. that provide gas at very low prices to buyers.

Commercial Sectors — This refers to sectors that use gas as fuel as opposed to feedstock. Unlike the two previous classifications, projects in this category are a potential major direct revenue earner for Nigerian gas in view of their capacity to bear high gas prices as the competing alternative fuel is LPFO. Typical sectors in this category include cement and domestic manufacturing industries, industrial Power etc.

(C) GAS PRICING REFORM – LIQUIDS BASED PRICINGAPPROACH

A widely known characteristic of Nigerian gas is its relative richness in liquids i.e. NGLs. NGLs continue to attract a high price in international markets (similar trend in crude oil pricing). As a result of the potential high revenue that comes from NGLs produced in conjunction with residue dry gas, it is possible for a gas supply project to accommodate a relatively lower price for the residue dry gas and still be a profitable supply project. Residue dry gas is used mostly in the domestic market.

This gas pricing policy aims to exploit this intrinsic value of NGLs in deriving a relatively low gas price for the strategic domestic sector – Power. It is recognized that not all gas resources in the country are rich in NGLs, consequently, it is intended that this philosophy be applied selectively — especially in the short term as the Power sector is currently unable to pay higher price for gas (in view of the low end user power tarrif that currently obtains in Nigeria).  It is however the expectation that in the medium term, power tariff will be more commercial and a higher gas price will be achievable.

Based on an assumption of $40/bbl long run NGL price, it has been established that across the Niger Delta, there is a limited volume of gas reserves for which the marginal cost of development and supply can be met profitably with a dry gas price of $0. l/mcf. This assumes that the supplier receives $0.1 /mcf for the residue dry gas in addition to other NGL revenues at $40/bbl. It is the intent of this policy that this category of gas reserves be deployed for use in the strategic domestic sectors. $0.1 0/mmbtu is therefore established as the floor price for the strategic domestic sector. This low price is in line with the strategic intent of ensuring a low cost gas supply to those critical sectors of the economy.

In addition, based on existing transmission infrastructure costs in Nigeria and international benchmarks, a transmission tarrif (on postage stamp basis) of $0.30/mmbtu is proposed. The Honourable Minister for Energy may revisit this tariff from time to time as appropriate.

D) THE GAS PRICING FRAMEWORK

The gas pricing framework proposed in this policy is a transitional pricing arrangement. The Honourable Minister of Energy (Gas) will monitor the environment and determine when the domestic market is fully developed and an alternative pricing approach is required.

It is important to establish that the pricing framework does not fix prices. It barely sets out a transparent structure for determining  the floor price for dry gas for 3 categories of demand sectors presented in section B. The floor price is the lowest price that gas can be supplied to a particular category of demand sector. The actual price paid is based on an indexation formula jointly determined during negotiation between the buyer and seller. In essence, the market actually determines the price by establishing the indexation mechanism.

Figure 3.1 below presents a schematic of the pricing framework. Three distinct price regimes are evident in the framework, corresponding to three different approaches for determining the floor price. The three approaches include

1. Cost of supply basis (regulated pricing regime)

2. Product netback price basis and (pseudo- regulated pricing regime)

3. Alternative fuels basis. (market led regime)

The Regulated Pricing Regime (cost of supply basis): This pricing approach applies specifically to the strategic domestic sectors of Power. As discussed in section C, the floor price for this category is determined primarily by establishing the lowest cost of supply that allows a 15% rate of return to the supplier. This has been established as $0. l/mmbtu for a limited volume of gas reserves. These reserves will therefore be assumed dedicated to the strategic domestic sector.

The Pseudo-Regulated Pricing Regime (Product Netback basis): The second floor price determination approach applies strictly to strategic industrial sectors i.e. sectors that use the gas as feedstock. For this group, the floor price is not based on the cost of supply of the gas, but on the netback of the product price. The product price used in determining the floor price is the assumed long run price of the product. With this approach, the pricing of gas will better reflect the ability of the sector to pay given the price of its product. However, since the intention of this policy is not to support sectors that are unviable i.e. sectors whose netback price translates to a gas floor price lower than the cost of supply of gas, the consideration of affordability will not be at the expense of sustainability of gas supply.

The Market Led Regime (Alternative Fuels Basis): The third floor price determination approach applies to all other sectors that use gas as fuel or wholesale buyers buying gas for subsequent resale. For this category, the price of gas is indexed to the price of alternative fuel such as LPFO. The indexation will be established during negotiation.

The foregoing structure provides the basis for the pricing framework illustrated below. Three segments can be identified in the framework consistent with the three demand sector groupings, starting with the lowest priced sector, the strategic domestic sector to the highest priced sector — the commercial sectors. It is assumed that pricing for each demand sector will transition to the next higher pricing band once a saturation level has been attained. For example, for the strategic domestic sector, once the domestic requirement has been met (domestic saturation point) and Power is now being exported, the framework proposes that export Power benefits from a relatively higher price, determined by the netbacking philosophy applied to strategic industrial sectors such as methanol. Similarly, once the capacity of a strategic industrial sector exceeds an export saturation limit (i.e. once Nigeria’s export capacity for that sector e.g. fertilizer is assumed to have reached an acceptable limit), any incremental capacity will attract a much higher price consistent with that of commercial sector buyers. Through this transitional mechanism, pricing can be aligned with required capacities within the economy.

Indexation

It is important to reiterate that the entire gas pricing framework simply specifies the floor price. Actual prices will include an escalation for inflation and an indexation to real time product price (which may be higher than the long run price used in the determination of the floor price) and/or any other indices considered appropriate by both buyer and seller of the gas. The indexation will be determined through a process of negotiation.

(E) IMPLFMINTATION

(i)The Downstream Gas Act

To underpin the proposed pricing framework, Government will establish a Gas Regulatory Agency, the Gas Regulatory Commission, through the proposed Downstream Gas Act. Amongst other functions, the Commission will have the power, where necessary, to regulate the price of gas supplied and utilized in the downstream gas sector and the power to promote reliable and efficient use of gas throughout Nigeria. It will also have the power to monitor and impose pricing restrictions on licensees. Pending the establishment of this GRC however, an interim agency will be set up by the Minister as a department within the Ministry of Energy (Gas).

Consistent with the pricing principles established by the Act, the Commission will have the power to regulate the prices charged by licensees where competition has not developed to such an extent as to protect the interest of consumers. The relevant pricing principles in this regard are cost reflectivity, price disaggregation and the earning of a reasonable return on investment by licensees.

A Transitional Pricing Plan setting out temporary or transitional pricing arrangements allowing for a gradual transition towards pricing arrangements that are consistent with the pricing principles above is required to be introduced by the Downstream Gas Regulatory Agency. The gas pricing framework presented in this policy document is designed to achieve this objective.

(ii) Domestic Gas Reserves and Production Obligation

In implementing this pricing policy, it is essential that there is sufficient gas available for the various demand sectors. To facilitate this, a domestic gas supply and reserves obligation will be imposed on all operators in the country. In essence, all gas (AG and NAG) asset holders will be required to dedicate a specific proportion of their gas reserves and production for supply to the domestic market. This is the “Domestic Reserves Obligation”.

The reserve obligation will be broken down annually to a production obligation for the same period. The sum total of all obligations will equal the planned domestic requirement for the stated period. Periodical reviews to the domestic obligation will take place to reflect the changing demographics of the demand and supply landscape i.e. new demand will be allocated accordingly as new suppliers come on stream. The Minister for Energy will periodically stipulate the reserves and production obligation of the various operators. The allocation of the obligation across operators will be based on the principles of equity to be determined by the Minister.

(iii) The Aggregate Gas Price and the Strategic Gas Aggregator

The gas pricing framework stipulates a pricing regime for various demand sectors ranging from a floor price of about $0.l/mcf for the strategic domestic sectors to over $2/mcf for the commercial sectors. The Aggregate Domestic Gas Price is the forecast average domestic price based on the projected total domestic demand portfolio using the relevant prices proposed by this framework.

All suppliers of gas in the country will be paid the aggregate domestic gas price. A target aggregate price will be set by the Gas Regulator based on the known portfolio of domestic demand. The portfolio will be balanced continually to ensure that the aggregate price does not fall below the threshold. In essence, the suppliers have a fixed price whilst the buyers will pay the sector price proposed in the framework. The aggregate pricing will ensure that regardless of their geographical location all suppliers are able to benefit from the high priced customers as well as from the low priced buyers. The aggregate price will ensure that the suppliers receive an acceptable return for their domestic obligation.

A Strategic Aggregator (under the auspice of the Department of Gas or the GRC) will manage the implementation of the domestic reserves and production obligation and the aggregate price. It will ensure a balanced growth of the domestic portfolio such that the target minimum aggregate price is achieved whilst not compromising the nation’s primary objective for economic growth by ensuring the availability of adequate volumes of gas to the strategic domestic sectors.

Conceptually, the Strategic Aggregator acts as a one stop intermediary point between the suppliers and the diverse demand sectors and will ensure that gas is supplied at the aggregated price. Through a Gas Management Model, the Strategic Aggregator plays the role of portfolio manager on behalf of all suppliers the primary objective being to preserve a minimum aggregate price portfolio. When the aggregate price is higher than the minimum threshold, an agreed portion will be paid out to the suppliers whilst the balance will be retained as cushion in the event that the portfolio mix for unavoidable reasons falls below the target minimum threshold.

Conclusion

The National Domestic Gas Supply and Pricing Policy therefore aims to fully align the gas sector with the economic growth aspiration of the nation. This policy will be applied in conjunction with the Gas Pricing regulations and modifications thereto.