Aelex Notes: “Critical considerations for the implementation of domestic crude supply obligations under the PIA”

Author: AELEX Energy & Natural Resources Team

On March 28, 2024, the Energy and Natural Resources Group at AELEX Partners (‘AELEX’) hosted the first edition of its webinar series for the year, themed “Critical considerations for the implementation of Domestic Crude Supply Obligations (DCSO) under the PIA.” This webinar became necessary in the wake of concerns expressed by industry participants following the publication of the domestic crude refining requirements and production forecast by the Nigerian Upstream Petroleum Regulatory Commission (NUPRC) early this year.

Mr. Olusina Sipasi, ‘Partner and Head of the Energy and Natural Resources Group at AELEX,’ moderated discussions at the webinar with contributions from an ensemble of seasoned experts in the oil and gas industry. Mr. Kingston Chikwendu, ‘Head, Regulations and Statutory Compliance, NUPRC’ represented the regulator on the panel and provided insight on the purpose of the Production Curtailment and Domestic Crude Oil Supply Obligation Regulation 2023 (the Regulations) and how the regulator intends to implement it. Joining the panel from the industry side, Mr. Akinyemi Osinubi, Group CFO of Levene Energy Group, provided some perspective on how these Regulations have been received by the oil producing companies and the refineries. Mr. Osinubi has years of experience advising on big-ticket oil and gas projects. Also on the panel was Mr. Kufreobongotu Medo, ‘Lead Commercial Counsel at Gas Aggregation Company of Nigeria (GACN).’ GACN has played a pivotal role in the administration of the domestic gas supply obligations (DGSO) framework and Mr. Medo shared some useful learning points from this experience for the implementation of DCSO.

Raymond Ofagbor, a Senior Associate in the Energy and Natural Resources Group at AELEX, delivered a presentation on the DCSO framework and described the process flow for the implementation as provided in the enabling Regulations. His presentation highlighted the concept of ‘willing buyer – willing seller’ under section 109 of the Petroleum Industry Act (PIA) and the steps that must be taken by the regulator before DCSO is issued. The goal of the DCSO framework is to address shortage of supply to the refineries which the normal market conditions have not been able to address.

Thereafter, the moderator and panellists discussed critical considerations arising from the implementation of DCSO in Nigeria in a question and answer type format. Highlights from the discussion include;

Current status of DCSO implementation:

Before actual issuance of DCSO by the NUPRC to any oil licensee or lessee, there are prior steps that must be taken under the Regulations. The intention of section 109 of the PIA that the supply of crude oil to local refineries in Nigeria should be on a willing seller – willing buyer basis is very clear. However, where the Nigerian Midstream and Downstream Petroleum Regulatory Authority (NMDPRA) notifies the NUPRC that there are local refineries with a shortage of supply of crude oil, the NUPRC will send out requests to the oil licensees and leases in Nigeria requesting quotations (RFQ) to supply the affected refineries with crude oil to fill the identified gaps. If the NUPRC receives RFQs from any oil licensees and lessees undertaking to fill the gap in supply, the NUPRC will make this information available to the oil refineries who are free to negotiate and enter bilateral contracts with the oil licensees and lessees. It is only after all of these steps have been taken, and the refineries still have a gap in supply, that the NUPRC will intervene to impose a DCSO on specific oil licensee(s) or lessee(s) to fill the gap. Currently, no DCSO has been issued to any oil licensee or lessee in Nigeria and participants are all operating under general market conditions.

Purpose of the domestic crude refining requirements and production forecast:

In response to a question on the purpose of the NUPRC publication that whipped up reactions from the industry on the supposed imposition of DCSO earlier in the year, it was explained that markets perform better when there is a symmetry of information and part of the NUPRC’s role as a regulator is to ensure that the information is available to all industry participants. The publication was in compliance with the regulatory requirement for the NUPRC to publish twice a year, at the start of January and July, a summary of the volume and specification of crude oil required by oil refineries in Nigeria for the 6 month period and also a forecast of production by the oil licensees and leases. The purpose of this publication is to provide suppliers, oil refiners and other stakeholders with information to plan their businesses and enter appropriate contractual relationships for the sale and purchase of crude oil locally.

Major concerns of Industry participants:

When considering the nature of a refinery project, the imposition of DCSO raises several concerns from an oil producer perspective. It is nearly inconceivable that any refinery project will reach FID without appropriate supply contracts for feedstock. Why do we need this statutory prescription in the PIA if a refinery should ideally have security of supply even before construction is complete?

Mr. Osinubi commented on the importance of understanding, stating that this type of statutory prescription is not novel as we have seen the implementation of a similar regime in the gas industry for several years now. In fact, the operators themselves recognised the need for DGSO and clamoured for it to address the unavailability of gas for domestic industries. However, there are important differences between the motivations and design of the DGSO framework and that of the DCSO under the PIA.

When the PIA was enacted in 2021, existing crude oil projects already had established operations, contracts and even financing commitments. The first worry DCSO creates for the industry is the thought that there are refinery projects coming on stream with significant gaps in feedstock supply. The numbers from unofficial sources indicates a shortage of about 800 000 barrels in supply which is alarming and indicate a major market failure which should be addressed squarely. Also, it indicates that supply contracts are not being fulfilled or there was poor project planning to begin with.

The concern arising from this is that, if producers are making up for shortages caused by these failures, why will they be given ‘an obligation to supply’ to remedy the situation caused by poor planning by the refineries or other market failures? What makes this concern worse is the threat of penalties for non-compliance, when almost all oil licensees and leases already have prior commitments for their crude in offtake contracts, pre-payment facilities, reserve based lending or other equity/finance structures. DCSO will require them to plan not only with incremental production but all their available production and may cause them to breach pre-existing obligations.

Another worry is whether there will be sufficient buy-in of all the producers and some uncertainty around how variations in production levels, location challenges, infrastructure and transportation network challenges, etc, will impact the application of DCSO.

Regulator’s perspective

Consistent with the mandatory requirements for subsidiary legislation under the PIA, it was stated that the Regulations were a product of co-creation between the NUPRC and stakeholders in the industry. Therefore, most of these challenges have already been taken into consideration when drafting the Regulations. This is why the Regulations provide conditions and steps that must be followed before imposition of DCSO which will address all these concerns.

It was further stated that as is expected for most new regimes created by law, there will be initial challenges in the implementation. It is expected that the implementation of the DCSO regime will modify the behaviour of producers, refiners, financers and other stakeholders in the industry until DCSO simply becomes one of many other risks to be considered in project planning and financial structuring for crude oil production and refinery projects in Nigeria.

It was emphasised that willing buyer – willing seller will continue to be the default position in a free market and DCSO will only come in as a last resort to ensure domestic supply to refineries where there are gaps. The ultimate purpose is for the local refineries to have sufficient supply so the products they produce will be available at good prices to the Nigerian people.

Also, the NUPRC is still working on forms and guidelines to implement DCSO and conversations are ongoing to ensure that the introduction of the new regime does not impair the smooth operation of the industry. Moreover, even when DCSO is imposed by the NUPRC, the parties can still arrange how the order will be executed. Penalties are important since it is a regulatory obligation and non-compliance should attract some form of sanction to encourage compliance.

Opportunities created from the implementation of DCSO:

Given the challenges outlined by Mr. Osinubi, such as how some oil licensees may be unable to fulfil their DCSO because of pre-existing contractual and financing obligations, size of their production, logistic challenges due to insecurity of pipeline and barging requirements etc., an opportunity for swap contracts arises. Participants should be able to swap DCSO or come to some other form of arrangements and the NUPRC should encourage these initiatives.

Lessons from the implementation of DGSO:

While acknowledging that DCSO is quite different from DGSO, Mr.
Medo identified some learning points from the experience of GACN in the implementation of DGSO that may improve the chances of success in the implementation of DCSO for crude. For example, the initial resistance from the industry may be solved by market participation in all phases of planning and implementation of DCSO. The participation of producers and refiners in the development of the procedure and even the contracting documents for DGSO was key to ensuring commerciality of the arrangements and created market balance and stakeholder buy-in. GACN takes a market-led approach and revises its strategies based on existing conditions on a case-by-case basis.

Another learning point that worked for gas was to limit the level of imposition to only volumes leaving the gas producers with some freedom to negotiate contracts with any of the willing buyers. Importantly, the challenges identified such as location and logistics challenges, existing obligations, production profile etc are considered and addressed in the issuance of a gas purchase order. Additional learning points include recognising supply to its own downstream affiliate, other local supply and even swap deals as means of complying with DGSO requirements to ensure there is some flexibility and the imposition is never onerous.

Role of the NUPRC in facilitating contracts under DCSO

Many industry participants have expressed worry that the facilitation of contracts by the NUPRC described in the Regulations may, in implementation, mean that the regulator becomes an integral part of the contract negotiations and conclusions. The regulator assuaged all fears and clarified that there is no contemplation for the regulator to be in the room for any negotiations. The limit of the regulator’s role to facilitate the bilateral contracts between oil licensees and crude oil refineries is the disclosure of the information obtained from RFQs to the refineries.

Next steps for DCSO:

Currently, the NMDPRA has notified the NUPRC of shortage of supply to local refineries. The NUPRC has not yet issued any RFQs because work on the guidelines and templates for implementing DCSO is still ongoing with consultations being held industry stakeholders. All of these steps will be taken before there is even a possibility of the imposition of DCSO by the NUPRC in future.

Conclusion

The webinar concluded with the panellists answering thought-provoking questions thrown up by the discussion and articulated by some of the listeners. The parting message is that the DCSO innovation under the PIA is a laudable introduction that potentially addresses shortage of supply of crude oil to local refineries. Crude oil remains an international commodity and it is expected that business as usual commercial arrangements will be made between willing buyers and willing sellers to ensure security of local supply in the market which will, in turn, ensure refined products are locally available at competitive prices.

A recording of the webinar is available at www.aelex.com. For more information, you may send us an email via [email protected].