MANAGING THE ACTIVITIES OF THE NIGERIAN OIL AND GAS INDUSTRY
BY STEPHEN LAZI AKHERE, Ph.D.
PENGASAN (2013), History of Nigerian Oil and Gas Industry. Retrieved from:
http://pengassan.org/pdf/History%20of%20Nigerian%20Oil%20and%20Gas%20Industry.pdf
1.0. NTRODUCTION
Oil and gas operations commenced in Nigeria effectively in 1956, with the first co
mmercial find in that year by the then Shell D’Arcy. Before this time, that is, from
November 1938, almost the entire country was covered by a concession granted to
the company to explore for petroleum resources. This dominant role of Shell in the
Nigerian oil industry continued for many years, until Nigeria’s membership of the
Organization of Petroleum Exporting Countries (OPEC) in 1971, after which the c
ountry began to take a firmer control of its oil and gas resources, in line with the pr
actice of the other members of OPEC. This period witnessed the emergence of Nati
onal Oil Companies (NOCs) across OPEC member countries, with the sole objecti
ve of monitoring the stake of the oil-
producing countries in the exploitation of the resource. Whereas in some OPEC m
ember countries the NOCs took direct control of production operations, in Nigeria,
the Multinational Oil Companies (MNOCs) were allowed to continue with such o
perations under Joint Operating Agreements (JOA) which clearly specified the res
pective stakes of the companies and the Government of Nigeria in the ventures.
This period also witnessed the arrival on the scene of other MNOCs such as Gulf
Oil and Texaco (now ChevronTexaco), Elf Petroleum (now Total), Mobil (now Ex
xonMobil), and Agip, in addition to Shell, which was already playing a dominant r
ole in the industry. These other companies were also operating under JOAs with N
NPC, with varying percentages of stakes in their respective acreages. To date, the
above companies constitute the major players in Nigeria’s oil industry, with Shell
accounting for a just little less than 50% of Nigeria’s total daily production, which
currently stands at about 2.4 million barrels of oil per day. JOAs are also still do
minant in the oil industry in Nigeria, accounting for over 90% of total oil and gas
production in Nigeria today. The emergence of offshore oil and gas operations a
nd the granting of deep water acreages to the oil producing companies has howeve
r witnessed a shift from JOA regimes to Production Sharing Contracts (PSCs), wit
h implications for the operation and regulation of the oil industry in Nigeria. This
shift is attributable to a number of factors ranging from the complexity of operatio
ns in the offshore terrain, (which makes regulation under a JOA more difficult), to
dwindling resources of the country, (which makes funding under the JOAs precari
ous for the government). At a time when the Nigerian government is intent on inc
reasing oil and gas reserves and the country’s production capacity without the nec
essary funds to back it up, a funding arrangement which achieves those objectives
without having a negative impact on the scarce resources available for investment i
n other sectors of the economy is imperative. A number of oil and gas projects usi
ng the PSC model are due to come on stream soon and the successes recorded so f
ar in this area have encouraged the government to consider extending PSC arrange
ments to other areas of the industry which had hitherto operated under JOAs. Th
is paper examines these contractual models in the Nigerian oil and gas industry, the
ir respective strengths and drawbacks, and the current shift in emphasis from JOA
s to PSCs, adducing reasons for this shift, and what this portends for investment in
the sector in Nigeria. The aim is to show the long term effects of this shift on the
investment climate and the overall development of the Nigerian economy, in whic
h oil and gas plays a central role. THE JOA AND HOW IT
OPERATES Modelled after partnership agreements, the JOA operates as a form
of partnership between the joint venture partners, which spells out the participator
y interest of each of the partners and also designates one of the partners as the oper
ator of the venture. In Nigeria, the NNPC represents the interest of the governmen
t in the joint ventures, whereas the respective MNOCs operate the different ventur
es with varying participatory interests. The JOA governs the relationship between
the parties, including budget approval and supervision, crude oil lifting and sale in
proportion to equity, and funding by the partners. In addition to the JOA, a Memo
randum of Understanding (MOU) governs the manner in which revenues from the
venture are allocated between the partners, including payment of taxes, royalties a
nd industry margin. The income derived from the operation is also shared in propo
rtion to the equity interests of the parties to the venture, with each party bearing th
e cost of its royalty and tax obligations in the same proportion. Allocations are als
o made from the revenue to take care of operating and technical costs. Challenges
of the JOA
ome of the constraints associated with the JOA include poor funding, due mainly t
o the imbalance in the financial capacity of the different joint venture partners, esp
ecially the government which has other pressures on its resources, leading often to
reduction in operations and consequential loss in revenue. JOA is also constrained
by allegations of gold plating of operating costs by the non‐
operators of the venture, which often leads to mutual suspicion between the parties
, and the rather unfair distribution of revenues, especially in the situation of upside
s from high oil prices. Additionally, the Operator also faces peculiar challenges in
Nigeria such as the need to meet the incessant demands by oil producing commun
ities for development programmes in their areas demands which could lead to disru
ptions in operations from time to time.
With the expansion of the Nigerian oil and gas industry, acreages started being allo
cated in the shallow and deep offshore areas, and this introduced the need for a dif
ferent regime, as it brought its own unique challenges in terms of funding and tech
nical complexity. This led to the introduction of PSCs in the new offshore and inla
nd basin acreages, which is gradually assuming prominence in the entire industry.
THE PSC AND HOW IT OPERATES
As the name implies, PSCs focus on the sharing of the output of oil and gas operati
ons in agreed proportions between the Oil Company, as a contractor to the govern
ment, and the NOC, as the representative of government interests in the venture. T
his form of contracts originated in Indonesia in 1966 and was modelled along the l
ines of share cropping in agriculture, where the owner of the land grants a farmer t
he rights to grow crops on his land and shares the proceeds with the farmer in agre
ed proportions after the harvest. Under a PSC, the contractor, usually a foreign oil
company bears the entire cost and risk of exploration activities, and only reaps the
rewards after a commercial find. In the event of a commercial discovery, the contr
actor recovers its costs fully from allocation of oil, referred to as ‘Cost Oil’. Allow
ance is also made from production for royalties, after which the remainder of the p
roduction, called ‘Profit Oil’, is shared in agreed proportions between the compan
y and the government as represented by the NOC. The Oil Company thereafter pa
ys income tax on its profits from the venture. The oil and all the installations rema
in the property of the host government throughout the duration of the contract. In
Nigeria, this form of contractual arrangement is relatively new, and covers mostly
acreages in the shallow and deep offshore areas and the inland basins. The major o
perators in Nigeria are still largely the holders of the PSCs but there have also bee
n new entrants, made up of independent foreign oil companies, which enter into pa
rtnerships with indigenous companies to bid for oil blocks, and thereafter operate i
t in line with predetermined contractual arrangements. In addition to the specific
contracts signed with the individual companies, the main law which regulates the
operation of PSCs in Nigeria is the Deep Offshore and Inland Basin Production Sh
aring Contracts Act No. 9, Laws of the Federation of Nigeria, 1999. This law sets
out the general framework for the operation of PSCs, including the applicable royal
ties, tax regimes, and the manner in which costs and profits are allocated between t
he parties. It provides for payment of a flat rate of 50% tax on petroleum profits b
y PSC operators, and sets different royalty regimes, depending on the water depth
in which the operation is carried out, ranging from 12% for water depths of 200‐
500m, to 0% for water depths in excess of 1,000m. PSCs in inland basins attract a
flat royalty of 10%. In addition to royalties, taxes and its share of profit oil, the
government also earns revenue from signature bonuses paid by the oil companies
upon successful bids. Most forms of payments under PSCs operating in Nigeria ar
e made in oil, as the law provides for cost oil, tax oil, royalty oil and profit oil. In
vestment Tax Credits and Allowances are also available to the investors at the rate
of 50% of the value of such investments. Some of the advantages associated wit
h PSCs include the relative flexibility in the management of the operations, and th
e fact that there is no financial burden on the host government, and even after a co
mmercial find, the payment to the contractor is in oil, which does not attract any di
rect financial cost. Leveraging on the technical know‐
how and experience of the companies in such operations, the government can focu
s its energies in other areas of the economy while trusting that the oil and gas indu
stry will develop at an acceptable pace without the usual trappings of cash call con
straints. However, PSCs have some drawbacks such as the risky nature of the ope
ration. For instance, in the event of an unsuccessful operation, millions of dollars c
ould be completely lost ‐ unless the local laws allow for costs from one acreage to
be transferred to another, which is not always the case, and would depend on the p
rovisions of the PSC entered into by the parties. Also, the fact that the contractor i
s usually allowed a relatively unfettered hand to draw up and execute its program
me could lead to allegations of gold plaiting of costs. The long term nature of tr
ansactions in the oil industry however usually mitigates some of these difficulties.
The tendency is usually for both parties to strive to make room for flexibility in dr
awing up the terms, and also make provisions for renegotiation in the event that pa
rticular provisions are later found to be causing undue hardship. In recent times, t
here has been a conscious shift in the contractual structure in the oil and gas indust
ry in Nigeria from JOAs to PSCs.
