The Firma Law Practice

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RECENT DEVELOPMENTS IN MIDSTREAM OIL & GAS UNDER THE PETROLEUM INDUSTRY ACT.

INTRODUCTION

The Nigerian oil and gas industry is divided into three sectors: upstream, midstream, and downstream, with several players and regulators operating throughout the value chain. With the oil and gas industry undergoing a transformation over the last few decades, there have been various changes in the way oil and gas are sourced, refined and transported to end users. This has led to the emergence of new players who focus on extracting hydrocarbons from depleted oil wells, pipelines, or other previously non-utilized sources. The midstream segment is one such part of the upstream oil and gas sector that focuses on filling operational gaps between the production of crude oil or natural gas and its end use as final products such as gasoline, diesel, or jet fuel.

International oil companies dominate the upstream oil and gas sector (IOCs). Shell, Chevron, Mobil, Agip, Addax, and Total currently control more than 80% of the country's crude oil production. The sector operates under a variety of agreements, including Joint Ventures (JVs) and Production Sharing Contracts (PSCs) with the Nigerian National Petroleum Corporation (NNPC). Contracts for sole risk and risk service are two other types of contractual arrangements. In addition, the IOCs control more than 90% of the oil reserves and operating assets. In addition, the IOCs control more than 90% of the oil reserves and operating assets. IOC production has declined by 4% per year on average over the last ten years, while marginal field players have increased production by up to 15% per year. (Marginal fields are discoveries that have not been exploited for a long time due to one or more of the following factors: very small reserve/pool sizes to the point of not being economically viable, lack of nearby infrastructure, and profitable consumers.)

 

DEFINITION OF TERMS

·         Downstream - Downstream operations are oil and gas processes that occur after the production phase to the point of sale. This sector of the oil and gas industry—the final step in the production process—is represented by refiners of petroleum crude oil and natural gas processors, who bring usable products to end-users and consumers.

 

·         Midstream - Midstream refers to points in the oil production process that falls between upstream and downstream. In particular, midstream activities include the storage, processing, and transportation of petroleum products. These may include companies that specialize in operating tanker ships, pipelines, or storage facilities.

 

·         Upstream - Upstream refers to the initial phases of oil and gas production, involving exploration, drilling, and extraction of crude oil and natural gas.

 

·         Production sharing Contracts or Agreements - Production sharing agreements (PSAs) or production sharing contracts (PSCs) are a common type of contract signed between a government and a resource extraction company (or group of companies) concerning how much of the resource (usually oil) extracted from the country each will receive.

 

·         Decommissioning and Abandonment - At the end of the production life, the project will be decommissioned and abandoned to restore the site to a safe condition that minimises potential residual environmental impact and permits reinstatement of activities such as fishing and unimpeded navigation at the site.

 

RECENT DEVELOPMENTS IN MIDSTREAM OIL & GAS

The PIA establishes clear distinctions between the operations of the midstream and downstream petroleum industries. The midstream sector includes the establishment and construction of refineries and lubricant and petrochemical production facilities. Construction of facilities for the transportation and storage of petroleum liquids is also included in this sector. The PIA informs players about the permissible activities in the sector, subject to obtaining the necessary licenses or permits.

·         Introduction of the NMDPRA (Nigerian Midstream and Downstream Petroleum Regulatory Authority)

The Nigerian Midstream and Downstream Petroleum Regulatory Authority was created in August 2021 in line with the Petroleum Industry Act 2021 which provides legal, governance, regulatory and fiscal framework for the Nigerian Petroleum Industry as well as development of Host Communities.

 

NMDPRA’s encompasses a merger of three defunct regulatory agencies: Petroleum Products Pricing Regulatory Agency (PPPRA), Petroleum Equalization Fund {Management} Board (PEFMB), the Midstream and Downstream Divisions of the Department of Petroleum Resources (DPR). This birth has ushered a new dawn for establishing a progressive regulatory framework that encourages investment and full optimization of the midstream and downstream sector of the petroleum industry in Nigeria.

 

The Authority is responsible for the regulation of the midstream and downstream petroleum operations in Nigeria which includes technical, operational, and commercial activities.

 

·         Introduction of fines and penalties

Section 174(4) of the Act introduces specific penalties for engaging in activities without obtaining approvals to operate within the sectors. Penalties include sealing of office premises, dismantling of unapproved facilities, confiscation of equipment, or imposition of penalties prescribed by regulations under the Act. The promoters of the company may also be prosecuted with imprisonment of up to 1 year or a fine as prescribed in by regulation to the Act. License holders are expected to apply to the authority for appropriate license within 2 years of the effective date of the Act. 

 

·         Accessing infrastructure, facilities and transportation network

The Act Introduces right of way permits. It stipulates network codes to govern access to facilities, pipelines and transportation networks between users including applicable charges and tariffs for access. Qualified 3rdparties can also gain access rights to any facility and infrastructure used in the midstream sector at commercials rates. Access to facilities should be granted without discrimination and based on availability.

 

·         National strategic stock

Section 181 of the PIA introduces a levy to be charged to operators within the sector for financing the National strategic stock. The costs will form part of the retail price of petroleum products. Designated locations across the country will be allocated for keeping the stock. Companies will also be required to maintain an amount of stock as provided by guidelines. The Act does not provide the rate of the levy but it is expected to be determined and published through a regulation.

 

·         Specific licenses to be obtained to operate in the midstream sector.

Sections 183-202 and section 204 of the PIA provides the specific licenses that an operator will require to play in the various segments of the midstream sector of the petroleum industry.  These licenses will be granted subject to the approval of the application and payment of fees. These relate to the following specific activities: crude oil refining, bulk storage, transportation pipeline, transportation network operations, wholesale petroleum liquids supply, petroleum product distribution and operation of facilities for production of petrochemicals.  It is notable to mention that the license for crude oil refinery needs to be approved by the Minister. The sections further stipulate the duties of the license holders and the conditions for granting the licenses. The tenure of each license and the conditions for granting a renewal is expected to be published through a regulation.

 

·         Pricing regime and power to regulate tariff

This eliminates government’s regulation on pump price of petroleum products and allows the market forces to determine price. The authority will however regulate prices and tariffs on products in the interest of the public where monopoly exists, or the market is at an infant stage.

Transactions between suppliers and customers are required to be at arm’s length. Suppliers will be required to furnish the authority with details of bulk sales within 14 days including the cost of making the supply. False declaration attracts a fine.

The authority will be expected to provide guidelines on prices based on guided principles. Licensees will also be required to publish prices for their customers.

 

·         Decommissioning and abandonment Fund

License holders in midstream operations are required to set up a decommissioning and abandonment fund which must be held by a financial institution that is not related to the license holder. The regulator will have access to the funds in settling such obligations where the license holder fails to do so. The amount to be contributed will be based on the decommissioning and abandonment plan provided to the authority.

 

·         Insights -connecting the dots

Players in the petroleum industry are now required to set up separate companies for carrying out their upstream, midstream and downstream operations. This provides clarity of regulation and fiscal regime applicable to midstream activities which are often regarded as incidental to upstream petroleum operations.

Transitioning existing license holders to the new licensing regime should be seamless to avoid negative impacts to current license holders.

It is also important to consider the tax impact of business reorganizations that will be required for companies that currently operate across different streams. Given that they are now mandated to separate these activities, assessment will have to be made on the transfer of tax attributes of the separating entity, the potential VAT, GCT and stamp duties.

There is the argument that separating the business operations help to manage risk by situating assets according to the risk profile of investors, however, the fiscals are not marked differently and the tax leakages on transfer can be significant. In the absence of any group reliefs, ring fenced losses cannot be utilized within group entities.

Pioneer status and gas utilization are some of the incentives targeted at encouraging investment in midstream operations. Tax leakages and additional costs such as the new levy under the PIA may be counterproductive to achieving this objective by making investments more expensive. Investors as well as other stakeholders will be on the lookout to see how well the funds generated will be managed to meet the set objectives.

On a positive note, there is the expectation that the introduction of a national strategic stock will help to address price stability and avoid stock outs or unending queues. It can also provide a buffer in the event of vandalizations.

 

CONCLUSION

With pump prices open to the forces of demand and supply, the expectation is that more players will be willing to invest in these sectors. However this may not play out as expected given the potential disincentive created by increased costs and regulations. Operators are likely to pass their costs on to customers subject to regulatory restrictions on market based pricing. Potential tax costs resulting from asset transfers will also have a negative impact on current players who are caught in this net.