A Quick Analysis of the CBN Governor’s Proposal to Sell a Portion of Government’s Equity in Joint Venture Oil Companies in Nigeria - Dr. Emmanuel Ojameruaye

Speaking to the Financial Times of London after the recent Presidential Elections in Nigeria, the Governor of the Central Bank of Nigeria (CBN) advised the incoming administration of Mr. Buhari to give serious thoughts to scaling down the Government’s majority shares in the Joint Ventures (JVs) with major multinational oil companies operating in the country (The Street Journal, April 23, 2015). According to the reports, the highlights of the CBN governor’s proposal are as follows:

·          The government should shed at least 25 per cent of its equity in the JV oil companies to raise emergency funds for infrastructure development in key sectors of the economy.

·         The government may realize about $75 billion (N14.93 trillion) if it cuts its JV equity to only 30 per cent.

·        CBN officials have been directed to evaluate the prospects of the proposal. The outcome of the study will be presented to Mr. Buhari when he assumes office on May 29.

·         Private equity companies can be encouraged to take over the relinquished government equity.

·         Part of the proceeds from the equity sale could be invested in transport and energy developments projects to grow the economy and create jobs.

·        Government could adjust upwards, petroleum profit tax payable by the oil companies, to compensate for the reduction in government’s equity.

·        The equity cut back is one of the most attractive options available in view of the drastic drop in revenue due to falling oil prices and the need to avoid piling up more debts.

The CBN governor acknowledged that the proposal could meet stiff resistance from oil firms, politicians and their allies who depend on oil resources for patronage. However, it should be welcomed by those who support the unbundling of the NNPC and curbing corruption by increasing private participation in the oil sector. Some observers believe that the proposal is a response to Mr. Buhari’s promise during the presidential campaign that his party would “break up the NNPC but the ultimate answer may well be to divest the whole thing”. However, he noted that the immediate priority of his administration would be to stop leakages in the oil industry so that revenues that belong to the people get into the federation account. The governor’s proposal requires careful analysis because it raises some fundamental questions that must be addressed.

Firstly, why did the Governor not offer the same advice to outgoing President Jonathan who appointed him? After all, oil revenue started crashing almost a year ago when the price of Nigerian crude oil declined from about $114 a barrel in June 2014 to $48.57 a barrel in January 2015, although it has increased to $65 a barrel as of May 6, 2015.  One can assume that either this idea just occurred to governor or that he decided not to advise President Jonathan about it because he knew that his advice would be ignored because of interests vested in retaining Nigeria’s majority shareholding in the JV oil companies to guarantee the political patronage and revenue “siphoning” it provides. Perhaps, the governor thought that the slump in oil prices was a temporary phenomenon that would not lead to serious financial hardship for the government as we are now witnessing. Secondly, what is the overarching reason for the advice? Is there a hidden agenda? Is the governor fronting for the private equity companies who are waiting in the wings to grab the lucrative government stakes in the JV oil companies and deep their hands further into the pockets of the Nigerian oil industry? Is the governor offering this advice altruistically and genuinely to solve the financial crunch the incoming administration will face in trying to meet the expectations of Nigerians for improved economic performance? I have no reason to doubt the governor is sincere about his advice and believes it is in the best interest of the government and people of the country. Thirdly, why has the governor recommended only a partial divestment, i.e. why reduce government stake to 30% and not to zero or convert the JVs to other forms of contractual arrangements such as production sharing contracts (PSC) or service contracts? I think the governor believes that it is critical for the government to continue to have an important stake in the oil industry in order to maintain some modicum of control of the “commanding heights of the economy”.

Fourthly, what is the benefits-costs ratio (BCR)? In other words, is proposal profitable to the government and people on Nigeria? Admittedly, it is almost impossible to come up with a BCR because some of the benefits and costs are non-quantifiable and cannot be ‘shadow-priced’. However, we can estimate the major quantifiable benefits and costs. The immediate reaction by some people to the proposal would be to dismiss it as dangerous and unprofitable because it could reduce future revenue stream into the federation account due to the reduction in  “equity oil” sales which may not be compensated by any reasonable increase in petroleum profit tax (PPT), royalties, rents, etc. As an empirical economist, I decided to conduct a quick “back-of-the-envelope” analysis of the proposal through the use of a simple economic model to estimate the likely loss in oil revenue, the possibility of realizing the $75 billion the governor expects the government to make from reducing its equity holding in the JV oil companies to 30% and the PPT rate at which government oil revenue will not fall if it decides to accept the proposal. In the remaining part of this paper, I will discuss the model, the simulation results and conclude with some recommendations for the incoming Buhari's administration.

The model I have developed to analyze the governor’s proposal (call it the OJV model) is made up of the following equations:

1.      G =  aQP –aC

2.      J = (1-a)QP – (1-a)C

3.      R = G + tJ

4.      A = J -  tJ  = (1- t) J

Where:

G= Revenue of the Government from crude oil sales (of its share/”liftings”)

Q = Total crude oil produced by the JV oil companies in a year in million barrels. We will assume Q =420 million in model simulation which is about quantity of crude oil produced under the JV arrangements in 2013.

P = Average price of Nigerian crude oil during the course of the year, in US$ per barrel

a= Average ratio/proportion of government shareholding (stake) in the JV oil companies (SPDC, Chevron, Mobil, Agip, Total and Texaco), currently about 0.57 (i.e. 57%)

t = PPT rate, currently 0.85 (85%)

C = Total cost of the JV companies (CAPEX and OPEX) in the year which must be funded by government and the JV partners in proportion to their shareholding. We will assume C = $5,000 which is about the average annual JV cost between 2011 and 2013.

J = Revenue of the private JV partners from crude oil sales (of their share/liftings) = Pre-tax profits of the private JV partners

R = Total Government Revenue from crude oil sales and Petroleum Profit Tax

A = After-Tax Profit of the private JV partners

Equation 1 states that government net revenue from its crude oil sales (liftings) in a year (G) is the product of its equity holding ratio (a), quantity of crude oil produced by the JV operators (Q) and average export price of Nigerian crude oil (P) less the government’s JV cash call obligation (aC) which is the product of its equity holding ratio and the agreed cost of production by JV operators (C). Equation 2 states that the other JV partners’ pre-tax revenue (J) is the product of their joint  equity holding ratio (1- a), quantity of crude oil produced by the JV operators (Q) and average export price of Nigerian crude oil (P) less their cash call obligation. Equation 3 states that the total government revenue (R) is the sum of the net revenue from crude oil sales (R ) and petroleum profit tax paid the other JV partners which is the product of the PPT rate (t) and their pre-tax revenue (J). Equation 4 states that the after-tax revenue (profit) of the other JV partners (A) is their pre-tax revenue (J) less the PPT paid to the government (tJ).

Of course, like in most economic modeling exercises, we have made some simplifying assumptions. For instance we have excluded gas sales and other sources of oil revenue such as royalties and rents. However, the relaxation of these assumptions will not significantly change the results and inferences from the model. Using the above model, and assuming that Q =420 million barrels (1.15 million barrels a day) and C = $5,000 million (=$5 billion), we computed the values of G, J, R and A based on three crude oil price levels ( P = $50, $75 and $100) and three government equity holding ratios (a = 0.57 or 57%, 0.30 or 30% and 0.0 or 0%). Table 1 below (shaded area) shows the results of our computation.

Table 1: Computed Value of Government Revenue and other JV Partners Revenue from JV Operations based on three Crude Oil Price Levels and Three Government Equity Holding Ratios                                                                           

                                                                                                           US $m

	Q	P	C	A	t	C	G	J	R	A
1	420	50	5,000	0.57	0.85	5,000	9,120	6,880	14,968	1,032
2	420	50	5,000	0.30	0.85	5,000	4,800	11,200	14,320	1,680
3	420	50	5,000	0.00	0.85	5,000	0	16,000	13,600	2,400
4	420	75	5,000	0.57	0.85	5,000	15,105	11,395	24,791	1,709
5	420	75	5,000	0.30	0.85	5,000	7,950	18,550	23,718	2,783
6	420	75	5,000	0.00	0.85	5,000	0	26,500	22,525	3,975
7	420	100	5,000	0.57	0.85	5,000	21,090	15,910	34,614	2,387
8	420	100	5,000	0.30	0.85	5,000	11,100	25,900	33,115	3,885
9	420	100	5,000	0.00	0.85	5,000	0	37,000	31,450	5,550

For example, row 1 indicates that at 57% average equity holding in the JVs and at P= $50 per barrel and at the current 85% (0.85) tax rate, government revenue from JV operations (R ) will be $14,968 million (or $14.968 billion or about N2.9 trillion) but when the equity holding is reduced to 30% (0.3) as proposed by the CBN governor (row 2), R will drop to $14,320million – a drop of 4.3% or a loss of about $648 million a year.