\IGERA ECO\OVIC REORT * * killl|t No.3 November 20'15  NIGERIA ECONOMIC REPORT No. 3 November 2015 G WORLD BANK GROUP  CONTENTS A b breviatio ns ............................................................................................................................................................................ v Introd uctio n ............................................................................................................................................................................ vii C hapter 1: M acroeco no m ic O verview .................................................................................................................................. 1 Sum m ar y ..................................................................................................................................................................................................... 1 The O il Price Shock .................................................................................................................................................................................. 1 G D P and Econom ic G row th .................................................................................................................................................................. 2 External B alance and M onetary Policy .............................................................................................................................................4 Inflatio n ........................................................................................................................................................................................................6 G overnm ent B udgets and Fiscal Policy ............................................................................................................................................7 The Eco no m ic O utloo k ........................................................................................................................................................................ 11 C hapter 2: O il Revenues and the Fuel Subsidy ............................................................................................................ 13 Sum m ary .................................................................................................................................................................................................. 13 Intr od uction n............................................................................................................................................................................................. 1 3 The Benefits of the Fuel Subsidy ...................................................................................................................................................... 14 The Costs of the Fuel Subsidy ........................................................................................................................................................... 16 Chapter 3: Unlocking the Potential of Nigeria's Natural Gas Sector ........................................................................ 23 Sum m ary .................................................................................................................................................................................................. 23 Introd uction ............................................................................................................................................................................................. 23 N atural G as Sector Regulatio n in N igeria ..................................................................................................................................... 25 The W a y Fo rw ard ................................................................................................................................................................................... 27 List of Figures: Fig ure 1.1: Brent crude prices (U S$ per barre l) ..........................................................................................................................2 Fig ure 1.2: N igeria's g ross fo reign reserves (U S$ billio ns) ............................................................................................... 4 Figure 1.3: Monthly exports and imports: 2014-2015 (US$ billions, free-on-board prices, three-m o nth m oving average) .................................................................................................................................5 Fig ure 1.4: Interbank and BD C naira/U .S. do llar exchange rates .................................................................................. 6 Fig ure 1.5: Inflatio n rates, 2008-2015 .......................................................................................................................................... 6 iii Nigeria Economic Report Figure 1.6: The headline inflation rate, 2014-2015 (year-on-year) .............................................................................. 7 Figure 1.7: Daily crude oil production (m onthly average) ....................................................................................................7 Figure 1.8: Revenues inflows to the federation account and the VAT pool .............................................................. 8 Fig ure 1.9: End-year balances in the eECA ....................................................................................................................................8 Fig ure 1.10: Revenues allocated by FAAC ......................................................................................................................................9 Figure 1.11: Percentage deviation of 2015 state budgets over 2014 approved budgets...................................... 9 Figure 2.1: Administrative petrol prices and average actual consumer prices (naira per liter) .......................16 Figure 2.2: Average actual consumer petrol prices by state, June 2015 (naira per liter) ...................................16 Figure 2.3: Oil price and gross oil revenues to government (trillions of naira and us$ per barrel)................ 17 Fig ure 2.4: Gross oil revenues to government (% of GDP) ................................................................................................. 17 Figure 2.5: D istribution of oil revenues (% of G D P) .............................................................................................................. 18 Figure 2.6: Share of fuel subsidy in government oil revenue (%) .............................................................................. 18 Figure 2.7: The size and distribution of oil revenues, scenario 1 (% of GDP) ......................................................... 20 Figure 2.8: The size and distribution of oil revenues, scenario 2 (% of GDP) ......................................................... 20 Figure 3.1: Megawatts of gas-constrained generation capacity.............................................................................. 24 Figure 3.2: Breakdown of natural gas use in the first nine months of 2015........................................................ 24 Figure 3.3: Overview of regulatory and pseudo-regulatory agencies..................................................................... 25 Figure 3.4: Determ inants of natural gas prices ...................................................................................................................... 27 List of Tables: Table 1.1: Real G D P grow th by sector (% ) ................................................................................................................................. 3 Table 1.2: Sector shares in Nigerian gross national product (% of GDP) ................................................................. 3 Table 1.3: The balance of payments of Nigeria (US$ billions) .................................................................................... 5 Table 1.4: The general government budget (% of GDP) ................................................................................................... 10 Table 1.5: Selected econom ic indicators ............................................................................................................................... 12 Table 2.1: Average value of the fuel subsidy by income decile: 2010 (naira per capita per month)............14 Table 2.2: Average value of the fuel subsidy by income decile: urban households, 2010 (naira per capita per m o nth) ................................................................................................................................... 15 Table 2.3: Share of Fuel subsidies received by each decile if administrative prices fully enforced, 2010 (naira per capita per m onth) ........................................................................................................................ 15 Table 2.4: Projections macroeconomic indicators for scenario 1 ............................................................................. 19 Table 2.5: Projected macroeconomic indicators for scenario 2.............................................................................. 20 Table 3.1: Recom m endations for gas sector reform ........................................................................................................... 29 iv ABBREVIATIONS bcf Billion cubic feet BDC Bureau de Change CBN Central Bank of Nigeria DGSO Domestic gas supply obligation DMO Debt Management Office DoG Department of Gas DPR Department of Petroleum Resources ECA Excess Crude Account FOB Free on board GACN Gas Aggregation Company of Nigeria GDP Gross domestic product GPD Gas and Power Directorate IMF International Monetary Fund LPG Liquefied petroleum gas mcf Thousand cubic feet mmBtu Million British thermal units MPR Ministry of Petroleum Resources MW Megawatts NAPIMS National Petroleum Investment Management Services NDGPR National Domestic Gas and Pricing Regulations NER Nigeria Economic Report NERC Nigerian Electricity Regulatory Commission NGC Nigerian Gas Company NGL Natural gas liquids NLNG Nigeria Liquefied Natural Gas NNPC Nigerian National Petroleum Corporation NBS National Bureau of Statistics OAGF Office of the Accountant General of the Federation PSC Production sharing contract SURE-P Subsidy Reinvestment and Empowerment Programme WAGP West Africa Gas Pipeline V  INTRODUCTION The Nigeria Economic Report (NER) is a regular publication of the World Bank. Each edition provides an overview of recent macroeconomic developments and devotes special attention to a topic of particular relevance or urgency. In this edition the macroeconomic overview is followed by both a detailed analysis of the country's fuel subsidy and an assessment of the current state and economic potential of its natural gas sector. 2015 has been a momentous year for Nigeria. The general elections held in March brought about the first democratic transition of power from a ruling party to an opposition party, heightening expectations for meaningful political change. The new Government is taking power during a very challenging time, however, marked by a sharp decline in global oil prices and continuing violence in the country's northeast.This creates a difficult context for realizing the new administration's ambitious reform agenda for job creation, the power sector, oil and gas, agriculture, and public administration. As noted above, this edition of the NER examines two prominent subjects of debate in Nigeria: the fuel subsidy and the natural gas sector.The current budgetary crisis has again motivated Nigeria to reconsider the fiscal costs of the fuel subsidy, while the acute inadequacy of power generation in Nigeria has cast increasing attention on the natural gas sector. Chapter 2 of the report analyzes the costs and benefits of Nigeria's fuel subsidy, including their implications for low-income households. Fuel subsidy costs are expected to amount to 18 percent of government oil revenues in 2015, and this share could increase to more than 30 percent by 2018 even if oil prices remain low. There is a general consensus that increasing the supply of power in Nigeria is critical to the future development of the country. The success of the current plans to boost generation capacity will hinge on the development of the natural gas sector. Nigeria is endowed with substantial natural gas reserves, but major reforms will be necessary to attract the investment necessary to harness the potential of the natural gas sector to supply the domestic energy market. Chapter 3 of this report summarizes the current regulatory situation in the natural gas sector and outlines potential avenues for reform. This edition of the NER was prepared by a World Bank team led by John Litwack (Lead Economist) and Khwima Nthara (Program Leader and Lead Economist). Masami Kojima (Lead Energy Specialist) is the primary author of Chapter 3, and also contributed to other sections. Andrew Dabalen (Lead Economist), Jariya Hoffman (Senior Economist), Gloria Joseph-Raji (Senior Economist), and Olayinka Babalola (Economist-Consultant) also made contributions. Vii  LU u U MACROECONOMIC OVERVIEW Summary Given the high dependency of Nigeria on oil revenues,the recent sharp decline in oil prices has given rise to major challenges in the form of external imbalance, steep falls in government revenues, and slower economic growth. In contrast to the period of 2008-2009, Nigeria no longer has a large fiscal reserve to buffer government budgets from the revenue shortfalls. As a result, distributions to federal and state government budgets declined in nominal terms by 39 percent in the first half of 2015 relative to the same period of 2014. Federal and state governments have slashed capital spending, and a number of states have struggled just to pay salaries to civil servants and service domestic debt obligations.The pace of growth in Nigeria has slowed in light of lower foreign inflows from oil and thefiscal contraction.The national currency has depreciated by 20 percent between November 2014 and March, 2015, leading to a significant import contraction that has alleviated some of the pressure on the naira. New currency controls on the forex market should bring further significant import contraction, although they are also expected to negatively impact trade and GDP growth. Other recent policy initiatives include a financial assistance package for State budgets, measures to rationalize the management and operation of the Nigerian National Petroleum Corporation (NNPC), fight corruption, and resolve the conflict in the North East of the country.The fuel subsidy, which is imposing a large and increasing burden on public finance, has become the focus of renewed policy debate. For the medium term, Nigeria will need to create the fiscal space needed to provide the public services essential for maintaining and accelerating progress in job creation and poverty reduction. However, it will likely be unable to rely on oil revenues as in the past. Oil prices are expected to remain weaker over the medium term than their recent historical levels. Even if oil prices rebound to those levels, the absence of growth in the oil sector implies that oil revenues will most likely continue to decline relative to the size of the Nigerian economy, as illustrated in Chapter 2 of this Report. On the positive side, the sovereign debt position of Nigeria is still strong, there is potential for boosting non-oil revenue generation, and investors stand ready to bring significant resources to the country if they receive signals of commitment by the new Government to policy directions and regulations consistent with strong private-sector-led growth. The Oil Price Shock Crude oil prices have declined sharply since June 2014 and are expected to remain significantly below their recent historical levels over the medium term. Bonny Light crude prices fell by almost 60 1 Nigeria Economic Report Figure 1.1: Brent crude prices (US$ per barrel) GDP and Economic Growth 160- 160- The pace of growth in Nigeria has slowed. 120- 100 growth declined to 4 percent, year-on-year, in the first 80 quarter of 2015, falling to 2.4 percent in the second 60 quarter and 2.8 percent in the third quarter (Table 1.1). 40 Non-oil GDP growth registered at 4 percent for the 20 first three quarters of 2015, down from the 7.3 percent 0d growth pace in 2014. NBS figures show the pace ofjob ar ine t creation slowing by 45 percent, year-on-year, in the ________________________________ second quarter of 2015, providing further evidence of Source: U.s. Energy Information Admistration. a significant economic slowdown. Falling oil revenues have weakened domestic demand, while rising uncertainty during the run-up to the general elections percent from a peak of US$114 per barrel in June 2014 to in March and a major fuel shortage in the second less than US$45 per barrel in January 2015. Prices briefly quarter related to fuel subsidy payments disrupted rallied, rising to over US$65 per barrel at mid-year before economic activity. After years of double-digit growth dropping again to less than US$50 per barrel. Oil prices manufacturing contracted by 2.1 percent, year-on-year, are inherently volatile and difficult to predict, but current in the first three quarters of 201 5.The oil and gas sector forecasts anticipate that prices will remain weak over the also declined in the first half of 2015. Oil production next several years. has contacted since 2011, and while output stabilized somewhat in 2014, recent liquidity and profitability Nigeria is heavily dependent on oil revenues, and concerns have negatively affected the sector, joining the decline in oil prices had a major impact on its the issues of low investment, regulatory uncertainty, economy and its public finances. In recent years oil and oil theft/vandalism that can also be associated with and gas have comprised over eu percent of Nigeria's previous years of output decline. However, growth in exports and more than 70 percent of consolidated the oil and gas sector in the third quarter of 2015 was budgetary revenue. While the oil sector accounts for less slightly positive. than 1 percent ofGDP, inflows from oil sales have helped bolster domestic demand, thereby driving economic Services accounted for 61 percent of Nigeria's GDP growth. When the global financial crisis caused oil prices during the first half of 2015, while the share of oil to drop during 2008-2010, the Government was able and gas fell to 7 percent. As industry and agriculture to draw on US$22 billion in fiscal revenue accumulated performed poorly in the first half of 2015, services and in the Excess Crude Account (ECA) to finance a fiscal trade expanded their share in GDP. The share of the stimulus that successfully sustained growth despite the service sector has risen steadily from 50 percent of GDP worsening external environment. At the time the current in 2011 to more than 60 percent in the first half of 2015. shock occurred, falling oil output and an increasing cost Trade, information and communications technology, ofthefuel subsidyduring 2011-2014 had alreadydrained and real estate together comprise almost 70 percent of the ECA down to US$2 billion. Consequently, 2015 has service sector output (Table 1.2). Trade was the single witnessed a major fiscal contraction and significant largest sectoral component of GDP in the first half of 2015 slowdown in economic growth. Given expectations for at 1.sl percent, followed by agriculture (17.8 percent), lower average oil prices in the future, Nigeria will likely information and communications technology (12. need to undergo a rapid fiscal adaptation that reduces percent), manufacturing (.7 percent), real estate (8.3 the dependency of government finance on oil. percent), and oil and gas (7.1 percent). 2 Macroeconomic Overview Table 1.1: Real GDP growth by sector(% 2011 2 Total GDP 5.3 4.2 5.5 6.2 4.0 2.4 2.8 Agriculture 2.9 6.7 2.9 4.3 4.7 3.5 3.5 Industry 8.0 2.2 1.8 7.0 -2.1 -3.3 -0.1 Oil and Gas 2.3 -4.9 -13.1 -1.3 -8.1 -6.8 1.0 Solid Minerals 14.5 19.7 16.5 14.9 11.3 7.1 7.0 Manufacturing 17.8 13.5 21.8 14.7 -0.7 -3.8 -1.8 Construction 15.7 9.4 14.2 13.0 11.2 6.4 0.0 Services 5.1 4.1 8.5 6.7 6.7 4.6 4.0 Information & Communication 2.2 3.1 8.2 7.0 9.5 6.3 5.8 Finance & Insurance -26,9 21,1 8.6 8.1 9.0 6.4 6.6 Real Estate 0.4 5.7 12.0 5.1 3.1 3.0 2.0 Accommodation & Food 9.2 15.9 73.9 18.3 26.7 -9.0 -5.4 Services Arts, Entertainment& 148.3 27.4 25.5 31.2 25.6 6.3 6.4 Recreation Trade (wholesale & retail) 7.2 2.2 6.6 5.9 6.5 5.1 1.0 Non-Oil GDP 5.9 5.8 8.3 7.3 5.6 3.5 3.0 Source:The National Bureau of Statistics (NBS). Table 1.2: Sector shares in Nigerian gross national product (% of GDP) 2011 20221 2014 12 5 205 Agriculture 22.3 22.1 21.0 20.2 17.8 17.9 Industry 27.8 26.8 25.4 24.2 21.1 21.2 Oil and Gas 17.5 15.8 12.9 10,8 6.6 7.6 Solid Minerals 0,1 0.1 0.1 0.1 0.1 0.1 Manufacturing 72 7.8 9.0 9.8 10.2 9.3 Construction 3.0 3.1 3.3 3.6 4.2 4.2 Services 49.9 51.1 53.7 55.6 61.1 60.9 Information & 10.1 10.1 10.4 10.8 11.9 13.9 Communication Finance & nsurance 2.4 2.8 3.0 3.1 4.0 3.7 Real Estate 7.3 7.7 8.3 8,4 7.8 8.7 Accommodation & Food 0.4 0.5 0.8 0.9 1.3 0.7 Services Arts, Entertainment & 0.1 0,2 0.2 0,2 0.3 0.2 Recreation Trade (wholesa e and retail) 16.4 16.5 17.1 17.6 20.1 18.9 Other services 13.2 13.3 13.8 14.5 15.8 14.8 Total 100.0 100.0 100.0 100.0 100.0 100.0 Source: NBS. 3 Nigeria Economic Report External Balance and Monetary provide important insights into the evolution of the Policy country's trade balance. Official customs statistics show a monthly trade surplus of US$2-3 billion during most The 20 percent depreciation of the naira and successful of 2014, which virtually disappears in 2015 (Figure 1.3). conclusion of peaceful elections stabilized the external According to preliminary data, the depreciation of the balance in the second quarter of 2015. Nigeria's external naira contributed to a 23 percent decline in the dollar balance had been almost uniformly negative since April value of imports, year-on-year, in the first half of 2015. 2013, resulting in a steady erosion of foreign reserves However, the dollar value of exports fell by 45 percent (Figure 1.2). Falling oil output began weakening the trade during the same period. Due to the pervasiveness of balance in 201 2,although strong short-term capital inflows "hidden" imports in Nigeria, the actual trade balance may of more than US$30 billion kept the balance of payments have shifted into deficit. The central bank's subsequent in surplus until mid-2013. An accelerated decline in oil imposition of currency controls in theforex market should output and more cautious attitudes among investors in cause imports to contract further, potentially restoring the latter half of 2013 and early 2014 put some pressure the trade surplus. on the naira. While a recovery in oil output and a more positive economic outlook briefly moved the balance of A stabilization in capital flows may also be assisting payments into surplus in mid-2014, the subsequent drop the recent restoration of external balance in Nigeria. in oil prices, magnified by election-related uncertainty, Table 1.3 presents the Nigerian balance of payments intensified exchange-rate pressures in late 2014 and early from 2011 through the first half of 2015. Since 2013, the 2015. However, following the depreciation of the naira balance of payments shows highly negative "errors and and a peaceful transfer of political power, Nigeria's balance omissions:' As markets perceive that much of the high of payments has showed signs of renewed stability, with portfolio (short-term) investment that came to Nigeria gross foreign reserves remaining at close to US$30 billion in the second half of 2012 and first half of 2013 has now from end-March through November. left the country, the US$42 billion in negative errors and omissions recorded in 2013 and 2014 likely contains Imports fell by 23 percent in the first half of 2015, much of this short-term capital outflow. Thus, one of the yet Nigeria's trade balance remains weak. Trade reasons for the stabilization of the balance of payments statistics must be interpreted with caution, as widespread since the second quarter of 2015, despite a weak trade under-invoicing and smuggling result in a large share balance, could be that there is no longer a large supply of of "hidden" imports. However, the available figures still liquid capital of this type in Nigeria. Figura monthl tradea' surps usrig ofere US$2- biliondurngsos 60.00- 50.00- 40.00- 30.00- 20.00- 10.00- of1 204 whc vitu ly diaper in 215Fgr 13) a) Q) ID Q)0) W) a)) ) valu of imp rts yero -er in th firs hal of) 2015. : 7 c,4 (N( ( (N(Nj (N (N1 (N (Nj N cN ('N N C) N~ cj~ cN~ cN N ~ "' (cN N c,4 c l N (CN N c,4 Source:The Central Bank of Nigeria (CBN). 4 Macroeconomic Overview Figure 1.3: Monthly exports and imports: The central bank has taken steps to unify the 2014-2015 exchange rate and depreciate the naira. Authorities three-month responded to the strong downward pressure on the 9.00 naira in the urt quarter o 2014 y epreciating the 8.00 currency by 6 percent, restricting access to the official 7.00 exchange window, and limiting its sales of forex at this 6.00 window.The initial depreciation in November, 2014 was 5.00 inadequate to equilibrate the forex market, and large 4.00 gaps opened up between the official exchange rate, 3.00 2.00- the interbank rate, and the bureau de change (BDC) 2.00 - 1.00 cash rate, while pressure on reserves continued. The 0.00 -, Central Bank reacted in February by closing the official t5 >~ U o ~sp window altogether and moving its interventions to the D U ) r- -0 0- CY) 0-1) 2013 2014 2015 Total oil revenues - Total non-oil revenues - Total revenues Source:OAGF Nigeriawas unableto buffertheimpactof oil revenue Moreover, a combination of rising inflation rates and the declines on government finance with the fiscal depreciation of the naira implies that the decline in real reserve (ECA) as in 2008-2009. The ECA had already purchasing power has been even greater. depleted to US$2 billion by late 2014. The Government's efforts to replenish the ECA during the period of higher oil A shrinking resource envelope prompted the prices from 2011 to mid-2014 were largely unsuccessful. Federal Government to introduce significant cuts Three primary factors prevented the accumulation of an and adjustments to the 2014 and 2015 budgets, adequate fiscal reserve since 2010. A majorfiscal expansion with a particular focus on capital expenditures. of the Federal Government in 2010 and early-201 1 virtually Federal revenues in 2014 were 15 percent below the level exhausted the remaining fiscal reserve at a time when the anticipated in the approved budget, with oil revenues country could have been rebuilding it. Beginning in mid- falling 6 percent below expectations. The Federal 2011 the authorities attempted to consolidate the public finances and rebuild reserves, and the ECA balance reached The Nigerian government has consistently over-projected US$10nonoil revenues. Until recently, nonoil revenue shortfalls were US$1 bilio atend-012 In201, hweve, dcliingoil offset by oil revenues, which were routinely under-projected. output negatively affected public revenues, while the fuel However, in 2013 and 2014 actual revenues in both categories subsidy became increasingly expensive. The fuel subsidy failed to meet expectations. is estimated to have cost the government US$35 billion between 2011 and 2014, which would have been more - b n i t E than enough to replenish the fiscal reserve. Yet when oil 25 prices fell in June 2014, ECA resources amounted to just US$3.6 billion, and by the end of the year the balance had 20 19.7 dropped to just US$2.1 billion. In the absence of adequate fiscal reserves, monthly . 18. revenue allocations to federal, state and local governments declined sharply from the second half 4.6 of 2014 through 2015. Between January and June 2015 0 funds distributed by the Federation Account Allocation 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Committee (FAAC) fell by 3p percent, year-on-year. Source:OAGoF 8 Macroeconomic Overview Figure -------- level. Resource allocations to priority social sectors such as 700- education and health were protected in the 201 budget. c:' 0 0The total share of education spending was 9.3 percent, 600- c M Ln clcompared to 9.0 in the approved budget for 2014, while 500- c 500 'o health spending accounted for 5.7 percent, up from 5.0 400- percent in 2014. However, in the context of the revenue 300 crisis, the execution rate for the 201 capital budget was 200 just 10 percent at mid-year. 100- Nigerian states have been hit particularly hard exp end itur price shock, Nigerian Niera' cpt- g on i 0 E E oFederation Account have geeaallocations for the vast speDi am oif) ez majority of their budgetary revenues and face greater 2014 2015 borrowing constraints than the Federal Government. They have therefore been compelled to tighten their Source: OAF. budgets substantially. Given the nature of the revenue sharing rule, the extent of the decline in oil revenues accruable to the Federal Government is identical for most Government responded by significantly reducing capital Nigerian states. For the oil-producing states, the decline expenditures in 2014. While Nigeria's capital-budget is even greater. Most states have limited borrowing execution rates have generally been low, in 2014 actual capacity and require federal approval for any foreign spending amounted to just 3h percent of budgeted borrowing. Many states reportedly accumulated salary spending, down from 60 percent in 2013. This was not arrears in 2015, some for more than six months, while merely the result of the usual implementation bottlenecks, a number have had difficulty servicing their domestic but a deliberate move by the Federal Government to curb debt. Twenty-seven of Nigeria's 36 states passed 2015 expenditures. The approved 201j5 budget is 4 percent budgets that were lower, in nominal terms, than those lower in nominal terms than the budget approved in approved in 2014. Approved state budgets for 2015 are 2014. Again, planned capital spending bore the brunt of on average 18 percent below the approved budgets for the impact, falling by 50 percent from its planned 2014 2014 (Flgure 1.1b1). Fiur 111 Prenag dvitinof205 t Ni ugeria stes. For4 tha oprodbucigestts,h eln 25- 20- 15- 10- 5- 0- -5- -10- -15- is~ 0 ~ ) evngetr"otsaeshv iie'orwn -35 -T E 2 LE w -p D~ a)0 0 m w m 0 0 0 E a])[ :'T CO o 0 -o 0>o co LU a w .u~0 capciyaad equrefedra apoa for an forig < (3 Source:World Bank Suwoeational latabase. 9 Nigeria Economic Report The President and the Central Bank announced an from resources otherwise held as obligatory reserves assistance package in mid-2015 aimed primarily with the Central Bank, and re-payment is guaranteed as at assisting distressed States for paying salary deductions from future revenues designated for FAAC arrears and meeting other critical expenditure distribution. A total of 27 states have applied for these obligations. An additional allocation of US$2.1 billion loans in the amount of N337.8 billion naira, and some to federal and state budgets was made out of tax are already drawing credits. The financial relief package reserves from the Nigeria Liquified Natural Gas Company is providing much needed short-term financial relief to and Shell. In addition, the Federal Government has Nigerian States, although major fiscal adjustment at the offerred a financial relief package consisting of two state level will likely be needed going forward. programs. First, the Debt Management Office (DMO) restructured states' short-term commercial bank debt Nigeria's fiscal deficit is expected to widen, yet the into long-term Federal Bonds with 20-year maturity and country still has space to borrow. While an uncertain yield of 14.83 percent (30 day average).This restructuring macro-fiscal context makes public revenues and was concluded in September 2015, and amounted to expenditures difficultto predict,thegeneral government N575.516 billion that was extended by 15 commercial deficit is currently projected to increase to almost 3 banks to 23 states. According to the Debt Management percent of GDP in 2015. This deficit will be financed Office, the debt restructuring for 23 states lowered the primarily through domestic sources. Nigeria's foreign short-term monthly debt service burden by 55 to 97 debt was restructured a decade ago, and subsequent percent, and generated interest rate savings from 3 to prudence in debt-management policy has afforded 9 percent per annum. Secondly, commercial banks were Nigeria some space to smooth the fiscal adjustment. encouraged to issue additional credits to states at 9 Nigeria's sovereign domestic debt represents less than g percent interest rate and 20-year maturity to help clear percent of GD, and its external public debt amounts to salary and pension arrears. Banks can finance these loans just 2 percent. withe the: Cenra Bank,a andrnen re-pymen is gurnte asP General Government Revenues 12.9 16.2 14.7 12.1 11.7 7.6 Federal 6.5 5.8 4.9 4.7 3.9 2.5 Consolidated States 5.9 6.0 526 5.6 4.5 3.1 Extra Budgetary Funds 0.8 0.9 2.5 1.7 2.0 1.0 Deductions for Fuel Subsidy 1.2 2.8 1.2 1.4 1.3 1.0 Net Accumulation to ECA -1.5 0.7 0.5 -1.4 0.0 0.0 General Government Expenditures 15.5 17.2 13.8 14.8 13.1 10.4 Federal 7.5 6.8 5.8 57 4.5 3.6 Consolidated States 6.0 6.5 5.9 6.0 5.3 4.8 Extra Budgetary Funds 0.8 1.0 1.0 1.7 2.0 1.0 Fuel Subsidy 1.2 2.8 1.2 1.4 1.3 1,0 General Government Balance -2.6 -1,0 0.9 -2.7 -1.4 -2.8 Federal Balance -1.0 -1.0 -0.9 -1. 0 -0.6 -1.1 Consolidated State Balance -0.2 -0.5 -0.3 -0.4 -0.8 -1.7 Consolidated Federal and State Balance -1.1 -1,5 -1.2 -1.4 -1.4 -2.8 Sources: GAGEp Ministry of Finance, World Bank Subeational patabase, dM Nore: ye to data limitations state-level figures should be treated as rough estimates. 10 Macroeconomic Overview The current budgetary crisis in Nigeria reflects conditions will be a critical challenge for Nigeria in the exceedingly low non-oil tax revenue. In recent, years, short and medium term. non-oil tax revenues in Nigeria amounted to a mere 4 percent of GDP, and much of this revenue has been Economic growth is expected to remain relatively concentrated in the single city of Lagos. Even compared weak in the short term. Nigeria's recent growth has to other highly oil-dependent countries this share is very been driven by domestic demand, which in turn has low. Nonoil tax revenue in Angola is equal to 8 percent been fueled by oil revenues. It has thus slowed along of GDP, while nonoil revenues in Cameroon and Gabon with domestic demand, and the currency controls in the represent approximately 13 percent and 21 percent second half of the year have also likely slowed commerce. of GDP, respectively. The nonoil revenues of the most Higher growth in Nigeria should gradually resume as oil-dependent countries in the Former Soviet Union, its economy adjusts to lower commodity prices. The Kazakhstan and Azerbaijan, equal more than 12 percent successful elections in March, 2015 brought new attention of GDP, and Russia's nonoil revenues reach 26 percent? to Nigeria, which could potentially manifest itself in an Nigeria has considerable potential to increase its nonoil acceleration of growth and investment in subsequent revenues, and as oil revenues continue to decline as years. The clarification and pursuit of key economic a share of GDP over both the medium and long term, policy directions by the new Government will be a key the country faces an imperative task of building a more determining factor for confidence in Nigerian markets. effective tax system and administration for generating The weaker naira should boost domestic competitiveness, non-oil revenues. with expanded opportunities for exports and import substitution over the medium term. The Economic Outlook Nigeria faces a difficult short and medium term reansune tu the dereationco macroeconomic outlook, but has the opportunity teaia andethe ton of capit ono to make major progress toward more diversified deveopmnt ad geate eficiecy n pulic appears to have been sufficient to restore general development and greater efficiency in public bancofpyeteqibru inhesod finance. Nigeria must endure a major fiscal adjustment half of 1.Tenas epreiai in a con to lower oil revenues. Even if oil prices rebound, the oall oi price nrateasigniin imot general rapid trend toward a decline in the share of ontacin. ile therte akenin ipr oil revenues in GDP should continue. However, the inJland August wul ther wi erted country has much room for increasing efficiency in fuh dnd pess on he naira,ite centra the public sector, including greater cooperation and bank's currency controls should continue to depress coordination in the budgetary policies of the Federal imports. Rising oil prices or increased capital inflows Government and Nigerian states in the priortization could also have a positive impact on the external of key public services and infrastructure for a maximal balance. impact on the welfare of Nigerians and the emergence of a single unified strong national market. As indicated above, there is also signficant potential for increasing 2 The above information was taken from IMF Article IV Reports non-oil tax revenues. Fiscal adjustment to the new for these countries. shortand ediumterm Nigeria Economic Report Table 1.5: Selected economic indicators GDP Growth (%) 5.3 4.2 5.5 6.2 3.2 Inflation Rate (CPI Dec/Dec, %) 10,3 12.0 8.0 8.0 9.5 General Government Budget Balance (% of GDP) -2.0 0.4 -3.1 -1.9 -3.1 Federal Government BudgetBa ance (% of GDP) -2.0 -1.4 -1.4 -1.1 -1.8 Fiscal Reserves (ECA/SWF) US$ b 4.6 8.6 3.0 2.1 2.1 Gross Monetary Reserves ($ b) 32.6 46.0 43.6 34.5 30.0 Nominal Exchange Rate (N/US$), eop 158 157 158 168 197 Sovereign Debt (% of GDP) 12.8 13.1 12.4 12.6 13.3 External 1.9 1.9 1.7 1.8 1,6 Domestic 10,9 11,2 10.7 10.8 11.7 Domestic Credit to the Private Sector (% of GDP) 22.5 21.0 20.0 23.9 25 Note: General Gov. balance includes Federal, State, Local, Extra-Bdg Funds, Fuel Subsidy, Net Change in ECA. * Projections. Note: Estimates as shares of GDP use new re-based GDP numbers. 12 LU U OIL REVENUES AND THE FUEL SUBSIDY Summary This Chapter examines the costs and benefits of the fuel subsidy in Nigeria in light of current prospects for oil prices and revenue. Overall, the fuel subsidy appears to have very modest benefits for everyday Nigerians, particularly given the fact that the administratively set prices for petrol and kerosene are no longer enforced in most of Nigeria. The lack of enforcement means that almost all benefits are captured by importers and traders; moreover, even if these prices were fully enforced, it is estimated that the richest 20 percent of Nigerians would capture most of the benefits. On the other hand, the costs of the subsidy are very high and growing with time, as increasing petrol demand in Nigeria outpaces growth in oil output or revenues. The US$35 billion cost of the fuel subsidy during 2010-2014 was a primary reason why Nigeria was unable to accumulate a fiscal reserve in the Excess Crude Account that could have protected the country from the recent oil price shock. Fuel subsidy obligations are expected to reach 18 percent of all government oil revenues in 2015, and, if the current regulated prices are maintained, this is projected to increase to more than 30 percent by 2018. Introduction A recent sharp decline in oil prices and revenues has once again motivated Nigeria to reconsider its commitment to the fuel subsidy, which compensates importers and traders of petrol and kerosene the difference between estimated world market prices and fixed pump prices of 87 and 50 naira per liter, respectively. The fuel subsidy has been a continual source of controversy in Nigeria. Previous governments have tried to remove it, but popular unrest led to its reinstatement. Some Nigerians considered the fuel subsidy to be one of the only tangible benefits that they receive from the Government, and have been skeptical that the Government would put the resources to better use for them in the event of its removal. The fiscal cost of the fuel subsidy is very high, reaching an estimated US$35 billion during 2010-2014. Moreover, annual costs are increasing over time due to rising fuel demand and the depreciation of the naira. In recent years numerous audits and reports have identified widespread corruption and fraud in the administration of the fuel subsidy, and official petrol imports have substantially exceeded actual consumption. Attempts by the Government to crack down on fraud and delay payment of the subsidy have commonly met with severe fuel shortages in the country that also impose high economic and welfare costs on Nigerians. This Chapter intends to inform the current discussions in Nigeria on the future of the fuel subsidy by seeking to clarify its current costs 13 Nigeria Economic Report and benefits to the country, and how the situation could prices had been fully enforced, the average consumer be expected to evolve in the near future. would have received a subsidy ofO6 naira per liter of petrol and 71 naira per liter of kerosene, and it is assumed that The Benefits of the Fuel Subsidy public transportation costs would have been 50 percent The oliy o th ful sbsid isto rovde eneits higher without the subsidy. It should be noted that these The policy of the fuel subsidy is to provide benefitsthe to the population and firms in the form of lower potential pass-through effect of subsidies on prices for petrol and kerosene prices.This has both direct benefits food and consumer goods. However, as most of Nigeria's for consumers as well as indirect benefits through lower domestic transportation services are provided by diesel- costs of transportation. However, the available evidence powered vehicles, and there is no subsidy for diesel, this suggests that the actual benefits received by most Nigerian pass-through effect is likely to be small. households, especially those in the middle and at the lower end of the income distribution, are marginal at best, Table 2.1 presents the average value of the subsidy particularly given the fact that the administratively set price that would have been received by Nigerian for kerosene has not been enforced, and enforcement of consumers in 2010 if the administrative prices the subsidized petrol price has also become increasingly for petrol and kerosene had been fully enforced. weak in recent years. Moreover, even if the administrative Benefits are broken down by income decile: "D1 "refers to prices were fully enforced, the inherently regressive nature the poorest 10 percent of the population, D2 refers to the of fuel subsidies would enable wealthier consumers to second-poorest, and so on. Assuming full enforcement capture the majority of benefits. of administrative prices the average per capita monthly The fuel subsidy is regressive in nature becausehave The uelsubsdy s reresive n nturebecuse been 460 naira; however, even under these conditions the wealthier households almost always spend more distribution of benefits would have been deeply regressive. on fuel than their poorer counterparts. The extent of The value of the subsidy received by the wealthiest 10 this regressivity is visible in Nigerian household budget percent is 30 times the value received by the poorest 10 data. In 2010-2011 the Harmonized Nigeria Living percent. Moreover, the majority of benefits that would Standards Survey (HNLSS) administered by the NBS asked accrue to the poor come from the kerosene subsidy, respondents how much they spent on fuel for private which is not enforced in practice.' If the kerosene subsidy consumption (i.e. private vehicles, generators, cooking, etc.), for business purposes, and for public transportation. Nigeria's poor have virtually no access to kerosene at the sub- At this time, the administrative prices for petrol and sidized price of 50 naria. This was emphasized in the 2012 Re- kerosene were 65 naira and 50 naira, respectively. If these port of the Ad-Hoc Committee of the House of Representatives Tabe .1:Avrae Vlu ofth FelubidybyI ould haeDecive da01 subsidyaofe61cnaira per lierofnptro All Subsidies 459.8 55.2 115.6 156.5 198.4 243.1 341,4 438,9 517.7 838.6 1692.2 Kerosene 171.5 37.2 62,5 79,6 103.1 118.9 144.9 182.5 215.6 299,7 471.0 Suhsidy Petrol Subsidy 82.9 1.3 5.6 9.8 12.4 20.0 36.0 57.7 77.7 139,8 468,3 Petrol Subsidy, 61.5 2.0 19.9 23.6 24.7 30,1 64,9 75.3 49.4 131,9 193.1 Firms Transportation 143.9 14.7 27.6 43.5 58.2 74.1 95.6 123.4 175.0 267.2 559.8 Subsidy 14 Oil Revenues and the Fuel Subsidy Table 2.2: Average Value of the Fuel Subsidy by Income Decile: Urban Households, 2010 (naira per capita per month) Al D1 D2 D3 D4 D D6 D7 D8 D 1 Al Subsidies 693.4 97.6 231.3 284.7 370.0 446.4 499.0 628.0 791.7 1266.8 2314.4 Kerosene Subsidy 255.6 59.3 107.7 144.3 171.5 211.2 247.7 261.9 321.8 413.8 615.7 Petrol Subsidy 88.0 1.0 6.9 11.7 20.6 26.6 32.1 55.8 93.4 1290 502.0 Petro Subsidy, 105.9 12.5 56.4 58.1 63.4 71.2 44.6 91.0 101.9 273.6 286.1 Firms Transportation 243.9 24.8 60.3 70.5 1145 137.3 174.7 220.1 274.5 450.4 910.3 Subsidy Table 2.3: Share of Fuel Subsidies Received by Each Decile if Administrative Prices Fully Enforced, 2010 (naira per capita per month) Al D1 D2 D3 D4 D5 D6 D 8D D9 D1 All Subsidies 100.0 1.2 2.5 3.4 4.3 5.3 7.4 9.5 11.3 18.2 36.8 Kerosene Subsidy 100.0 2.2 3.6 4,6 6.0 6.9 8.4 10.6 12.6 17.5 27.5 Petrol Subsidy 100.0 0.2 07 1.2 1.5 2.4 4.3 70 9.4 16.9 56.5 Petrol Subsidy, 100.0 0.3 3.2 3.8 4.0 4.9 10.6 12.2 8.0 21.4 31.4 Firms Transportation 100.0 1.0 1.9 3.0 4.0 5.1 6.6 8.6 12.2 18.6 38.9 Subsidy is not included, the poorest 10 percent of Nigerians would remains extremely regressive. Excluding the kerosene receive an average estimated per capita benefit from the subsidy, the benefits to the poorest 10 percent of the fuel subsidy of just 18 naira per month. urban population would be less than 4S naira a month, and the benefits to the poorest 50 percent of the A large share of poor Nigerians live in rural areas, population would be less than 265 naira a month. where they receive almost no benefit from fuel subsidies. Since benefits to the poor are concentrated Finally, Table 2.3 shows the share of fuel subsidy in urban areas, Table 2.2 presents estimates for the urban benefits that would have accrued to each decile of population exclusively. While the estimated benefits the population if administrative prices had been to urban consumers are larger than they are for the fully enforced. The results are stark: the bottom 60 population as a whole, the distribution of those benefits percent of the population would have received a mere 17 percent of the value of petrol subsidies, while the wealthiest 10 percent would have received a full 46 "To Verify and Determine the Actual Subsidy Requirements and Monitor the Implementation of the Subsidy Regime in Nigeria." An attempt had previously been made to eliminate the kero- 30 percent of the population would still have captured 58 sene subsidy by Presidential Decree in 2009 on the grounds that percent of its benefits. When both subsides are combined, "subsidy payments by Government do not reach the intended beneficiaries" Indeed, the kerosene subsidy is so unenforced households in the wealthiest decile would have received that is widely believed to have been repealed, yet subsidy pay- about 37 percent of the overall benefits, and households in ments to the NNPC continue, the 6 poorest deciles would have received just 2 o percent. 15 Nigeria Economic Report Figure 2.1: Administrative petrol prices and Fgr .:Aeaeata osmrpto average actual consumer prices (naira per liter) pie ysae ue21 niaprltr 130 155 Niger138.33 120-Kg 128.33 Nassarawa 126.08 110 125 Adamawa- 122.5 100-Buh 121.67 Taraba118.33 90- Cross River 117.7 Imo 116.57 80-Kb i 115.91 Benue 115.88 70- 115.71 Yobe 115.14 Kacluna 113.87 M D_ t- > U -0 Elkit 113.16 Abia'111.67 Averge price paid U Regulated price 110.57 Jigawa109.13 Source: NBS. 109 Ondo'108.19 Delta106.4 Anambra106 Plateau105.43 Osun 105.4 The weak enforcement of administrative prices Gombe 104.38 Kano 104.23 further reduces the benefits of fuel subsidies to Lagos 102.63 Katsina97.78 Nigerian households. The NBS has been surveying Abua 97.25 households since mid-2014 to document the actual 95.8 E u 94.45 petrol prices paid by consumers in each Nigerian state. Zamfara 93 The survey confirms that actual petrol prices have 0 20 40 60 80 16o 1 iO 40 108 systematically exceeded administratively set prices. Source: NBS. Furthermore, this gap grew significantly in 2015 (Figure 2.1), and as of June the national average consumer price periodic fuel shortages and long lines at petrol stations for petrol was 112 naira per liter. While NBS data show that would otherwise not exist. large variations across states (Figure 2.2), the actual price in each state is higher than the administratively set price The Costs of the Fuel Subsidy of 87 naira per liter. In June 2015 the average actual consumer price was under 100 naira in only 6 states, while The fiscal cost of Nigeria's fuel subsidy has risen in 7 states the actual consumer price was over 120 naira. to US$4-6 billion per year. There are other important costs as well. Uncertainty about the fuel subsidy has These results indicate that most Nigerians receive strongly discouraged investment in domestic oil refining. little benefit from the fuel subsidy. To the degree Moreover, artificially low fuel prices distort incentives and that the pump price of petrol is enforced, the majority encourage excessive consumption of energy. Allegations of benefits are captured by the richest 20 percent of of corruption and fraud surrounding the implementation the population. To the degree that these prices are not of the fuel subsidy are costly to the reputation of enforced, all of the benefits are captured by fuel importers government. Finally, subsidy-related fuel shortages have and traders. Certainly, there is at least a small group repeatedly disrupted economic activity and imposed of Nigerians of modest means who continue to profit serious welfare costs on Nigerian households. significantly from the fuel subsidy, for example taxi drivers in regions where the subsidy is enforced to at least some Annual spending on the fuel subsidy now accounts degree. Even for these consumers, those benefits would for roughly one-fourth of all federal budgetary need to be weighed against the costs for them of related spending. This is significantly greater than the entire 16 Oil Revenues and the Fuel Subsidy executed federal capital budget, and greaterthan all federal relative to the size of the Nigerian economy is far greater spending on education and public health combined. than the nominal declines (Figure 2.4). Oil revenues Following the reduction of the subsidy in 2012, the tumbled from a peak of 14 percent of GDP in 2011 to Government channeled some of the savings into a Subsidy a projected 4.4 percent in 2015. Reinvestment and Empowerment Programme (SURE-P), with the explicit purpose of demonstrating superior Figure 2.5 gives the distribution of Government oil alternative government programs. The assessment of the revenues between budgets, cash calls to NNPC, the results of SURE-P proved somewhat controversial. However, fuel subsidy, and net accumulation to the ECA. Cash the World Bank's 2013 NER highlighted a particular cost calls to NNPC are intended to finance the Nigerian part in of the fuel subsidy that often goes unacknowledged: investments by joint ventures in the oil sector. In recent the opportunity cost of not accumulating fiscal reserves years, these allocations have reportedly been inadequate as a buffer against future oil-price shocks. If the US$35 to finance planned investments, leading to increased billion spent on the fuel subsidy between 2011 and 2014 debtsof NNPCto internationaloil companies. Expenditure had instead accrued to the ECA, Nigeria would now be in a much more advantageous position for protecting priority expenditures in the wake of the oil price shock. The 2013 NER examined the projected evolution of U p oil revenues and the ECA under various assumptions 10 120 9- for oil prices, the fuel subsidy, and policies B 100 surrounding distribution to budgets. The analysis 7 80 reached two overarching conclusions. The first was 6 5 the necessity of a fiscal adjustment. Even in 2013 it was 5 already apparent that without a major increase in nonoil 4 40 revenues the current level of government spending as 20 a share of GDP could not be sustained. The second 1 conclusion was that fuel subsidies were imposing a large 0 0 and increasing burden on public finances, as domestic200 01 212 03 214 O5po and ncrasig budenon ubli fiancs, a doestc 0Oil revenues (tr. NI - Average bonny light oil price (right axis) fuel consumption was growing at a faster rate than oil production. In addition, every time the naira depreciates, Sources:OAGECBN. the cost of subsidizing a nominal fixed price increases. The 2013 NER identified the fuel subsidy as the primary obstacle to rebuilding ECA reserves when oil prices were high. This edition of the NER reexamines these questions ( in light of Nigeria's experience over the past two years. 16 The analysis presented below underscores the enormity 14 14.0 of the current and projected costs of Nigeria's fuel subsidy. 12 11.2 10- . 8.5 In recent years oil revenues have steadily decreased 8 7.6 in both nominal terms and as a share of GDR While 6 44 oil prices remained strong through the fourth quarter 4 of 2014, an unexpected drop in oil output diminished 2 revenues already in 2011-2012 (Figure 2.3). A combination 0 of low prices and output is projected to reduce nominal 2010 2011 2012 2013 2014 2015proj revenues even further in 2015. The drop in oil revenues Sources:OAeF NBS. 17 Nigeria Economic Report Figurescandal and investigation in Nigeria. In 2012,an increase in (%the domestic fixed price on petrol from 6 to 97 naira per 16- liter, together with a crackdown on fraudulent imports, 16- 14- decreased the burden of the fuel subsidy. Due largely 14- 12- to the weakness in oil output, however, distributions to 10- budgets of oil revenues were more modest at 7.5 percent 8- of GDP, while the ECA balance increased to an estimated 6- US$8.7 billion by the end of the year. In 2013, a significant 4- fall in oil output required the use of US$6.5 billion dollars 2- from the ECA to maintain distributions at 7.1 percent 0- of GDP while meeting growing obligations for the fuel -2- subsidy and cash calls. In 2014, after the ECA balance fell -4- to only US$2 billion, the Government took the decision 2010 2011 2012 2013 2014 2015proj to stop drawing down the ECA to support distributions. 0 Net inflows to the ECA 0Distributions to budgets Distributions to budgets of oil revenues fell sharply to an 0 Fuel subsidy N Cash calls Soures:OAGF NB, Wold ank alclatirs.estimated 4.8 percent of GDP in 2014, and are expected at 2.1 percent of GDP in 2015. Since 2012, the burden of the subsidy on on the fuel subsidy is dictated by the difference between government finance has steadily increased, and is the world marketandfixed domestic naira prices on petrol now almost as great as in 2011. This can be seen in and kerosene, plus margins for profits and transportation Figure 2.6, which illustrates fuel subsidy obligations of costs. In Figure 2.5 and what follows, fuel subsidy the Federal Government as a share of oil revenues. The payments are listed on an accruals basis. Distributions of rising burden of the fuel subsidy can be associated with oil revenues to budgets were sometimes higher or lower the combination of falling oil revenues and increasing on a cash basis than illustrated in Figure 2.5 due to the domestic petrol demand. While the halving of the fuel accumulation or payoff of fuel subsidy arrears. Also, in this subsidy in 2012 broughtthe burden of related obligations, Chapter, "distributions to budgets" is defined loosely to the share of the fuel subsidy in Nigerian oil revenues include direct FAAC distributions to budgets and extra- has increased every year since. As in 2014, fuel subsidy budgetary funds, as well as SURE-P and other small final uses of oil revenues other than cash calls, fuel subsidy payments, and ECA accumulation. Distributions of oil revenues to budgets have ge.murmnt oil evenmI[u (% gradually eroded in recent years. In 2010, distributions 25- to budgets of oil revenues of 8.4 percent of GDP, as well 202 as cash calls and fuel subsidy payments, were supported 16 18 18 12-6 through drawing down US$5.5 billion dollars in reserves 15- 1 from the ECA. Higher oil prices in 2011 can be associated 13 12 1 with distributions to budgets of 8.9 percent of GDP 10-1 and even a small accumulation in the ECA. A very large increase in fuel subsidy payments to more than US$11 5- billion in 2011 prevented what would have been a much 0 more substantial augmentation of the ECA. This massive 2008 2009 2010 2011 2012 2013 2014 2015proj increase in fuel subsidy payments became the subject of Sources: OAGF, NBS, World Bank calculations. 18 Oil Revenues and the Fuel Subsidy obligations in 2015 are projected to amount to 18 percent Table 2.4: Projections macroeconomic of government oil revenues. indicators for scenario 1 Part of the reason that the burden of the fuel subsidy did not decline in 2015, despite much lower oil Bnig6 prices, was the decision in January to decrease the GDP Growth 3.5 4 5 6 administered naira price of petrol from 97 to 87 per Oil Output (m1 2.2 2.3 2.3 2.4 liter. The logic given for this decision at the time was that b/day) the world price of petrol had declined to the point where Naira Exchange Rate 195 205 207 210 the size of the fuel subsidy would become negligible, Infation (CPI) 9.5 8.5 8 7 and some of these benefits could therefore be passed on Source:World Bankstaff. to petrol consumers in Nigeria. But the naira was under downward pressure at the time,and its further depreciation due to the fall in oil prices was inevitable. Following the Scenario 1 is based on current projections for depreciation of the naira, as well as a partial strengthening the global oil market, and prices are expected to of oil and petrol prices, the expected burden of the fuel remain well below their recent historical averages subsidy once again rose to a level comparable to that through 2018. The average oil price is projected to of 2014. As of early July, 2015, the PPPRA determined an gradually increase to US$59 a barrel by 2018. The GDP estimated open market price of petrol at 138 naira a liter growth rate is expected to slow to 3.5 percent in 2015 and open market price for kerosene of 117.95 a liter, before rebounding to 6 percent by 2018 as the economy implying a subsidy of 51 and 68 naira for every liter of petrol adjusts to an environment of lower oil prices.The average and kerosene consumed, respectively. If these prices had interbank exchange rate is expected to rise from an been maintained for the rest of 2015, the burden of the fuel estimated 195 naira per US dollar in 2015 to 210 by 2018. subsidy would have grown to more than 20 percent of oil The CPI inflation rate is projected to ease from 9.5 percent revenues. In light of lower oil prices, the size of the subsidy in 2015 to 7 percent by 2018. fell to 15 and 56 naira a liter, respectively, by October. However, expected subsidy obligations in 2015 are still Under Scenario 1, the fuel subsidy and cash calls close to 800 billion naira. would increasingly crowd out distributions to budgets. In this scenario, Nigeria's GDP will continue to The analysis presented in this chapter includes grow faster than oil revenues; as a result, oil revenues will two prospective scenarios for oil revenues and the decline from 4.4 percent of GDP in 2015 to 3.7 percent by fuel subsidy. The following assumptions underpin both 2018 (Figure 2.7). Rising fuel consumption and a weaker scenarios: (i) gross government oil revenues will remain at naira will push the cost of fuel subsidies to a projected 50 percent of total oil revenues, consistent with the 2012- 35 percent of total oil revenues by 2018. Fuel subsidy 2014 average; (ii) cash calls will represent 1.3 percent of costs would actually exceed budget distributions of oil GDP, slightly lower than in recent years; (iii) domestic fuel revenues, as the latter would account for just 29 percent consumption will grow at the same rate as GDP; (iv) oil of oil revenues, or 1.1 percent of GDP. output will be 2.2 million barrels a day in 2015, rising to 2.3 million in 2016-17 and reaching 2.4 million in 2018; and (v) the current administrative prices of 87 and 50 ca i sre hcined in cntas rarily dujo n n- naira per liter of petrol and kerosene, respectively, will be as government revenues are typically greater under the latter. maintained over the projection period. Projected import The increasing use of modifed carry agreements, under which prices for petrol and kerosene are based on global oil- international oil companies finance part of the government's share of joint investments in return for future tax exemptions, price projections. For the sake of simplicity, both scenarios is also contributing to the decline in the government's share of assume no net change in the ECA. oil revenues. 19 Nigeria Economic Report Figure 2.7: The Size and distribution of oil Table 2.5: Projected macroeconomic indicators revenues, scenario 1 (% of GDP) for scenario 2 5.0- 4.5- Bonny Light Oil 56 65 75 90 4.0- Price 3.5- GDP Growth 3.5 45 6 7 3.0- 2.5- Oil Output (mn 2.2 2.3 2.3 2.4 2.0- b/day) 1.5- Naira Exchange 195 197 197 197 1.0- Rate 0.5- Inflation (CPI) 9.5 9 8.5 85 0 2015proj 2016proj 2017proj 2018proj Source: World Bank staff. Distributions to budgets E Fuel subsidy 0 Cash calls Sources: OAGF, NBS, World Bank calculations. essentially unchanged at 2 percent of GDP from 2015 to Under Scenario 1 the elimination of the fuel subsidy 2018.The fuel subsidy would consume the entire increase would enable budget distributions of oil revenues in oil revenues (relative to GDP) during the projection to be maintained at 2.4-3.0 percent of GDP period, reaching 36 percent of oil revenues by 2018. throughout the projection period. Postponing new More rapid GDP growth would cause the demand for oil investments could conceivably reduce the burden of petrol to increase at a faster pace, and higher oil export cash calls as well, though evaluating the implications of prices would imply higher petrol import prices. Under this this option is beyond the scope of the present analysis. scenario the elimination of the fuel subsidy would enable It is possible that a substantial share of recent cash calls budget distributions of oil revenues to increase from 2.1 have been devoted to servicing the NNPC's large debts to percent of GDP in 2015 to close to 4 percent by 2018. international oil companies. In conclusion, the recent decline in oil prices, Scenario 2 presents a more optimistic forecast, in together with increasing demand for petrol and which oil prices rise to US$90 per barrel by 2018, a weaker naira, have increased what were already and annual economic growth accelerates to 7 percent. In this scenario the naira would likely appreciate in real terms. The analysis assumes that central bank F 2 T s a d o oil would maintain the exchange rate at 197 naira per US r dollar and use the opportunity to rebuild the country's 6 foreign-exchange reserves, allowing the real appreciation to occur via inflation. Consequently, the inflation rate in Scenario 2 is higher than in Scenario 1. 4 Despite increasing oil revenues are a share of GDP in Scenario 2, the rising costs of the fuel subsidy 2 prevent a corresponding increase in distributions 1 to budgets. Under Scenario 2 oil revenues would 0 rise from a projected 4.4 percent of GDP in 2014 to 5.1 2015proj 2016proj 2017proj 2018proj percent in 2018 despite the more rapid pace of economic Distributionstobudgets NFuelsubsidy ECashcalls growth. Nevertheless, budget distributions would remain SourcesfOAGF, NBS,iWorld Bank calculatons. 20 Oil Revenues and the Fuel Subsidy enormous costs of the fuel subsidy on government increase due to higher world market petrol and kerosene finance in Nigeria. The fuel subsidy is projected to prices and the increase in domestic demand. reach a 18 percent of government oil revenues in 2015. Furthermore, maintaining the fuel subsidy at current fixed These projected costs of the fuel subsidy should be pump prices in the near future will cause its burden to weighed against its perceived benefits. As indicated steadily increase, reaching over 30 percent of projected above, the vast majority of the these benefits have been government oil revenues by 2018 under different captured by richer Nigerians as well as fuel importers and assumptions about oil prices and economic growth. In traders. In addition, the benefits that ordinary Nigerians the event that oil prices remain weak, the cost of the fuel were receiving from the fuel subsidy largely vanished by subsidy will increase due to depreciation of the naira and mid-2015, with the prices actually being paid for petrol higher fuel demand as the economy grows. In the case and kerosenein manypartsofthecountrybeingcloserto that oil prices rebound, the cost of the fuel subsidy will world market than regulated prices. 21  LU u U UNLOCKING THE POTENTIAL OF NIGERIA'S NATURAL GAS SECTOR Summary Nigeria's natural gas sector has enormous potential to boost the country's power supply, driving accelerated growth and diversification. However, attracting the billions of dollars of investment necessary to develop the sector will require a well-designed institutional and policy framework backed by a credible political commitment.The authorities will need to re-examine a range of critical issues, including the impact of obliging many gas producers to supply the bulk of the gas delivered to the domestic market at a single low price, continuing uncertainty about future gas prices and other critical parameters, the absence of contractual terms to commercialize gas in certain felds, and the pseudo-regulatory roles played by some market operators. In this context, realizing the vast potential of Nigeria's natural gas sector will demand a bold new strategy that includes the establishment of an independent regulator. Introduction Nigeria's natural gas reserves are the gth largest in the world,' yet the country suffers from chronic gas shortages. Most of Nigeria's electricity is generated by natural gas, and gas shortages have contributed to an inadequate power supply that slows economic growth and inhibits diversifcation (Figure 3.1). In the first nine months of 2015, Nigeria produced 7.8 billion cubic feet (bcf) of natural gas per day, of which 44 percent was exported and another 43 percent was used for purposes other than commercial sale,6 leaving just 13 percent, or about I bcf/day, for the domestic market. Moreover, only two-thirds of the natural gas supplied to the domestic market-or 9 percent of total gas production-was used for power generation (Figure 3.2). Even in the midst of serious disruptions to the gas supply in the first half of 2015, more gas was being flared than used to generate electricity.7 Although gas shortages have now subsided, meeting 5 Nigeria's natural gas reserves are estimated at 180 trillion cubic feet. 6 These include re-injection for enhanced oil recovery, flaring, and fueling other oil and gas operations. 7 A large proportion of natural gas is associated gas, which is a byproduct of oil production. Being far more prof- itable than gas, oil production is the main commercial interest. If gas prices are lower than costs of processing and transporting associated gas, it is more economic to flare (burn) than to commercialize it. While some flaring is unavoidable for safety and other technical reasons, it is possible to commercialize production of associated gas and eliminate routine flaring, enabling more productive use of the gas. 23 Nigeria Economic Report Figure 3.1: Megawatts of gas-constrained providethecapital necessarytodevelopit, provided generation capacity a set of fundamental conditions are met. The first condition is confidence that future revenue streams 3,000- from natural gas production will justify the large initial 2,500- investment costs. Building this confidence will require 2,000- setting credible expectations regarding the regulatory conditions under which producers will operate, including 1,500- market access, prices and payments terms. 1,000- 500 Successive administrations have been aware of the need to provide sound regulatory and commercial R of conditions for natural gas development, but a e i e i t progress made in modernizing the sector has 0 z - u 4 - < Stor eig.been limited. In 2008 the Government adopted the c eiNational Domestic Gas and Pricing Regulations (NDGPR), which were intended to provide an adequate return theGovernment's target set in the Roadmapfor Power Sector to gas suppliers while also ensuring low prices for the Reform of generating 40,000 megawatts (MW) of power by power sector. The NDGPR established the Department 2020-five times its current installed capacityfwill require of Gas (DoG), a regulatory body within the Ministry of a massive increase in the volume of gas sold to the power Petroleum Resources (MPR), to regulate the midstream sector. Securing a sufficient, sustainable and progressively and downstream natural gas sector and ensure equitable increasing supply of natural gas to fuel domestic power access to the country's network of gas pipelineshe DoG plants will require adequate commercial incentives for was authorized to issue Domestic Gas Supply Obligations producers and billions of dollars in additional investment, (DGSOs) in order to maintain an adequate gas supply mostly provided by the private sector. for the domestic market. The regulations also created a domestic gas aggregator to serve as an intermediary Fiur 32:Brakon f atra gs s i teibeie lminted. In 2008teGvenetadpe5h Invetorshav recgnied te hge ptenialf Nbtwen soestis and rs.Ocenga agegationstaDGRs, Nigeia'snatral as ecto an areprearedto whc domeiga aggrneatory proviea deutea single Fuel gas Powersuppe i al Fa Power 686 o Industry 341 4% eumestic morket 1,028 Nigeria LNG (NLNG) 2,963 West Africa Gas Pipeline 64 Reinject NILING Natural gas liquids (NGL)/LPG 234 29% 38% wscravos Gas to liquids (EGTL) 156 Exports 3,417 Reinjected 2,245 LFlared 748 % % Fuel gas 404 NGULPG INon-commercidt 341 4% 1 % Total 7,842 Source: Performance data at http://www.nnpcgroup.com. 24 Unlocking the Potential of Nigeria's Natural Gas Sector aggregate (unified) price, which is the average of all prices in the NNPC's Exploration and Production Directorate, paid by different consumers. is "charged with the responsibility of managing Nigeria Government's investment in the upstream sector of the An uncertain regulatory framework and the oil and gas industry"' and oversees upstream petroleum perception of inadequate transparency represent operations conducted via joint ventures, production- major obstacles to investment in Nigeria's natural sharing contracts (PSCs) and service contracts. The Gas gas sector. Sectoral regulations are incomplete, their Aggregation Company of Nigeria (GACN) was established terms are often unclear, and their implementation has before the DoG became operational and is jointly owned been inconsistent. Some institutions have been engaged by several major oil and gas companies.The GACN has not in both regulatory and commercial activities, giving rise yet begun aggregation because the requisite conditions to conflicts of interest. The prices that gas suppliers are for gas aggregation have not been met to date. allowed to charge on the domestic market are much lower than in many other countries, yet payment arrears Because the NNPC and GACN represent commercial continue to grow. The perception that supplying gas interests in the gas sector, the fact that they also to the domestic market will prove unprofitable for play pseudo-regulatory roles creates a conflict of an independent firm strongly discourages firms from interest. Before it was administratively restructured in entering the market. The main issues facing the gas August 2015, the NNPC's Gas and Power Directorate sector can be divided into five categories: (i) regulatory (GPD) had influenced the overall strategic orientation for institutions, (ii) regulatory uncertainty, (iii) incomplete Nigeria's natural gas sector. The involvement of the GPD regulations, (iv) pricing systems, and (v) payment systems. in policy-setting intensified investor concerns that the Security has also become an increasingly important issue institutional arrangements regulating the gas sector are in Nigeria's natural gas sector, but it is beyond the scope not transparent and that certain operators exercise undue of the present analysis. influence in the gas market. Natural Gas Sector Regulation in The process by which gas sector regulations are Nigeria implemented representsa major source of uncertainty for investors. Regulatory conditions are communicated The institutional framework for regulating the to gas producers through informal channels, and their natural gas sector is not well designed, unevenly enforcement is unpredictable. For example, the price of gas implemented and suffers from weak incentives, sold to the power sector was supposed to rise to US$2.0 While the DoG was intended to regulate the midstream per million British thermal units (mmBtu) in January 2015, and downstream elements of the gas sector, its purview yet gas producers are still not receiving this price, in has been far narrower in practice. The DoG did not part because the MPR has not yet provided the relevant become operational until 201f2, four years after the passage of the NDGPR. Its resources are inadequate to fulfill its mandate, and it has not played a meaningful Fiur 3.3 Ovrve of reuaor n regulatory role in the sector to date. Instead, the thatrgltr theycals Department of Petroleum Resources (DPR) in the MPR remains in charge of the day-to-day regulation of the MPR gas sector, while the Nigerian Gas Company (NGC),D subsidiary of NNPC, controls the pipelines through DoG DPR which most domestic gas is transported. The NGC alsoGPD sells gas and plays a pseudo-regulatory role, such as bya awarding franchises. The National Petroleum Investment Management Services (NAPIMS), a corporate service unit See the NAPIMS official website: www.napims.cm. 25 Nigeria Economic Report stakeholders with a formal written document defining the monopoly, pipelinetariffs must be regulatedjust liketariffs new price and start date. Tariff schedules and regulations for electricity, water or other network-based systems, for various categories of producers are rarely published, and regularly analyzed and revised as necessary. Clearly and in some cases they are not communicated to gas defined rules and regulations are required to facilitate suppliers in writing. Contrary to the spirit of the NDGPR, non-discriminatory third-party access to gas pipelines. pseudo-regulated sectors such as methanol and fertilizer Nigerian PSCs have no provision for commercializing gas, production have received prices far below those received despite the fact that 1.7 bcf/day of gas was produced in by producers supplying the power sector. areas governed by PSCs during the first nine months of 2015. In principle, provisions for the commercialization Some regulations have been more aspirational than of gas are included in supplementary agreements, but in feasible. The DGSOs require all licensed producers to practice no such agreements have been signed for more supply a certain amount of gas to the domestic market. than two decades. The absence of key regulations in Although regulations require that they be issued every these and other areas implicitly grants broad discretionary year, DGSOs have reportedly been issued only twice powers to the MPR, NNPC and NGC, further discouraging since 2008. Moreover, they are not disclosed to the private investment. public, and the basis for volume assignments is unclear. Aggregate targets for DGSOs have been set at very high Nigeria's natural gas pricing policies have levels. According to NNPC statistics about I bcf per day consistentlysetpricestoolowtoprovideasufficient of gas was delivered to the domestic market during the return on investment. The NDGPR established a floor first nine months of 2015, yet the volumes mandated by price for natural gas supplied to the power sector at just DGSOs reportedly total almost seven times the actual US$0.10/mmBtu, roughly one-thirtieth of the average delivery. Gas flaring regulations have suffered from similar world market price in the late 2000s. The NDGPR based weaknesses, and the deadline for banning routine flaring this policy in part on the idea that'gas liquids,"a byproduct has been repeatedly postponed. of natural gas production, generate a sufficient return on their own to largely finance gas projects. The decision in Clarity is needed for some regulations and late 2014 to increase the regulated price paid by power regulatory actions. There is substantial disagreement producers from US$1.50 to US$2.50/mmBtu as of January over the official penalty for gas flaring-the government 2015 was an important step, but 11 months later the has stated that the penalty has been raised to US$3.50 per power sector continues to pay only US$1.50/mmBtu. The thousand cubic feet (mcf), while industry representatives pseudo-regulated prices set for other gas consumers are report that the official penalty is still 10 naira (US$0.05) per even lower than those paid by the power sector, in some mcf. License renewal is another source of uncertainty, and cases as little as half. Thus potential investors in the gas licenses have been known to lapse for several years before sector not only face substantial uncertainty about their renewal is finallygranted.Theconditionsfor pipeline access obligations to supply the domestic market, but also have are also unclear. The lack of well-defined, transparent and reason to expect that controlled prices for domestic sales predictably enforced regulations in these and other areas may be too low to cover their costs. Against the backdrop seriously inhibits investment in the sector. Ending routine of serious gas shortages, gas purchasers entitled to low gas flaring is a priority, but accomplishing it will benefit government-controlled prices have increasingly turned the domestic market only if there is an effective policy for to market-based arrangements, in which they pay more commercializing gas-otherwise, producers who reduce in return for supply security. flaring may cut back on production elsewhere to maintain the same volume of supply to the domestic market. The government's attempts to keep gas prices artifi- cially low through regulatory intervention are slow- In some areas critical regulations are either missing ing the growth and diversification of the Nigerian or incomplete. Because gas transportation is a natural economy by discouraging energy efficiency, inflat- 26 Unlocking the Potential of Nigeria's Natural Gas Sector Figure synergy between the natural gas and power sectors, the financial health of the latter has important implications for the former. Because the marginal cost of electricity generation falls with increasing scale, an inadequate and unreliable gas supply can create a vicious circle in which electricity plants producing below capacity become increasingly unable to cover the cost of their gas purchases. The possibility of non-payment is an obvious singldisincentive to investment in the gas sector, and the Government's 2010 Roadmap for Power Sector Reform is t powintended to help ensure that electric utilities pay their gas suppliers on time and in full. However, its implementation is taking longer than planned, and a power-tariff policy Note:NERC=NigeranElectrictyRegulatoryCommission.Theleftcolumn reversal in March may even have increased debts to gas describes the gas supply chain under the DGS. The regulated price for the power sector is subject to MPR and NERC approva while the pseudo- suppliers in 2015. regulated price is subject to MPR approva aone. Once gas aggregation starts, the A N gs to compute the average prices paid, determine the t single aggregate prce, and pay gas se lers accordingly. Outsde of the DGSO, gas selers are free to pursue market-based prices, but gas sold to power generation companies s stil mpcity subject to NERC tariff Developing the natural gas sector and leveraging approval, its potential to meet the growing energy demands of the Nigerian economy will require policymaakers to address and resolve numerous weaknesses in the ing demand and aggravating supply shortages. The sector's institutional and regulatory framework. The thermal efficiency of "open-cycle"gas power generation is Government's overarching goal should be to clearly signal about 20 percentage points lower than "combined-cycle" its resolve to build a stable and transparent administrative generation. However, combined-cycle generation is also environment that can reasonably ensure a fair, market- more expensive to install, and its use can be justified based return on investment. Given the deep and far- only if the savings from reducing gas consumption are reaching nature of the necessary reforms, the Government sufficiently large to offset the higher capital investment could giveserious consideration to establishingataskforce required. In other words, the higher the price of gas, the comprising recognized experts with in-depth knowledge greater the incentive to invest in more expensive but ef- of the Nigerian gas sector to formulate an appropriately ficient generation technology. Running every gas-based comprehensive strategy. The MPR in particular requires power plant in Nigeria would require a total of about 1.7 specialized expertise in gas sector policy, data collection bcf/day of gas at the thermal efficiency of open-cycle and market analysis. The current administration has technology, while shifting to combined-cycle generation demonstrated a credible commitment to reforming the would require less than 1.1 bcf/pay. The latter is broadly sector, and the NNPC recently identified 20"fixes" (priority the amount of gas supplied to the domestic market in action areas), providingahistori opportunityto decisively 201G. reform the gas sector and unlock its economic potential. Artificially low gas prices are compounded by It may be more effective to treat oil and gas payment delays. This issue is particularly acute in the separately in the legislation governing the power sector, which accounts for two-thirds of domestic midstream and downstream components. In the gas consumption. The generally weak financial state of past, combining oil and natural gas legislation led to Nigeria's power utilities prevents the use of enforceable inadequate attention being devoted to the natural gas sales contracts in the power sector. Given the clear gas sector. Oil and gas should be addressed jointly in 27 Nigeria Economic Report the legislation governing the upstream elements of promote investor confidence. Comprehensive regulations the sector, but it is not necessary to do so elsewhere. governing the pipeline network would help to ensure The concern about inadequate attention paid to the non-discriminatory third-party access. Supplementary gas sector can be addressed by passing a separate bill agreements to enable the commercialization of gas regulating the midstream and downstream components in PSCs are also a key priority. In the absence of formal of the gas sector. The drafting of the 2005 Downstream agreements, production-sharing contractors are implicitly Gas Bill, which was not passed, has laid some analytical being asked to deliver gas free of charge to the NNPC. groundwork for future legislation. One way of not delaying this important measure would he to treat gas terms in PSCs separately from any revision Establishing a separate regulatory agency for of oil terms. the midstream and downstream gas sector with commissioners appointed by an independent Prices for domestic gas suppliers must be sufficient supervisory board could increase transparency to cover costs and justify major commercial and accountability. This regulatory agency could be investments. Gas-pricing reform should re-examine formed as a separate institution or conceived as an both the regulated and pseudo-regulated prices. There expanded role for NERC. As long as NERC is careful to is no rationale for keeping gas prices for some industries avoid focusing narrowly on supplying gas for power as low as US$1/mmBtu, nor should those industries be generation, expanding its mandate to cover midstream subsidized at the expense of gas producers or buyers and downstream regulation has several advantages. in other industries. Costs of gas development vary Expanding the scope of NERC would take much less substantially from one field to another and the regulation time than setting up a new regulatory agency, and NERC of prices prevents the development of certain types of already possesses an extensive knowledge of the power gas field.' Contrary to the assumption embedded in the sector that could form the basis for setting appropriate current policy, the sale of gas liquids is not sufficient to price levels for natural gas supplied for electricity meet the cost of most non-associated gas production, generation, which is the dominant domestic consumer especially in a context of low global prices. Domestic gas of gas. In addition, the NGC should cease to perform its prices are effectively capped at export-parity levels, which current quasi-regulatory role and be divided into a gas are much lower than in the past due to the abundant transmission company and a separate gas distribution supply of liquefied natural gas on the global market. Prices company. Unbundling of the NGC is one of the 20 priority in the power sector are implicitly limited by electricity action areas identified by the NNPC. tariffs, which are subject to NERC approvalTogether, these factors present a compelling case for shifting to a more Official schedules and guidelines for tariffs, DGSOs, market-oriented pricing structure. penalties for gas flaring, and other important parameters should be published in a clear and Making fiscal terms robust to be able to cope transparent manner. The authorities will also need with wide fluctuations in costs and prices is also to allay investor concerns regarding the process and important. The return on investment is determined methodology by which future tariffs, penalties, and largely by costs, prices and fiscal terms. One option is to DGSOs will be determined. Gas transmission tariffs should base fiscal terms on a measure of profitability, thereby be subject to economic regulation, and a financial model automatically adjusting government take as a function of underpinning proposed tariff increases should be made changes in project costs, prices and volumeThis makes the available for review, as it is in the power sector. License- renewal processes should be streamlined, clarified and accompanied by a specific deadline for the government's Lean gas, non-associated gas, and deepwater gas are gener- ally more costly to develop and produce. The regulated price of response. Finally, building a reputation for implementing US$2.50/mmBtu is likely to he too low to make most non-associ- regulations consistently and impartially will be critical to ated gas commercially viable. 28 Unlocking the Potential of Nigeria's Natural Gas Sector fiscal rules more predictable and transparent, because it Finally, the government could reconsider costs and substantially reduces the need to make adjustments to the benefits of gas aggregation and aggregate pricing. rules when economic conditions change, such as a sharp After more than five years, gas aggregation has not yet drop or increase in world gas prices. Prospective revisions started, while one of the policy's initial goals-to increase of fiscal terms and gas prices should be tested in a range demand for gas on the domestic market-has already of economic scenarios, and the resulting calculations and largely been achieved. Moreover, averaging consumer their underlying assumptions should be shared with key prices into a single aggregate price would present stakeholders to enable an open and informed debate. a further disincentive to investors, except those selling gas at low prices. To date, the GACN's primary role has Special measures are needed to ensure that gas been to carry out due diligence and match sellers and producers supplying the power sector are paid purchasers. However, payment risk has remained a serious promptly and in full. Nigeria's bulk power trader was problem, stalling gas sales agreements, preventing established in part to address the large arrears owed by would-be sellers from moving on to other buyers, and power producers and ensure timely payments to gas leaving commercially viable gas stranded. Promoting suppliers. However, thus far the bulk power trader has not a more decentralized contracting system under which been able to reduce these arrears, because many power gas suppliers could freely choose to service reliable producers cannot cover their costs.The full implementation consumers and cease supplying unreliable ones would of the Roadmap for Power Sector Reform, and especially its strengthen payment discipline. Table 3.1 summarizes tariff-reform provisions, will be vital to improve the financial these and other recommendations for reforming Nigeria's health of both the power and gas sectors. natural gas sector. An adequate institutional and Failure of gas aggregation Reconsider continuation of gas Discontinue gas aggregation policy framework capable aggregation and terminate if of supporting robust private deemed no longer suitable investment Absence of clear, predictable, Formally issue new gas prices Shift to market-based sales and transparent pricing policy with effective dates and post agreements them on a government website Provide financial justification Conduct regular tariff reviews for increases in pipeline transportation tariffs Lack of transparency in DGSO Explain the basis for the 2014 Establish realistic medium- assignment DGSO assignments and long-term targets in Include gas sold under market consultation with stakeholders conditions in DGSCs Decoupie from gas aggregation Absence of network code Conduct consultations with key Adopt and implement network stakeholders code A strong legal, fiscal, and Uncertainty about future fiscal Test fiscal terms against a range Adopt fiscal terms that contractual framework terms of prices and costs to ensure ensure reasonable returns to that the fiscal regime is robust investment to price and cost volatility Gas legislation subsumed Begin consultations on a new Adopt and implement an act for in petroleum legislation bill dedicated to mid- and midstream and downstream gas dominated by oil focus downstream gas (conrinued on nexrpoge) 29 Nigeria Economic Report Table 3.1: Recommendations for gas sector reform (continued) A strong lega, fiscal, and Absence of supplementary Issue supplementary Define fiscal terms for gas contractual framework agreements for PSCs agreements produced in b ocks governed (continued) by PSCs Time y renewa of expiring Keep track of expiring icenses licenses and undertake timely decisions Independent regulation of the Pseudo-regulatory roles played NNPC and NGC to cease NNPC and NGC to be confined gas sector by NNPC and NGC assuming pseudo-regulatory to commercial operations only roles Overlapping responsibilities Begin setting up an Establish and strengthen the between DoG and DPR independent gas regulator regulator An inter-institutional division of NGC acting as a gas marketer Accelerate work on network Fundamenta restructuring responsibilities that minimizes and transporter code of NGC, including vertical the potential for conflicts of unbundling interest Directions for gas sector NNPC to stop setting directions MPR to set policy and directions frequently set by NNPC on behalf of MPR GACN owned by major gas See the above on recommendations on aggregation producers Reasonable assurance of an Significant payment arrears for Enforce gas sales agreements Electricity bulk trader to pay on adequate rate of return on gas in the power sector time for all gas purchases investment Predictability, effective implementation, fiscal terms that enable reasonable returns for efficient operators, as covered above The analysis for this chapter was financed in part by the Energy Sector Management Assistance Program (ESMAP). 30 WORLD BANK GROUP 1818 H Street, NW Washington, DC 20433