The Petroleum Industry Act 2021 (PIA) attempts, quite objectively, to the amorphousness in the regulatory and governance institutions in Nigeria. It establishes three governance institutional framework to anchor the provisions in the Act, which are germane to promoting efficiency, effectiveness, and equity among stakeholders. In addition, the PIA 2021 established a framework to restructure and refocus the national petroleum company towards a viable commercial entity to achieve profit optimization objectives. The Act also mandated the creation of a host communities development fund to assuage communities impacted by petroleum industry operations along the petroleum value chain. It provided an effective and progressive fiscal system to attract investments to engender new reserves addition and ultimately makes the industry internationally competitive. An important PIA 2021 core objective is safeguarding the mutual benefits of oil and gas extraction to all stakeholders, including effective funding of the federation budgets, optimally.
The proportion of the aggregate annual budgets of the Federal Government of Nigeria accounted by petroleum revenue is still significant, although, a lot less than it used to be. The decline is not necessarily because of any meaningful diversification of the Nigeria economy, but perhaps, because of a shrinking petroleum revenue base and expanding loan profile to fund the budget in the more recent years. This op-ed presents matters arising from PIA 2021 regarding government access to petroleum revenue. The op-ed aims to provide good understanding of how a couple of the mandated obligations in PIA 2021 may affect government access to petroleum revenue. The first obligation of critical importance is the business structure of NNPC Limited. The second and third obligations, respectively, are the royalty schemes by value, volume and terrain, and the dual tax system structure. Finally, and also of significance is the impact of host community development fund in the PIA on the government access to petroleum revenue.
2.0 – BUSINESS AND GOVERNANCE STRUCTURE OF NNPC LIMITED
Accordingly, NNPC Limited is created in the PIA to operate as a commercial company with capitalization and shares traded in any stock exchange market within recognized jurisdictions. This presupposes a big change in the business structure of the present NNPC who dabbles quite regularly into commercial, regulatory and policy activities, without hesitancy. The old business operating strategy to maximize public goals for the government (Federal Government mostly) is mandated by the PIA to shift to a new business strategy. The new strategy is to maximize profit for optimal returns on investment for its stakeholders in an efficient manner without recourse to government fund. It has an obligation to operate assets responsibly and commercially, and responsible for the management of investments in all industry businesses by the government of the federation.
Further, NNPC Limited has the responsibility to lift and sell royalty oil, tax oil, and profit oil on behalf of the Commission, the Service, and the Federation, respectively. Interestingly, PIA 2021 empowers NNPC Limited to manage the 30% of Profit Hydrocarbon escrowed for frontier exploration fund. This particular provision is at odd with the commerciality objective as stated in the PIA and has generated a lot of discussions in terms of the constitutionality and the appropriateness of the provision. Legislating how a liability company must disburse its earnings seems quite worrisome. That notwithstanding, even if it is lawful, is it expedient? Investing 30 percent of an aspect of federation fund as a line-item budget of a liability company for exploration in frontier basins. It also seems at odd with the risk attitude and profile of a risk averse investor, like the government of Nigeria, which has competing usage of limited fund.
Having become commercial, even though owned and managed by supposedly apolitical board, NNPC Limited seizes to be a resource of last resorts to the federal government in times of financial distress, if the NNPC Board works as expected. Thus, in the short to medium term, NNPC Limited can no longer transfer earn dividends from its assets to the federation account as at when needed, without following the due process. It is important to not as well, that even though it seems to be less significant now, the 30 % of NNPC Limited PSC profit petroleum assets might become a significant hemorrhage to the federation account as IOC investments begin to shift away from onshore and shallow-water terrains to offshore terrain. It is, thus, more likely than not, that NNPC Limited provision in the long run have diminishing implications on petroleum revenue flow to the federation account and by extension the budgets of it component units.
3.0 – ROYALTY DESIGN AND IMPLICATIONS
Certainly, the consequences COVID 19 pandemic and pronouncements coming out of developed economies seem to signal an apparent premature prediction of the end of the crude oil era, making the PIA fiscal terms overtly generous for investments. In an overall sense, PIA 2021, having established three vitally strong institutions to support fiscal competitiveness and attractiveness goal of the reform process, enhances good public policy perception of industry governance in Nigeria. As a result, it is expected that revenue base would be widened, in the not too distance future, because of new investments into the oil and gas sector. The only caveat is the dominant influence of political expediency as against the drive for institutional efficacy, competence, and efficiency.
In the short to medium term, diminishing petroleum revenue flow into the federation account is inevitable. This is plausibly so because, the royalty scheme is deliberately skewed in favour of investors. The scheme is also unwisely designed with favourable disposition towards existing Deepwater PSC arrangements. Consequently, lessening the potential flow of the quantum of petroleum revenue flow from the PIA mandated deep-water royalty to federation account. Table 1 and Figure 1 illustrate the points squarely.
Table 1: Comparison of Royalty Terms and Instruments
Figure 2 illustrates graphically, the impact of limiting the tranches to only two instead of three with production demarcation at 50 MBbl per day instead of 100 MBbl per day. Thus, a deep-water asset producing aggregate 400, 000 barrels per day across the water depth terrains in the aggregate will pay less royalty in the short run. Yes, royalty as a rent instrument is regressive but a consistent design can lessen repressiveness to improve equitable rent distribution. The inconsistency in tranche design impacted federation revenue much more than necessary (Figure 3).
Figure 2: Royalty Payments
Figure 3: Sliding Scale Royalty Design in PIA 2021
It is evident from Figure 3 that Onshore and Shallow-water terrains have three royalty tranches, while deep offshore terrain has just two tranches. The justification for this truncated design is untenable. The only plausible argument from my point of view is to minimise narrative perception that deep-water royalty rate has climbed too high from 0 to 10 percent, if the design had included the third tranche above 100MBbble with 10% royalty as was the case in PIFB 2012. Yes indeed, the effective royalty rates for deep offshore PSC assets have gone up from zero to a maximum of 7.5%. And as mentioned earlier, the government in the process undercut its revenue interests by capping the tranches at two and limiting the scaling by daily production to 50, 000 barrels per day instead of three ranches with ten percent royalty cap beyond 100,000 barrels per day. This is a design error that reduces government access to revenue, significantly, in the short run. The cumulative short falls may be difficult to remedy, in the long run, if investment flow does not respond to this government generosity to expand production. Interestingly too, the same argument was invoked to exclude deep water assets from hydrocarbon resource extraction tax or what is traditionally called severance tax in the United States.
Additionally, the royalty scheme in the PIA has become less regressive in onshore and shallow water terrains in the Niger Delta. This is also good news to incoming investors. The effective royalty rate, a proportion of gross revenue or gross production payable to federation account, is significantly lower than the flat 20% before PIA for onshore and shallow terrains at maximum unattainable values of 15 and 12.5 percent, respectively. Figure 4 illustrates the apparent and immediate impact PIA royalty scheme in onshore and shallow water royalty revenue in the short to medium terms.
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Figure 4: Comparative Impact of Onshore and Shallow Water Royalty by Volume.
Indeed, access to government revenue through royalty has reduced significantly, by more than 50% according to this preliminary analysis. Unfortunately, the optimism to expand production from these terrains, because of this less regressive royalty design, is dampened by speculative IOC divestment announcements. Also bothersome is the technical competency and effectiveness of the likely players in these terrains to rekindle the productivity required to, in the long run enhance royalty revenue through expanding production capacity. Additionally, if one might speculate, it may take a while and perhaps a little bit difficulty for the Commission, which has been designated to collect royalty in kind or cash for the government, to step up the plate and deal decisively with fresh-from-the oven investors in these terrains.
4.0 – THE DUAL TAXATION MECHNISM AND ITS IMPACT ON FEDERATION
The upstream petroleum businesses in Nigeria paid only petroleum profit tax, majorly, over the years, since 1959 to be precise. PIA 2021 mandated a full departure from the single taxation mechanism along the petroleum industry value chain. Of course, the adoption of the dual tax system, resource tax and corporate income tax, has its merit and demerits. The purpose of this section the op-ed is to discuss the implications of the dual-tax system on the Federation access to petroleum revenue.
In the short run, certainly, the dual tax system will more likely than not reduce petroleum contributions to the federation budgets-feral, states, and local. First the design of the dual taxation mechanism is as generous to the investors as the royalty schemes, purposely to attract investments to explore for fresh deep-water assets, develop and produce existing assets under these new fiscal terms. In a way the government seems to be less risk averse in its quest for revenue extraction from oil and gas development with this latest strategic choice for the more progressive profit oriented rent extraction mechanism. Thus, the effective tax rate in the PIA is lower than the traditional PPT, decreasing from a flat rate of 50% to a maximum of 30%, subject to voluntary assets conversion. This low effective tax rate makes the PIA fiscal framework attractive and competitive with potential to grow the petroleum business and expand the revenue base directly and indirectly in the long run. Of course, the caveat, things must be done right and in the right way in the governance of the sector.
Secondly, as laudable as the dual tax system may be, with respect to investment attractiveness, it is astonishing if not bothersome that deep-water-assets are exempted from the hydrocarbon resource tax, perpetually. No dusk is mandated to end this exemption in the PIA. The government in my opinion, bent too backward in exempting deep-water terrain from hydrocarbon resource tax. Of course, exempting gas development from hydrocarbon resource tax without a sunset is also worrisome in the long run. Frankly, this reminds me of the generous PSC 1993 terms that only ended in 2019 with significant costs and fiscal burden.
Further, the effective tax rates, for hydrocarbon assets in the shallow offshore and onshore terrains are also significantly reduced in the PIA from a maximum of 85% to a combination of 20% hydrocarbon tax and 30% corporate income tax rates. Interestingly, these are mostly JV assets that are under divestment threat. Unfortunately, empirical evidence suggests that the potential buyers of these assets have higher propensity for tax avoidance than the previous JV parners (See Figure 5).
Figure 5: PIA Resource Tax Scheme by Terrain
Finally, let me conclude with this great optimism despite the diminishing revenue outlook in the short and medium run as narrated above. PIA offers great potential to expand the economic outlook for Nigeria through a vibrant oil and gas sector as the ultimate engine to its economic diversification objective. Yes, there is the renewable energy transition dynamics to manage, and PIA took cognizance of the transition. The Act defines fiscal terms for gas development, recognizing the fact that natural gas is the globally acceptable transition fuel. Thus, PIA targeted gas for domestic economic expansion and if that works, the federation tax revenue base is more likely than not to expand, in the long run.
Fortunately, as I mentioned earlier, the PIA tends to recognize the importance of governance and regulatory institutions to enable business and investment environment in Nigeria to unlock its abundant gas. Political expediency in the management of these PIA institutions is not the way to go if the inevitable reduction in petroleum revenue in the short to medium terms is to be reversed in the long run. Effective, efficient, and equitable governance of the three PIA institutions is key to realizing the overall potential of PIA to unlock the abundant petroleum and human resources endowment in Nigeria. Efficiency means doing things right, effectiveness means doing the right thing, and equity means not leaving competency for incompetency because of political expediency.
Wumi Iledare, Professor Emeritus in Petroleum Economics, UCC Oil and Gas Studies, Ghana & Executive Director, Emmanuel Egbogah Foundation, Nigeria