Fashola - Let There Be Light: Why the Energy Sector’s Gas Based Strategy Can Cost Nigeria About $60 Billion in Economic Growth (A Response To Minister Fashola)
In an earlier article, I identified three fundamental problems with the Nigerian power sector and proposed some solutions for resolving the challenges. These were: (i) eliminating the vulnerability of electricity generation to gas pipeline sabotage by developing liquefied natural gas (LNG) capacity (ii) localizing some aspects of power generation and supply and (iii) ensuring the complete integration of major players in the N 1 trillion self-generated power market into the new power sector economy. The details for each proffered solution can be read in more detail in the initial article.
Sadly, the events of the last two months since I published that article on March 13th have further confirmed the concerns I expressed about the vulnerabilities of our exclusive gas based power strategy. On March 31st, Nigeria experienced its first ever zero power generation event, attributed largely to the vandalization of gas pipelines. In the month of April, a new militant group called the Niger Delta Avenger announced their presence with a series of ruthlessly efficient acts of sabotage on oil & gas pipelines. The need for urgency in developing a LNG strategy to guarantee natural gas supplies to Nigeria’s power plants is even more pressing.
Fashola’s Criticism of the Three (3) Proposed Solutions for Nigeria’s Power Sector Challenges
I was recently made aware of an article published in the Vanguard edition of April 13th, 2016 titled “Electricity: The Price Nigerians Must Pay.” It was a public information piece authored by the Minister for Power, Raji Fashola.
In that article, the Minister gave his views on the root causes of the challenges in the power sector and closed out by addressing the reasons why he believed some of the solutions I had recommended for getting Nigeria out of the challenges it was facing with power, were not workable.
Ultimately, the thrust of the Minister’s counter to my suggestions came down to the economics of power generation, transmission and distribution. He argued that if Nigerians were complaining about the recent 45% tariff hike, any solutions that increased cost in any part of the power value chain (e.g., using LNG instead of simply relying on pipeline-delivered gas), would not be viable.
I agree with the Minister that any solution must be evaluated strictly on the basis of its economic viability. I will demonstrate using a systemic macroeconomic analysis – viewed at the level of the national economy – that rather than adding cost, guaranteeing stable power supply using a LNG based gas supply option will actually help grow the Nigerian economy.
The Impact of Pipeline Vandalization on Power Sector Stakeholders
To fully understand the enormity of the challenges that Nigeria faces from disruptions to gas supply to power plants due to vandalization, we must quantify three things – (i) the frequency with which incidents of pipeline vandalization occur (ii) the impact of vandalization on the operations of the power sector and (ii) the opportunity cost of gas supply disruptions.
The frequency of pipeline disruptions: Industry estimates indicate that product deferments due to pipeline vandalism in Nigeria occur for an estimated period of 100 days per year. Another estimate indicated that about 60 pipeline incidents had been reported from January through May of 2015 – an average of 12 disruptions per month, or one every 2-3 days. Repairs for simple leaks on a pipeline can take as many as 10 days.
More substantial damage that affects the structural integrity of pipelines takes much longer to repair. The available data indicates that pipeline sabotage in Nigeria can keep pipelines offline for as much as 27% of the time (100 days divided by 365 days per year).
The operational impact of disruptions: Pipeline gas cannot be stored, unless liquefaction and cryogenic storage facilities are available at the use point. Nigerian power plants do not have onsite LNG storage facilities. This means that once a gas pipeline is offline, every power plant downstream of that facility can no longer function. The operational impact of gas line disruptions on the ability of power plants to generate electricity is, therefore, total. With any pipeline vandalization event, gas suppliers will no longer have a product to sell, GENCOs will have no product to use for generating power, and DISCOs will have no power to distribute to the end user.
Cost of pipeline disruptions: Earlier this year, Mr. Fashola provided a clear picture of the costs of pipeline vandalization to the power sector value chain using the Escravos Lagos Pipeline System as an example. The pipeline which supplies 160 million standard cubic feet per day of Gas to power generating plants, used for generating about 660 MW of power was vandalized by Niger Delta militants. According to the Minister, N470 million was lost to power sector stakeholders for every day that the pipeline was offline. These losses are comprised of about N80 million per day in lost gas sales, and N390 million per day in lost revenues to the generation and distribution companies. These costs amount to $14/MMBTU or $0.15/kWh (N30/kWh). This does not include about N120 million estimated for the repairs of the pipeline for that single attack.
The Macroeconomic Impact of Power Sector Policies – The $4.3/kWh (N861/kWh) Economic Benefit
When the GDP and Power consumption of various nations is plotted on a graph, the result is a largely linear relationship, with a constant of about $4.3/kWh. What is the significance of this relationship? It means that every kWh of consumed power generates about $4.3 (or N861 at a N200/$ exchange rate) in gross domestic products (GDP) on average. It means that every time a sabotaged gas pipeline causes power not to get to the end user, the cost to Nigeria is not the N30/kWh that stakeholders lose because they cannot sell or use gas to generate power – but about N861/kWh in GDP that is lost. The direct stakeholder losses come to only 3.4% of the systemic macroeconomic losses.
Nigeria’s actual ratio of GDP per kWh is higher – at over $9/kWh. Nigeria, like other resource rich countries, has some economic output that is not tied to labor productivity of its citizens, e.g., oil & gas revenues. For the sake of this analysis, we will utilize the more conservative global average value of $4.3/kWh as the economic benefit derived from available power as the basis for our evaluation of an optimal fuel diversification strategy for Nigeria.
Source: GAIN Research based on World Bank Data
Why do governments build roads or invest in newer and more efficient rail systems? Why do states subsidize fertilizer costs to farmers or provide free healthcare and education to their citizens? At the core of such actions is the belief that the long-term impact of these policy positions provides systemic macroeconomic benefits that far outweigh the short-term costs of implementing the policies.
Good roads imply that goods and people can flow freely – enhancing trade and assuring the safety of individuals and products. Free education tends to ensure that a nation’s citizens are well-educated and better equipped for productive engagement in the economy. Free healthcare services enhance the life and productivity of citizens – farmers can till the land, and workers can provide long productive hours in their workplaces. The resulting effect is growth – economic development.
While there can be debates about how to measure the real impact of policies like having good roads, or providing free education, there is a very clear and consistent impact of energy on macroeconomic growth that comes to approximately $4.3 of economic output for every kWh of energy consumed in an average economy. We must note that this value is actually a conservative one to use for Nigeria.
This implies that every time that we allow a vandalized pipeline to prevent the generation of power, the systemic cost to Nigeria is not just the $0.15 / kWh that is lost because the gas provider cannot sell their gas, the GENCO company cannot generate power and the DISCO cannot get revenues for providing energy to homes and offices. The economy – energy graph suggests that the power system stakeholder costs only come to about 3.4% of the overall economic costs (i.e., $0.15 cents per kWh of energy generation and distribution costs divided by $4.3/kWh of systemic economic benefits). This means Nigeria loses about $100 Billion of economic growth for every 1,000 MW of power kept offline annually due to pipeline vandalization.
Here is the intuition: when power is available, labor and capital productivity is higher. The saw mill can use their electrical chain saws for splitting wood and shaving off bark to make plywood. The hospital can process more patients. The restaurateur can power their refrigerator, grinder and oven with electricity rather than producing power using a more costly diesel based generator. The student can be better prepared for class. The automobile mechanic can place batteries on an electric charger. The printing company can churn out more books using a relatively cheaper power source. Even if the revenues of businesses stayed the same, gas based power generation will lead to a reduction in energy related costs, leading to higher profits. With higher profits comes more disposable income, and the “excess” funds can be turned towards economy growing ventures like building homes, buying clothes, eating out, traveling, purchasing home appliances – all of them vital means for growing an economy.
Comparative Costs of Different Power Generation Fuel Sources
Different fuels (e.g., Diesel, LNG, Natural Gas, etc.) can be used to power electricity generation systems. In order to bring all these disparate fuels to a common basis, the industry uses the thermal energy content pf the fuels as a baseline for reporting fuel costs. The preferred unit of measure is $ per million British Thermal Units (MMBTU). Each fuel type has a BTU to kWh conversion ratio that allows the determination of the $/kWh generation cost from the $/BTU cost.
Table 1 summarizes the electricity generation costs for the three major fuels used for power generation in Nigeria – Diesel, Natural Gas and Liquefied Natural Gas.
Natural gas requires pipelines for its transportation. Gas is placed in the pipeline at a source point, and transported under pressure in the pipelines to its final destination – usually a power plant. Globally, pipelines cost about $1 – 2 million per km to construct. In Nigeria, pipeline construction costs tend to be much higher. In the last 10 years, pipeline construction costs in Nigeria range from about $1.3 million per km for the completed underwater 20-inch West African Gas Pipeline that runs from Nigeria to Ghana; to $5.8 million per km for the 48 inch East West Line and $18 million per km for the 24 inch Northern Option Pipeline (NOPL). Both the East - West and NOPL lines are still under construction.
LNG and Diesel are liquid fuels and typically do not require pipelines for their transportation. They are mainly transported via trailers on trucks, or rail cars. They are not vulnerable to pipeline vandalism and are therefore important to consider when developing strategies for mitigating the impact of vandalism on power generation.
LNG is generated by compressing natural gas until it becomes a liquid. The liquid formed is about six hundred times smaller in volume than the gas itself (so 600 m3 of natural gas becomes about 1 m3 of LNG). At the point of use, the LNG has to be converted back to gaseous form before it can be utilized. This requires onsite storage and regasification capacity.
For the analysis, it is assumed that power generators relying on Diesel and LNG are online all the time (100%), while gas based generators are online 90% of the time. Based on the scant available data, the online period for gas pipelines are likely only about 70%. The estimated costs relate only to fuel & related handling costs, and do not include labor and interest charges for the assets. Transmission and distribution costs will be the same for all the options – so those are not listed in the analysis.
Table 1: Summary of Power Generation Cost Implications for Different Fuels. Value chain costs consider losses to industry stakeholders in addition to fuel costs, while total economic costs factor in system-wide, macroeconomic losses
Key Observations from the Analysis
Diesel is not a viable alternative: At an assumed price of about N174 per liter, diesel-based power generation costs about N52/kWh. With average tariffs currently being in the range of about N24/kWh, a diesel based option is not a cost effective alternative. Diesel is also almost exclusively imported, and reliance on diesel will exacerbate an already strained forex regime.
Natural Gas is a great option for Nigeria: At a cost of $2.5/MMBTU, power generation costs with natural gas come to about N6.6/kWh. Nigeria has vast reserves of natural gas, as well as significant gas production and liquefaction capacity. This analysis assumes that there is absolutely no vandalism of natural gas pipelines. With about 180 trillion cubic feet of estimated reserve capacity, Nigeria’s natural gas reserves are a cheap and reliable source of fuel.
LNG adds about N8/kWh in Costs to Power Generation vs Natural Gas: Total power generation costs with a LNG option will be in the N14-15/kWh range. The higher cost relative to natural gas based power generation (N6.6/kWh) is due to the need for liquefaction, storage, transportation and regasification capacity. This implies that LNG use adds about N8/kWh to power generation costs, when compared to the zero vandalism (100% uptime) natural gas case.
Considering stakeholder losses and systemic economic losses shows the true value of LNG diversification strategy: When the opportunity cost to stakeholders and macroeconomic losses are considered, the true cost of a natural gas-based solution rises to between N9.7/kWh to N93/kWh at an assumed 90% uptime rate. If the more realistic uptime rate of 73% is used (based on industry data indicating there are about 100 product deferment days per year), the true costs of a natural gas-based power generation option range from about N15.1/kWh to N242.9/kWh. The lower cost bound includes stakeholder losses only, while the upper bound considers systemic macroeconomic costs.
Minimum online percentage of 99.1% is required for Natural Gas pipelines to make LNG diversification option unnecessary: It is estimated that a minimum uptime rate of 99.1% for natural gas pipelines is needed to ensure that macro-economic losses do not exceed the incremental cost of a LNG based strategic option. Under the current situation, it is certain that no one can guarantee a 99.1% uptime rate on any pipeline – even if the entire army was drafted to monitor them. Given the increase in acts of pipeline vandalism and sabotage, it is unfortunately possible, even likely, that we might yet see less than 70% effective uptime on natural gas pipelines.
Renewables (Solar & Wind): The absence of renewables like solar and wind in this analysis is glaring. Without policy incentives (tax breaks, tax write offs, etc.) renewable energy solutions will struggle to be cost effective. It is not yet clear what the policy thrust and the related commitment to a renewable energy portfolio is for the Buhari government. As a result, no reliable estimation of costs can be determined.
If an LNG-based strategy that adds N8/kWh to the cost of power can potentially result in a N861/kWh impact on the national economy, this would be a cost well worth investigating with some seriousness. Who should pay for this cost? This is an important question that will be resolved in the next section of this article.
Options for Paying for an LNG Diversification Strategy
Our recommendation is not for LNG to completely replace pipeline gas. Since the maximum impact seen so far from pipeline vandalism is about 100 days of product deferment (27% downtime), the recommended strategy only calls for power plants fed by the most vulnerable pipelines to develop a fuel diversification strategy that will require that they source about 30% of their fuel from LNG. Since only 30% of the effective fuel mix will be from LNG, the effective cost increment will only be about N3/kWh (i.e., 30% multiplied by N8/kWh).
Here are the proposed elements for a LNG diversification strategy:
Enable NLNG and Private Sector Players to Generate LNG for up to 30% of Power Sector Gas Requirements: The Nigerian Natural Gas Liquefaction Company has significant liquefaction capacity, and currently sells about 22 million tonnes per annum of LNG from its Bonny Island facility. Because NLNG has only six trains and is locked into long-term contractual agreements for LNG supply, it might have contractual constraints that will prevent it from meeting local needs. Whatever shortfall results from these constraints should be passed on to private sector providers of liquefaction, storage and logistics capacity. If firm and enabling policies are in place, multinational industrial gas companies (Praxair, Air Products, Air Liquide, Air Gas, Nippon Gas, etc.) should find this sector interesting. These companies prefer to self-finance their assets, in return for long-term supply contracts. The long-term contracts can be assured by requiring that all GENCOs include at least a 30% LNG portion in their fuel mix.
Cost Option 1: Pass on Costs to Large Scale End Users: The major economic benefits of reliable power mostly accrues to major power users. They should probably bear most of the burden for the enhanced stability and reliability that a LNG strategy will provide. Any single point use of power than exceeds the equivalent of about 50 kW of installed capacity (i.e., about 1,200 kWh/day) could be charged at a higher rate, sufficient to mitigate the higher costs from using LNG.
Cost Option 2: Government Should Finance All of the Cost Increase: If every kWh of power truly generates about N861/kWh in GDP, government can expect to obtain about N86/kWh in revenues and taxes assuming an effective 10% tax rate. Certainly, a subsidy of about N3/kWh in return for a return of about N90/kWh in tax revenues is a great deal for any government. Even at an effective tax rate of 1%, the government will still be making about N8.6/kWh – well in excess of the effective cost increment from using a 30% LNG – 70% Natural Gas fuel mix.
Cost Option 3: Pass on Costs to All Users and Provide End of Year Rebates to Alleviate Concerns & Enhance Metering: One of the major problems that the power sector experiences is the absence of effective metering. If a N3/kWh increment is passed on to most consumers there will certainly be a firestorm of resistance and opposition. However, since the government is going to be generating tax revenues, it (government) can institute a rebate policy paid through the DISCOs. To qualify, users can be required to bring their tariff payment receipts to their DISCO at the end of the year. This means the end user must be metered. The government can use the rebates as a means to pass back about 10% of tariffs back to the end users. This might very well serve as a year-end fiscal stimulus that will also end up stimulating the economy. Based on about 5,000 MW of power generation, this rebate (estimated at N3/kWh) can easily amount to about N130 Billion per year. Besides, given the choice between zero or epileptic power supply based on the current strategy and paying about N3/kWh more for stable power, my guess is that Nigerian consumers will likely opt to pay the slightly higher price.
Concluding Thoughts
Since my last article, even more acts of pipeline sabotage have occurred. Nigeria experienced its first zero energy generation event as a result of sabotage on March 31st. New players like the Niger Delta Avengers have emerged, that have promised to disrupt oil and gas shipments and have demonstrated a capacity to do so with ruthless efficiency.
So far, the Buhari government has proposed two solutions to the menace of pipeline vandalism. The first is a military solution, while the other – proposed by Minister Fashola is a forlorn hope that an attitudinal change by the host communities through which the pipelines pass will resolve the problem of vandalism.
I do not believe either of these proposed solutions will yield any results in the next three years. I am concerned that the government’s threats to “deal with vandals” using military might has not worked in over a decade of militancy and vandalism in the Niger Delta and will likely not work now either.
Mr. Fashola has suggested that the biggest contribution to reducing or eliminating acts of pipeline vandalism will have to come from the communities through which the pipelines pass. Most Nigerians have never seen a gas pipeline and they never will, and the communities though which pipelines pass only get to see a small fraction of the asset. This is because only small runs of pipeline actually pass through inhabited communities. Vandalism is not something that is discussed at village squares or community youth centers. It is not an act that is voted upon by community members. Any strategy for pipeline security that relies on communities spontaneously forming vigilante groups to police pipelines is unlikely to be successful.
Even if pipeline security can be improved at the community level, what about the thousands of kilometers of pipeline that are in miasma swamps, mangrove forests and tropical jungles – far removed from any human habitation? Even swiftly deployable, mobile security aids like drone surveillance will be of limited value in forested areas, where tree cover will reduce aerial visibility and the tough terrain will make rapid response difficult, if not impossible. Pipeline security can be enhanced, but no one can adequately police thousands of kilometers of pipeline – most of which are in the middle of nowhere.
If Mr. Fashola and the Buhari government want to succeed in the 3 years left on this current term, then this government must urgently consider a LNG based fuel diversification strategy. Pipeline Vandalism keeps an estimated 1,500 MW of power generation capacity offline. Mr. Fashola’s success in guaranteeing fuel sources for this idling capacity will ensure that about $60 Billion per year in GDP is safeguarded.
Dr. Malcolm Fabiyi coordinates the Governance Advancement Initiative for Nigeria (GAIN) poll. He has served as a Visiting Professor at Lagos Business School, and previously worked as a managing consultant with McKinsey & Company. He can be reached at [email protected]