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UNCLAS SECTION 01 OF 04 LAGOS 000096 
 
SIPDIS 
 
SENSITIVE BUT UNCLASSIFIED - HANDLE ACCORDINGLY 
SIPDIS 
 
DOE FOR GPERSON, CGAY 
TREASURY FOR ASEVERENS, SRENENDER, DFIELDS 
COMMERCE FOR KBURRESS 
STATE PASS USTR FOR ASST USTR FLISER 
STATE PASS TRANSPORTATION FOR MARAD 
STATE PASS OPIC FOR ZHAN AND MSTUCKART 
STATE PASS TDA FOR NCABOT 
STATE PASS EXIM FOR JRICHTER 
STATE PASS USAID FOR GWEYNAND AND SLAWAETZ 
 
E.O. 12958: N/A 
TAGS: EPET ENERG PGOV NI
SUBJECT: EXXONMOBIL'S ASSESSMENT OF CHALLENGES TO THE OIL 
AND GAS SECTOR 
 
 
LAGOS 00000096  001.2 OF 004 
 
 
Sensitive But Unclassified;  Business Confidential;  Handle 
Accordingly 
 
¶1.  (SBU)  Summary:  Nigeria's ambitious plans for increasing 
natural gas production could be hampered if the challenges 
facing the companies leading this enterprise are not 
resolved.  The major challenges are underfunding of joint 
venture (JV) projects by the Nigerian National Petroleum 
Corporation (NNPC), pressure on the companies to fund 
greenfield refineries, local content legislation, caps on 
company operating margins, gas taxation legislation, the 
pricing provisions of the Gas Master Plan, and terms of 
Production Sharing Agreements.  End Summary. 
 
Nigeria's Goals for the Oil and Gas Industry 
-------------------------------------------- 
 
¶2.  (SBU)  In a business issues briefing, ExxonMobil 
Production executives told Pol Econ Chief that Nigeria has a 
number of political goals that impact on the company's 
ability to operate:  1) stimulate economic growth, alleviate 
poverty, create jobs, and grow the tax base;  2) develop 
local capacity and diversify the economy;  3) build gas and 
electric power infrastructure to attract non-oil investment; 
4) build a self sufficient refining and chemical sector; 
(Note: Currently Nigeria has only 150,000 bd of nominal 
refining capacity.  Only the Port Harcourt refinery is 
operating.  The Warri and Kaduna refineries are not 
operating.  End Note) and 5) grow Nigeria's share of the OPEC 
quotas. 
 
Goals of the Oil and Gas Industry in Nigeria 
--------------------------------------------- 
 
¶3.  (SBU)  Within this general framework, the Nigerian oil 
and gas industry has the following additional objectives:  1) 
increase production to 4.0 mbd by 2010;  2) achieve national 
reserves of 36 gb by 2007, and 40 gb by 2010;  3) eliminate 
routine gas flaring by 2008;  4) increase gas revenue to 
approximate oil revenue by 2010;  5) increase local content 
of oil and gas sector inputs to at least 45 percent by 2006, 
and to 70 percent by 2010; and 6) achieve and maintain world 
class safety and health standards. 
 
Underfunding is Major Impediment to Reaching Goals 
--------------------------------------------- ----- 
 
¶4.  (SBU)  ExxonMobil believes it will play a major role in 
meeting Nigeria's goals and achieve industry goals as well. 
However, company executives believe, there are major 
impediments to meeting those goals:  1)  The government's 
time frames are unrealistic;  2) joint venture (JV) funding 
by the Federal Government of Nigeria (FGN) is seriously 
deficient;  3) even the alternative funding mechanisms 
ExxonMobil routinely uses to supplement FGN JV funding are 
insufficient to meet the government's ambitious national 
objectives.  Oil production from any given field declines by 
10 percent each year.  Therefore, joint venture partners must 
invest additional amounts over the initial investment each 
year merely to maintain current production.  To increase 
production, even more additional capital needs to be 
invested. 
 
¶5.  (SBU)  The FGN has under-funded JV operations since 1996, 
ExxonMobil claims.  Although Nigerian National Petroleum 
Company (NNPC) contributions to JV funding have increased 
over time, they have not kept pace with ExxonMobil's 
investment needs or requests.  This means that ExxonMobil 
must compensate for the FGN investing less than its 
 
LAGOS 00000096  002.2 OF 004 
 
 
agreed-upon share.  In 2006, the shortfall between the amount 
needed and the amount provided by the NNPC was approximately 
USD 1 billion. 
 
¶6.  (SBU)  To bridge the gap, ExxonMobil has been successful 
in using non-equity sources to fund priority activities.  In 
2005, ExxonMobil managed to raise over USD 2G of non-equity 
funding.  The mechanisms for doing so varied.  In the Yoho 
project, ExxonMobil provided up front funds, which were then 
repaid in crude oil.  In the NGL II project, the company 
borrowed from banks.  In the Satellite Primers project, the 
company was successful in obtaining bank financing at a low 
interest rate. 
 
¶7.  (SBU)  ExxonMobil works from extensive JV funding 
projections.  These projection show that the funds planned to 
be provided by the NNPC will not be sufficient to meet 
production objectives.  The funding shortfalls are so 
significant that they will delay projects.  As projects are 
delayed, both production and reserves will decline, flare 
elimination will be deferred, and revenue to the Federal 
Government from the oil and gas industry will decrease. 
 
Pressure to Fund Greenfield Export Refineries 
--------------------------------------------- 
 
¶8.  (SBU)  Since 2003, when the Federal Government of Nigeria 
proposed to deregulate the downstream sector by privatizing 
its three oil refineries, ExxonMobil, like other 
international oil companies (IOCs), has been pressured by the 
FGN to invest in these refineries.  In 2005, NNPC proposed 
additional regulations pursuant to the Petroleum Act.  The 
new regulations would require the IOCs to refine in country 
some proportion of crude oil produced.  A bill has been 
introduced and is being considered by the National Assembly 
requiring that 50 percent of crude oil be refined 
domestically.  The bill also requires that equity crude be 
refined in country, and imposes severe penalties of up to $4 
bbl for non-compliance. 
 
¶9.  (SBU)  To help the FGN understand the costs involved in 
taking over one of the refineries, the upstream majors, 
including ExxonMobil, Shell, Chevron and Total, participated 
in a feasibility study with the NNPC.  The study assessed the 
legacy environmental issues, security, regulatory 
environment, and manpower problems that are associated with 
the refineries.  The study concluded that the cost for a 200 
kbd single train refinery would be USD 4.3G.  Because 
refining at best yields only the most marginal of profits, 
the IOCs will not take it on, the executives said. 
 
Local Content Legislation 
------------------------- 
 
¶10.  (SBU)  Since the return to democratic rule in 1999, the 
country has intensified efforts to promote local content 
development.  The company supports those efforts and has been 
working to incorporate best practices from its worldwide 
operations into the process.  The FGN's stated objective is 
to retain in-country an increasing percentage of the annual 
oil and gas industry investment (approximately USD 10 G) and 
have set local content targets of 45 percent by 2006, and 70 
percent by 2010.  The NNPC has created a Nigerian Content 
Division which works to assure that every contract over USD 
500,000 has the requisite percentage of Nigerian content. 
Contracts can take from 18-24 months to negotiate.  The 
Nigerian Content Requirements slow the process even further. 
 
¶11.  (SBU)  The National Assembly has had three bills on the 
 
LAGOS 00000096  003.2 OF 004 
 
 
Nigerian Content issue under consideration.  The Chairman of 
the Senate Committee on Upstream Petroleum Resources, Senator 
Lee Ledogo Maeba's bill, called the Nigerian Content 
Development Bill of 2005, has been through two readings and 
is scheduled for third reading early in February.  The bill, 
which made it through second reading before the industry 
became aware of it, contained in its original form several 
punitive provisions, including criminal penalties for CEOs, 
for non-compliance.  An IOC industry group proposed a 
harmonized bill that eliminated objectionable elements from 
the Chairman's bill.  One provision the group succeeded in 
having removed from the original bill related to the creation 
of a monitoring board;  the industry prefers monitoring 
through the NNPC be continued. (See septel) 
 
Caps on Company Operating Margins 
--------------------------------- 
 
¶12.  (SBU)  Nigeria has had a series of Memoranda of 
Understanding through which it provides incentives to the 
IOCs to increase crude oil exports and encourages investments 
in exploration and development.  The current MOU was signed 
in 2000 for the purpose of creating incentives for investment 
when oil prices are low, ExxonMobil executives said. 
 
¶13.  (SBU)  Clause 2.6 of the MOU states that the Minister of 
Petroleum shall advise of any change in applicable margins 
when crude oil prices exceed USD30 bbl.  Because oil prices 
have been high, the industry expected that their operators' 
margins would increase under the MOU.  However, the NNPC 
decided instead to cap the operators' margins at USD 30 bbl. 
Once the price of oil rises over USD 40 bbl, the Petroleum 
Profits Tax controls. 
 
¶14.  (SBU)  The industry agreed in January 2005 to pay its 
2004 taxes in accordance with the margin cap, with the 
understanding that an Inter-Ministerial Committee (IMC) would 
be constituted for the purpose of renegotiating the MOU.  The 
IMC was set up in May 2005, and set a target of August 2005 
to conclude negotiations.  A revised MOU was planned to 
become effective on January 1, 2006. 
 
¶15.  (SBU)  However, the talks stalled.  The Minister of 
Petroleum confirmed that the FGN is willing to share upside 
benefits in exchange for increased work by the IOCs in the 
onshore, shallow water areas.  However, the Ministry of 
Finance has insisted on keeping the margin cap at USD 30 bbl 
and only increase fiscal costs to USD 5 bbl. 
 
Pending Taxation Legislation 
---------------------------- 
 
¶16.  (SBU)  There are two competing gas tax bills currently 
under consideration by the National Assembly.  One bill, 
drafted by the NNPC, removes existing gas incentives, has 
higher tax rates, and would adversely impact gas development, 
according to ExxonMobil.  According to ExxonMobil's analysis, 
a large percentage of Nigeria's gas reserves would not be 
developed if this bill passes.  A second bill, drafted by the 
Federal Internal Revenue Service (FIRS), would be acceptable 
to ExxonMobil if modified.  The FIRS bill was introduced in 
December 2005 and passed the House without input from the 
industry.  However, at the request of ExxonMobil, the Senate 
Finance Committee considered modifications proposed by the 
industry.  The companies are seeking grandfathering for 
existing projects. 
 
Downstream Gas Act 
------------------ 
 
LAGOS 00000096  004.2 OF 004 
 
 
 
¶17.  (SBU)  The Downstream Gas Bill, introduced by the NNPC 
to create a legal and regulatory framework, including a 
Regulatory Commission, for natural gas, would, in its 
original form, require the industry to move gas into the 
domestic market either "free of cost at the flare" or at a 
negotiated price.  The bill allows prices to be set below the 
market price, and would make it difficult, if not impossible, 
for the IOCs to earn a profit.  ExxonMobil is part of an 
industry group that is engaging with the Senate on this 
issue.  Public hearings on the bill have been held by the 
House of Assembly and the Senate (see Septel). 
 
NNPC Gas Master Plan 
-------------------- 
 
¶18.  (SBU)  The NNPC released the Gas Master Plan (GMP) in 
October 2005.  Phase One of the plan includes sector 
diagnosis and concept development while Phase Two of the plan 
establishes the gas pricing framework.  The objective of the 
plan is to grow the Nigerian economy by maximizing the 
multiplier effect of gas.  It mandates that gas be supplied 
to the domestic sectors of the economy, sets a low price for 
gas to strategic domestic sectors, and gives suppliers a 15 
percent rate of return.  However, the single low price does 
not reflect the costs inherent in the diversity of sources 
from which the gas is drawn.  Some areas have small reserves 
that must be linked, creating higher costs, while gas drawn 
from a single large reserve will have lower associated costs. 
 ExxonMobil and the rest of the industry believe that the 
open market approach, rather than the approach included in 
the GMP, is the best way to incentivize economic gas supply. 
 
¶19.  (SBU)  President Obansanjo has already intervened in the 
gas price discussion, raising the price from USD 0.05 to 0.10 
per cubic meter of gas.  However, the underlying assumption, 
that is that every company can make a 15 percent profit at 
this low price, is incorrect, ExxonMobil pointed out. 
 
Deepwater Gas Rights Under PSAs 
------------------------------- 
 
¶20.  (SBU)  ExxonMobil has a production sharing agreement 
(PSA) with the National Petroleum Investment Management 
Services (NAPIMS), a division of NNPC, to produce gas from 
the Bonga field.  The PSA provides that ExxonMobil, as 
contractor, has the right to participate in production of the 
gas on behalf of the leaseholder.  After it is produced, the 
Bonga gas is delivered to NNPC's JV partner Shell Production 
and Development Company (SPDC), in which Shell, Total and 
Agip all participate.  SPDC then sells the gas to Nigeria 
Liquified Natural Gas (NLNG).  Proceeds from the sale are 
shared between NNPC (55 percent) and SPDC (30 percent).  No 
compensation is paid to the PSA contractor. 
 
¶21.  (SBU)  ExxonMobil interprets the PSA as providing that 
the company has a split share with NAPIMS in the gas 
produced.  NAPIMS, however, believes that it has full, not 
partial, ownership of the Bonga gas.  This underlying dispute 
has not yet been resolved.  However, an interim agreement 
between ExxonMobil and NAPIMS which provides that the 
proceeds of gas sales are paid into an escrow account has 
been reached.  NAPIMS has said that, while it is willing to 
allow ExxonMobil to share in the proceeds of the sale of the 
gas, it will do so only if ExxonMobil concedes that it has no 
rights under the Production Sharing Agreement to the gas 
itself.  ExxonMobil has received no revenue from the Bonga 
project, which has been flowing since December 2005. 
BROWNE