Before You Invest In That Modular Refinery in Nigeria

Many people are pushing for modular refineries in Nigeria. It is indeed a very exciting business, on the face of it: Nigeria needs fuel to run our generators and drive our cars. And with our refineries not producing the capacity the nation needs, we have been importing for years. Indeed, government will like to substitute the imports with locally refined products especially in this age of foreign exchange scarcity. It makes economic sense because Nigeria has the crude oil and we have no business importing refined products.

That is the optimistic exuberance why most people are getting into this. According to the Vanguard, Nigerian National Petroleum Corporation (NNPC) expects about 20 investors to pump in $20 billion in the business.

THE Nigerian National Petroleum Corporation, NNPC, has commenced move to attract 20 companies to make substantial investment worth $20 billion in order to meet the Federal Government’s target of increasing refining capacity in the country.

Investigations showed that the apex oil corporation has, in the past few weeks, been engaging with the investors in order to inform, educate as well as assist them to prepare various packages required in the process of applying for licence. On completion of the engagement, the promoters of the modular refineries would be equipped with vital knowledge to submit their applications to the Department of Petroleum Resources, DPR, that is vested with the responsibility to issue such licenses.

It is indeed an exciting sector. This article provides a good rosy picture for Dangote Refinery, which is certainly the one that matters at the moment, as it is already building, to begin operations in 2019.

THE 650,000 barrels per day Dangote Refinery has been projected to hit 50 per cent capacity utilisation by 2020. The capacity utilisation of the Lagos-based plant, scheduled to come on stream in 2019, would rise to 90 per cent by 2030.

PriceWaterCoopers, in its latest report, Modular refineries: Merits and challenges, made available to Vanguard, stated that the feat would make West Africa to become a great refining hub in Africa.

The report, which puts existing refineries at 20 percent utilization, stated that Nigeria and West Africa have a deficit of 113,000 barrels per day, bpd. “Nigeria’s refineries continue to operate at abysmally low utilisation rates. 8.5 percent combined utilisation as at 2016 and 37 percent as at 2017. Refineries have been forced to halt operations multiple times as crude supply lines have been routinely targeted by militant groups.

That is a very interesting projection. And that makes sense because Nigeria presently imports most fuels. So, with local demand, Dangote Refinery will not have any problem in getting to near-capacity utilization; our national refineries are largely non-functioning.

Then read this from Quartz newsletter:

This week the UK became the fifth country—after the Netherlands, Norway, India, and France—to commit to selling only electric cars in the near future. It will do so starting in 2040, while Norway and India are more ambitious, aiming for 2025 and 2030 respectively.

As battery prices fall, it’s clear that electric cars are the future. How soon we get there will depend on how serious we are about reaching emissions goals set under the Paris accord….

If any country seems to be on track in this regard, it’s China. In 2016, the country registered 350,000 electric vehicles (the US was a distant second with 160,000). It has tax exemptions in place worth $6,000 to $10,000 per car. It boasts 150,000 charging stations, with 100,000 more coming in 2017 (the US has just 16,000). And it has plenty of spare capacity to power all these vehicles, with its thermal power plants running only half the time.

Comments

From these two bits of news, one can deduce as follows:

• The future of refineries cannot be assured because batteries and electronics will get cheaper, as always. The implication is that fossil-powered cars will be the alternative cars in most parts of the rich world by 2040. If that happens, the fossil-powered cars may not even be produced. Understand that the market for Nigeria, unless we can get more people into upper middle class, may not be too huge for GM, Toyota, Ford etc to be making cars they cannot sell in U.S., Japan, Western Europe, and other rich countries. (I make this statement believing that making electric cars will be cheaper than fossil-powered cars within 15 years, for comparative cars.)
• So, if the rich world pivots to electric, the end of fossil-cars can happen. That will affect the refinery businesses in Africa. It is important to note that this will not happen overnight; we have about two decades on this, in Africa.
• Most refineries in leading economies will struggle because of many factors: electric vehicles, car-sharing (lesser on the road), vehicle energy usage efficiency, solar etc. So, the implication is that any projection in long-term, based on today’s refined-product demand will be careless; one has to consider the technology trajectory and how it will affect demand. This is where I see challenges for small refineries in Nigeria because demand will drop and price must crash for a product that is largely undifferentiated.
• Sure, refineries are not just there to produce petrol for cars. However, in Nigeria, that is the main demand driver. The generators are there but I expect solar to have a good take on that within a decade. In other words, solar will become a good source of energy for most homes or government will figure out the electricity problem.

Investing in Modular Refineries

Refining is a commoditized business where scale matters more than anything. If Dangote Refinery takes off, as expected, it will be the industry leader. If that happens, it will have a huge advantage on building the necessary distribution facilities first. Should you need to come, say five years, after Dangote Refinery begins operations, you need to carefully analyse how soon you can recoup your investment before an expected fundamental industry-level redesign begins to affect demand. The five year projection is based on my model that NNPC may finalize all permits by next year and it will take each company 3-4 years to build.

Besides, if electric cars become far cheaper than fossil-powered cars, petrol demand will struggle. And since electric car penetration is always correlated with solar electricity home usage, we can also see more homes and offices getting electricity from solar at the same time they are driving electric cars. This means that if that happens in Nigeria, we may not even need generators.

So from the electric cars and generators, we will see multi-pronged challenges for refiners, depressing earnings for a commoditized product. We may end up having only the expected industry leader, Dangote Refinery, winning and every other participant largely struggling.

Rounding Up

Refinery business is not trading, it takes years to recoup the investments and as you work on the break-even analysis, consider the technology impact and the fact that we already have a category leader. In the short-term, modular refinery makes business sense in Nigeria. But after the next two decades, it may be worthless.That understanding should help to ascertain if the business is worth the risk.

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