Examining The Operationality And Enforcement Of The Domestic Crude Oil Supply Obligation

Introduction

Pursuant to the Petroleum Industry Act (“PIA”) 2021, the Nigerian Upstream Petroleum Regulatory Commission (“Commission”) is empowered to issue regulations or guidelines on the mechanism for the imposition of a domestic crude oil supply obligation (“DCSO”) on lessees of upstream petroleum operations. Further to the foregoing, the Commission has issued the Production Curtailment and Domestic Crude Oil Supply Obligation Regulations, 2023 (“Regulations”) and the Guidelines for the Operationalisation of Domestic Crude Oil Supply Obligation, 2024 (“Guidelines”). The essence of the DCSO is to ensure adequate supply of crude oil to domestic refineries.

In the succeeding paragraphs, we shall discuss the concept of the DCSO and its operationality within Nigeria's domestic petroleum market.

Overview of DCSO

Generally, the imposition of DCSO is not meant to be instinctively or indiscriminately imposed by the Commission. Per the provisions of the Regulations and the Guidelines, there are set of procedures to be undertaken prior to the imposition of a DCSO on a

A. Publication of Crude Refining Requirements

The Regulations require the Commission to publish on its website and three (3) national dailies on a biannual basis, the domestic crude refining requirements of operating refineries in Nigeria based on the information provided to the Commission by the Nigerian Midstream and Downstream Petroleum Regulatory Authority (“Authority”) on the crude oil requirements of refineries in operation in Nigeria. The information to be published on the Commission's website shall include (a) name and location of each refinery, (b) total number of operating refineries in each period, (c) name plate crude requirements of each refinery, (d) actual forecasted daily crude requirement of each refinery for the publication period, and (e) crude specification or grade for each refinery.

In addition to the foregoing, the Commission will provide corresponding information on its website relating to the (a) production forecast of each producing licensee or lessee for the corresponding period based on a daily rate, (b) name, location and the terminal stream of each producing licence or lease, (c) name of the licensee or lessee of each producing licence or lease, and (d) crude specification or quality produced from each licence or lease.

Per the Regulations, the purpose of these notifications/publications is to facilitate crude oil sales transactions between producers (lessees/licensees) and the operating refineries in Nigeria, commercially negotiated on a free market basis.

B. Issuance of Request for Quotation (RFQ) by the Commission

Where a refinery is not successful at independently sourcing future crude oil supplies from licensees/lessees or is unable to secure the minimum volume required for its forecasted period, the refinery is required to report to the Commission before the fifteenth (15) business day of the third (3rd) month stating the grade(s) involved and reasons for the inability to secure the crude oil supply from the licensee/lessee(s). The Commission shall, based on the refinery's notification, intervene to avoid potential supply shortages/inadequate supply conditions by:

1. Directing a licensee/lessee to enter into a crude purchase agreement with a refiner where a licensee/lessee has refused, failed, or neglected to enter into an agreement upon the request of a refiner.
2. Where the potential shortfall is due to a stalemate in commercial terms other than price, the Commission may request the parties to the crude purchase agreement under negotiation to present the terms of their proposed contract to the Commission for consideration, and in such a situation, the Commission is expected to ensure that parties reach amicable terms.
3. On the other hand, where the disagreement between the parties is on price, the Commission will direct the parties to agree on a fair price by comparison with the Fiscal Oil Price differentials¹ published by the Commission.

Where the above procedures meant to ensure that the domestic market is always supplied under market conditions by allocating dedicated volumes to lessees, have been followed and crude supply to the domestic market remains insufficient to bring about full supply, the Commission will then issue a Request for Quotation (“RFQ”) to producing licensees/lessees, directing them to submit their respective quotations for the supply of the required volumes to meet the shortage or close the inadequate supply condition. The RFQ shall indicate the following:

1. The volume of crude oil required to address the shortage or inadequate supply condition
2. The volume of crude oil required to address the shortage or inadequate supply condition
3. The price at which the licensee or lessee shall supply with volume² and
4. A specific time within which a response shall be submitted and the form in which the response shall be submitted.

Where the Commission receives a response to an RFQ, it shall communicate same to the available refinery and this shall be the basis of a crude supply contract on a willing buyer, willing seller basis. The Commission may impose an obligation on a licensee or lessee to supply the crude volumes required where parties fail to consummate the crude supply transaction or due to insufficient quantities or unreasonable demands of the seller. However, the Commission will not impose an obligation where it is satisfied that the failure to enter into the contract on willing buyer, willing seller terms is due to the unreasonable behaviour of a buyer. Accordingly, the Commission shall communicate its decision to the Authority.

C. Imposition of DCSO

Prior to the Commission's imposition of DCSO on producing licensees or lessees, the Commission will identify and select the producing licensees based on (i) the proximity of and accessibility of the supply location to the refinery's location; and (ii) matching of the licensees or lessees' crude specification to the grade requirement for domestic supply. Where more than one licensee or lessee fits these considerations, the Commission shall impose the obligation to supply by allocating volumes to each lessee based on its weighted proportion of total production, taking into consideration any existing refinery supply contract it may have, export commitment and production quotas.

D. Penalty for Non-Compliance with the DCSO

The Regulations provide that any licensee or lessee who fails to submit an RFQ or submits an RFQ outside the time specified is liable to pay an administrative fine or USD$10,000³ to the Commission.

Also, where a licensee or lessee fails to comply with the DCSO by (a) failing to enter into a contract for the delivery of DCSO volumes; or (b) failing to deliver under a contract for the supply of DCSO volumes (except in the event of force majeure; default of the buyer under the crude supply contract or any other reason acceptable to the Commission), such licensee or lessee shall be liable to pay an administrative penalty of 15% of the fiscal price of the DCSO volume imposed, payable to the Commission.

Operationality of the DCSO Vis-à-vis the Proposed Amendment to the Regulations and the Outstanding Issues

The objective of the DCSO, i.e., ensuring that shortages of crude supply to the local market are addressed, and adequate feedstock is made available for refining by local refiners to serve the local market, is commendable. As earlier mentioned, we note that there is a draft Amendment to the Regulations to ensure the effective administration of the Regulations. However, despite the Draft Amendment, in our view, there are some lingering issues that are yet to be addressed in order to ensure the smooth enforcement of the DCSO and recently, local refineries have complained about the insufficiency of feedstock from producers in the country. These issues are discussed below.

A. Existing Contractual Arrangements

Considering the capital-intensive nature of operations in the petroleum industry, we understand that lessees and licensees enter into various financing contracts, e.g. vendor-financing contracts, financial and technical services contracts, forward sale contracts, etc. Under such arrangements, it is not unusual for a producing lessee/licensee to pledge a part of their production to their financiers/lenders as repayment for the funding provided. This means that the licensees/lessees will only have control over the part of their production that has not been pledged to the lenders and which part they can practically commit to their DCSO. There is, thus, a need to balance the domestic crude supply regime with typical investment realities such as this.

In our view, provisions should be introduced into the Regulations that accommodate such contractual arrangements to avoid issues on contract defaults between the licensees/lessees and their funding partners or offtakers. Additionally, for proper implementation of the DCSO and to avoid non-compliance, a clearly defined timeline can be included in the Regulations wherein a licensee would have to amend contracts in which they have committed their crude production under funding arrangements to meet their DCSO. A cue can be taken from the phasing out of the concept of “Marginal Field” under section 94 of the PIA.

B. Supplier of Last Resort

One way of addressing supplier default is through a supplier of last resort (“SOLR”) procedure, which allows an emergency supplier to automatically fill in for a defaulting supplier under a supply arrangement. In relation to the supply of crude to the domestic market under the DCSO regime, a supplier of last resort would be expected to step in and supply outstanding crude volume to a refinery in need in the event of a lessee/licensee's inability to meet its DCSO allocation.

By so doing, the SOLR procedure protects the local refineries by ensuring seamless continuity of supply. However, under the present DCSO regime, there is no provision for an SOLR. We are of the view that a supplier of last resort provision should be incorporated into the Regulations, as this will help to resolve supply default concerns and thereby, further the implementation of the DCSO framework.

Conclusion

Commendably, the Federal Government of Nigeria (“FGN”) has taken steps to ensure that the country has fully functional refineries with adequate feedstock supply to resolve petroleum product scarcity and price hikes through the DCSO initiative. To fully reap the expected benefits of the initiative, the FGN should liaise with industry stakeholders to resolve the outstanding concerns for a smooth and effective implementation of the DCSO. Where these concerns (such as those highlighted above) are resolved in addition to the amendments proposed in the Draft Amendment, it is expected that crude supply to the local refineries will be greatly improved as envisaged under the Regulations.

Footnotes

1. We note that this provision might be inconsistent with section 109(4)(b) of the PIA, which provides that “the supply of crude oil shall be commercially negotiated between the lessee and the crude oil refining licensee, having regard to the prevailing international market price for similar grades of crude oil”. Thus, the PIA does not give the Commission powers to rely on the Fiscal Oil Price differentials.

2. Please note that based on the draft Amendment to Production Curtailment and Domestic Crude Oil Supply Obligation Regulations, 2023 (“Draft Amendment”), it has been proposed that this provision be expunged.

3. Please note that, based on the Draft Amendment to the Regulations, this amount is proposed to be changed to N20,000,000.00.

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