At the 26th United Nations Climate Change Conference of the Parties (COP26) held in Glasgow in November 2021, representatives of governments, businesses, and other organisations, with influence over the future of the automotive industry and road transport made commitments to accelerate the transition to zero emission vehicles. This commitment is driven by the need to achieve the goals of the Paris Agreement by 2035 in leading markets and no later than 2040 globally.
It is important to note that the commitment to transit to zero emission vehicles is just one out of several commitments by relevant stakeholders to phase out reliance on fossil fuel in the near future. However, a swift shift to zero emission and renewable energy sources appears not only radical but impracticable given the complexity of technologies and huge capital outlays associated with such a shift. Thus, a number of industry players have identified gas as the viable transition fuel given the superior economic viability for its production and utilisation when compared to the results of business models for renewable energy.
Interestingly, Nigeria holds Africa's largest natural gas reserves (currently at 206 trillion cubic feet) but the resource has been largely lost to flaring for a couple of reasons, including the issue of the old petroleum laws not recognizing natural gas as a resource in its own right. Although the recently enacted Petroleum Industry Act, 2021 (PIA) is silent on energy transition, it clearly recognizes gas as a distinct resource that investors should explore and develop with focus.
In this article, we review some legislative provisions that have specific implications for gas businesses in Nigeria with a view to identifying the Nigerian Government's case for gas as a transition fuel.
Petroleum versus Oil
Prior to the enactment of the PIA, the focus of most investors and the government was on oil and this was driven by administrative actions as provided for in the Petroleum Act of 1969. In fact, the main industry regulator issued exploration, prospecting and mining licences as though the licences were only in respect of oil reserves, with minimal reference to the gas components in the reserves.
With renewed recognition of the commercial opportunities for gas, Nigeria has taken steps to create a distinct gas economy by providing legal frameworks and incentives for the exploration and utilisation of gas in Nigeria, via the recently enacted PIA. The PIA now appropriately references the word 'petroleum', the composite word and not just oil.
More importantly, the PIA establishes new regulators, the Nigerian Midstream and Downstream Petroleum Regulatory Authority (the Authority) and the Nigerian Upstream Petroleum Regulatory Commission (Commission) for the governance of activities in the gas sector. For instance, the PIA now saddles the Authority with the responsibilities of providing pricing and tariff frameworks for natural gas in midstream and downstream gas operations while the Commission will see to a number of upstream activities targeted at the exploration and production of petroleum (gas inclusive).
Gas Flaring
One of the age-long misfortunes that has bedevilled the Nigerian Petroleum Industry is gas flaring. Given the abundance of gas in our reserves, most operators encountered gas as associated components in their oil fields. However, a number of them viewed associated gas as obstacles and simply flared gas because of the "significant" initial outlay for gas capture, transportation and processing when compared to the ease of monetizing oil.
However, the PIA now contains prohibitive provisions for gas flaring, except for few circumstances in which there is no other reasonable option than to flare gas. More so, fines/fees paid for gas flaring are not eligible for cost recovery or tax deductibility based on the PIA. In fact, one of the technical functions of the Commission now includes setting, defining and enforcing regulations on the monetization of gas and elimination of gas flaring.
Gas Sales - Value Added Tax
Gas (i.e. Liquefied Petroleum Gas) is fast becoming a household commodity for most Nigerians. Given that the supply of commodities is a VATable activity, the VAT (Modification) Order 2021 ("the Order") imposes VAT on the supply of natural gas to most gas-based industries with the exception of power generation companies. Meanwhile, the VAT (Modification) Order 2020 exempted both natural gas and Liquefied Petroleum Gas (LPG) from VAT, but only locally produced LPG is now exempt from VAT, based on the amendments introduced by the 2021 Order. This implies that natural gas and imported LPG will now attract VAT.
It is apt to presume that the intention for imposing VAT on imported LPG is to discourage importation of the commodity and encourage local production. However, there appears to be a lacuna in the policy documentation given that natural gas is a feedstock for LPG. Thus, the imposition of VAT on natural gas is counterproductive to the national policy direction of domestic gas production and utilisation. This is a significant point for consideration given that the PIA requires operators to delineate their upstream and midstream activities using separate entities. As such, there could be instances where VAT becomes applicable on gas supplied by related entities when transferred from the producing entity to the processing entity.
The issue of VAT on natural gas needs to be quickly revisited by industry players and policymakers to ensure that the pursuit of gas as a transition fuel is carefully and constructively executed. This is especially important given the far-reaching implications of the VAT recovery mechanisms and the potential increase in the market price for LPG.
Fiscal Incentives for Actualizing Nigeria's Gas Potential
The PIA provides that Hydrocarbon Tax (HT) will not apply to associated natural gas, including gaseous natural gas liquids (NGLs) produced in the field and contained in the rich gas, and non-associated natural gas. HT will also not apply to condensates and NGLs produced from associated and non-associated gas in fields or gas processing plants, regardless of whether the condensates or NGLs are subsequently comingled with crude oil. However, the applicability of HT will depend on whether the volumes of the condensate or NGLs can be determined at the measurement point or exit of the gas processing plant.
More importantly, the PIA expands the list of companies eligible for the gas utilisation incentives (GUI) provided for under Section 39 of the Companies Income Tax Act (CITA). Specifically, companies engaged in midstream petroleum operations and large-scale gas utilisation industries (i.e. large-scale industries that use natural gas as a feedstock such as gas-to-liquid plants, petrochemical industries and fertilizer plants; and mini-LNG plants and power plants) are now eligible for the GUI. In addition, investors in gas pipelines are eligible for an additional tax-free period of five years at the expiration of the tax-free period granted in Section 39 of the CITA. The expectation is that these incentives will encourage domestic gas production and utilisation in line with the ongoing global energy transition.
However, the Finance Act, 2021 includes amendments that suggest that the GUI is targeted at companies and not operations or the qualifying capital expenditure involved in gas utilisation projects. For instance, the amendment law provides that the GUI is not claimable by a company that once enjoyed it, including scenarios where another company is formed from a restructuring scheme out of a company that has already enjoyed the GUI.
While one would have expected that the restriction of the incentive would be based on the underlying capital expenditure, investors need to pay attention to the new provisions especially when planning to buy-out companies engaged in gas business given the potential implications for surviving companies.
Conclusion
Recent changes in the legislative framework as they apply to the Petroleum Industry show that the Nigerian Government is not oblivious to the nation's huge gas potential and the importance of gas as a transition fuel. However, there is a need for concerted efforts to ensure that the policy direction from various policymakers are aligned for more effectiveness.
Meanwhile, investors need to stay abreast of the changing regulatory landscape and conduct relevant due diligence to ensure optimal success in their bid to develop the rich gas resource in Nigeria.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
