A financial model of the Dangote refinery

INTRODUCTION

In December 2015, the US Congress repealed the crude oil export ban which was a product of the Energy Policy and Conservation Act and had been in place since 1975. This allowed the free export of U.S. crude oil worldwide. According to the Government Accountability Office, the repeal became necessary as US crude oil production nearly doubled from 2009 to 2015 on the back of the shale oil boom made possible by advanced drilling technologies.

2-years before the ban was lifted a Nigerian billionaire businessman was putting together a vision of what was initially a $9 billion, 450,000bpd refinery. That billionaire was Aliko Dangote.

He envisaged $3 billion would be invested by the Dangote Group and the remainder of the costs sourced via commercial loans. In his visioning, the refinery would begin production in 2016. Construction started in 2016, with major structural construction starting in 2017.

It turned out 10-years after the vision to be a $19.5 billion, 650,000bpd single train behemoth that could not source all its crude oil requirements from the convenience of nearby oil fields.

Who would have thought that the United States’ repeal of a 40-year-old oil export ban would be critical nearly a decade later to the feedstock required to start up Africa’s largest and most complex refinery?

Nevertheless, the coming of the Dangote refinery has been heralded as a special and major event and a lot of hope has been pinned on its launch. Every move towards its completion has been closely watched.

This article will also train its eyes on the Dangote refinery, and I invite you to join me to assess its value – by the numbers as usual.

PROFILE: DANGOTE REFINERY

It is situated on a parcel of land that is approximately 2,635 Ha in size within the Lekki Free Trade Zone, Lekki, Lagos State. The refinery boasts the largest sub-sea pipeline infrastructure of the world (1,100 km long). The processing facilities comprise:

a.????? crude distillation unit

b.????? residue fluid catalytic cracking unit

c.?????? diesel hydro-treating unit

d.????? continuous catalyst regeneration unit

e.????? alkylation unit

f.??????? Sulphur recovery and Hydrogen generation facilities

g.????? polypropylene unit

The refinery with a Nelson complexity index of 10.5, is designed to process Nigerian Crude mix with Nigerian OSO condensate. Its products are propane, Gasoline and Diesel Products meeting Euro V norms, Jet Fuel and Slurry Oil meeting carbon black feed stock (CBFS) specification. The complex will also generate solid products of polypropylene and sulphur.

According to the project’s ESIA report of 2015, the location of the project was to take advantage of the proximity to offshore oil and gas blocks in Nigeria that could be a source of feedstock. This is illustrated by the following graphic extracted from the report.

MODELLING ASSUMPTIONS…

To proceed with the refinery's financial modelling, I will set out some assumptions on oil price, product price, costs, and the applicable fiscal terms.

Oil price

The price of oil is an important driver of refinery economics as it determines the feedstock cost as well as the price of refined products. For this model, I will adopt $65/bbl as the flat price for the horizon of the model as the average oil price between 2000 and 2023 is $64/bbl. Oil price exhibits volatility and time series probabilistic models can be used to capture that behaviour for forecasts. But I will not be modelling that today – sorry hard core data science folks!

However, as a compensation, I will offer up a sensitivity analysis.

Product Pricing

The resulting product prices from the Dangote refinery has perhaps been of the utmost concern to the consumers.

My base assumption here is that the products will be priced on an import parity basis.

You'll be able to read more about this basis here, here and here. Import parity pricing refers to a pricing strategy that prices the refined products as though they were imported. Consequently, all the costs associated with the import of the refined product goes into the determination of its price.

In a previous article, I had described how the import parity pricing mechanism works in some detail.

Table 1 shows the applicable product prices indexed at $65/bbl on an import parity basis.

Fiscal Regime

The location of the Dangote refinery in the Lekki Free Zone (LFZ) implies that it is exempt from taxes. According to Section 8 of the Nigeria Export Processing Zones Act (2004):

“…approved enterprises operating within Free Zones shall be exempt from all Federal, State and Local Government taxes, levies and rate.”

Further, Section 18(1) of the NEPZA provides that

“… legislative provisions pertaining to taxes, levies, duties and foreign exchange regulations shall not apply within the Zones…”

However, if the refinery were not located in a trade-free zone, it would be treated according to the provisions of Section 302(6) of the Petroleum Industry Act (2021), Section (39) of the Companies Income Tax, as well as relevant provisions in the Finance Act (2023).

The relevant fiscal provisions are codified in Table 2

While the location of the refinery in the LFZ exempts it from taxes, the estimation of government receipts allows me to estimate the “forgone” receipts to government by having the refinery in the LFZ. These may also be viewed as the cost of the incentives enabled by the NEPZA and enjoyed by the project.

Financing

According to the erstwhile Governor of the Central Bank of Nigeria , the refinery was 50% debt-financed. I have assumed an interest rate of 8% as my estimate of the blended rate and tenor of 10 years. This is summarized in Table 3.

Refinery Attributes

Table 4 summarises the refinery's attributes relevant to the financial model. I have the advantage that key components such as the CAPEX are already known. Construction of the refinery started in 2017 and took 7 years. I have thus used the S-curve method in cost engineering to estimate the CAPEX schedule.

I assume a long-term capacity utilization of 80% and an annual on-stream day of 350 days.

Using OPEX figures from US refineries, I assume variable OPEX of $8/bbl and fixed variable of $200 million. Additionally, I input a $300 million maintenance CAPEX incurred every three years after the refinery commences operation.

The yield of the refinery is captured in Table 5. This shows how much product can be expected from a barrel of crude oil refined from the refinery.

Gasoline is the most product produced from a unit of crude oil at 45.8%, followed by jet fuel at 29%.

Even though foreign exchange is an important factor in the refinery's assessment, I have not explicitly modelled its impact. I have assumed revenues and costs in a single USD currency.

I have also not modelled Nigeria’s refined products demand and, by extension, the fraction of refined products that will be exported vs. that which will be sold domestically. This is an important factor in segregating the pricing basis of products from the refinery.

RESULTS…

And now for the outcome!

I have provided the refinery valuation results with and without the LFZ's tax exemptions. My modelling indicates that the Dangote refinery delivers an NPV10 of $38 billion with the LFZ's tax exemption benefits. Without the tax exemptions, its value would still be $27 billion.

Table 6 provides some more detail.

Note that if the refinery were subject to tax, I estimate that total government receipts over the 20-year time period of the model would amount to $27 billion. The refinery’s total cash flows would be $74 billion instead of the $101 billion estimated in its current tax-exempt jurisdiction.

Illustrated below is a graphic showing the project's net cash flow with and without the tax exemptions.

Without the benefit of the FTZ, the refinery project net cash flow (represented as the blue line) would decline from 2029 due to the commencement of tax payments, five years after the commencement of production in 2024. However, because taxes do not encumber the project, a higher level of net cash flows, represented by the red line, is possible.

ALONG CAME A SPIDER: SENSITIVITY ANALYSIS

I provide the spider chart below, which characterizes the size and direction of key variables' impact on the refinery project's value. I focus on three variables: crude oil price, product price, and OPEX. Since the CAPEX is already spent, I ignore this variable which would otherwise be an important consideration. Exposure to foreign exchange risk would also be an important variable for assessing its impact on the refinery project value. However, I do not consider that here.

The steeper the line, the more influential the variable it represents is on the net present value. Additionally, a positive sloping line indicates that increase in the variable leads to increased value and vice versal.

Armed with this understanding, we see that product price exhibits the most significant impact on the net present value of the refinery project – and in a positive direction too. For every 10% increase in product prices, NPV10 increases by $37 billion. However, a 10% increase in oil price will improve value by $12.6 billion, and a 10% increase in OPEX will decrease refinery value by $2.9 billion.

This sensitivity shows clearly that product pricing is critical to delivering value to the refinery project.

IN SUMMARY…

The Dangote refinery was conceived as an export-oriented facility and designed to receive and process as much 10 different crude types. The scale of the project can be appreciated if it is considered that its capacity alone has increased Africa’s total refining capacity by 20%.

Financial modelling of the refinery project yields an NPV10 of $ 38 billion, which would have been $ 27 billion if the project were not in a tax-exempt jurisdiction. Meanwhile, under NEPZA, the government has given up $ 27 billion in lifecycle receipts from the project, which has propped up the refinery cumulative cash flows over the 20-year model horizon to $ 101 billion. Product pricing is the most significant factor on the project value.

Over the period I modelled, the refinery will process 2.9 billion bbls of crude oil – which is about 8% of Nigeria’s current reserves – and consume 25.5 bcf of gas. Further, I reckon that the refinery will emit an average of 8 million tCO2eq/annum, which is about 7% of Nigeria’s total emissions as of 2019. This amount works out to 122 million tCO2eq over the life of the model, and if carbon pricing were implemented at $30/t, it would add $ 4 billion to the coffers of the Climate Change Fund (Section 15(1-e) of the Climate Change Act) – only if the refinery were not in a tax-exempt jurisdiction.

PLEASE TAKE THIS AWAY…FOR NOW

The multi-billion-dollar Dangote refinery represents a significant investment and a value proposition difficult to discount. Sensitivity analysis shows that its value is most sensitive to the price of refined products. While consumers have been interested in whether the refinery will lead to reduced prices at the pump, the analysis suggests that it is in the interest of the project owners to maintain a product pricing strategy that preserves the value of the investment for the long haul.

I have only provided a deterministic view of the refinery valuation; however, such valuation will benefit from a stochastic treatment. Probabilistic modelling allows exploring a wider spectrum of possible futures using a rich ensemble of distributions.

The project can alter the crude oil and refined product trade flows with implications for the Atlantic Basin and downstream markets. I'd like you to stay tuned for my next article.