Saturday, 14 May 2016

Petroleum subsidy saga and solutions

Picture of a government owned
filling station selling at new
ceilling price
By Dr. Ahmed Adamu

Recently, the Nigerian government once again removed subsidy on petroleum consumption in the country, on the account that setting the price at equilibrium will ensure optimal supply, competition, and end the illicit trade of the Nigerian subsidised products in the neighbouring countries. This sparked lots of comments and different opinions, and this article will shed more light on the subsidy and its flip side with some recommendations.

Petroleum subsidy existed for long time and in many countries, especially oil rich countries as it serves as the direct benefit citizens drive for having petroleum deposits in their countries. Initially, the subsidy was economically introduced to support structural changes in economies, and encourage usage and shift to more efficient technology and fuels. It was introduced in petroleum sector to enable access to cheaper factors of production, so that factories and industries can buy petroleum products and transport their products cheaply. This helped in quelling inflation, and increased investment. The subsidy also protected consumers from the volatility of the petroleum products prices.

Nigeria being one of the leading oil rich countries in the world introduced subsidy for over two decades, and for many Nigerians, they do not know how to live without the subsidy. As a result, any attempt to remove the subsidy is followed by protest and unrest. Recent of which is the 2012 subsidy removal. With the latest removal, some Nigerians still think, it is a wrong decision or bad timing, and may consider going to the streets, and the Nigerian labour union has already expressed dissatisfaction with the decision.

However, within Nigerian context, the subsidy was considered unbearable due to the increasing consumption of the petroleum products, which make the government spend up to a trillion Naira in just a year for subsidy payment. The petroleum subsidy regime had created avenue for corruption adding more to the subsidy cost. The subsidy payments keep increasing year by year, which could reach N2 trillion in two years time due to the increasing demand for local consumption, corruption and illegal exportation of the subsidised product. This has affected the government’s performance in major sectors of economy, and if allowed to continue will affect future economic growth. This can be worse if Naira continue to depreciate, as Nigerians have to pay more in local currency to import a unit quantity of the refined petroleum product.

The petroleum subsidy in the country was not targeted as even the rich people who could comfortably buy at competitive price still enjoy the subsidy, and yet, they consume more than the poor. So, the subsidy benefited the rich more than the poor.

Similarly, providing the subsidy has caused market failure as setting prices below the equilibrium, will cause excess demand, where consumers will be willing to buy more than the suppliers are willing to supply. Supply of petroleum products under regulated petroleum prices are discouraged as the suppliers are attracted to higher or competitive prices. So, the subsidy causes market imbalance, which is not desirable.

With the recent reduction in crude oil prices, the Nigerian foreign earnings reduced drastically, which depleted its foreign currency reserves, and resulted to its failure to meet local hard currency demand. This affected supply of the petrol, as marketers could not secure sufficient US dollars for the importation. This has caused further market imbalance, as it caused lower supply. So, the government is left with no option than to allow marketers with autonomous sources of foreign currency to import and sell at competitive price. Even though, access to local currency is not lacking, but lack of its convertibility has compounded the situation. So, foreign currency shortages made the market monopolistic, as only few marketers with independent sources can import, and this elongated the distribution chain, and increased the pump price.

Being someway monopolistic market, the anticipated competition may not come easily due to the reliance on few ways to acquire foreign currency, and due to the capital intensiveness of the petroleum importation. So, there might be cases of collusion to exploit consumers, which has started manifesting in some parts of the country. So, the country is seriously hit by resource curse, since despite its resource availability, it heavily imports most of its consumables, making supply of its local currency higher than its demand. Similarly, the too much sentiment and profit seeking in the industry make distributors aim for higher profit above the normal profit. The marketers must be sincere and sympathetic, as they are leaders in their own right, they should go for as minimal profit as possible. The consumers can play their role, by boycotting any filling station selling above the ceiling price.

Without the subsidy, any future inflation of petroleum products will be transferred to the citizens. However, if there is deflation, the government will not have the chance for over recovery, so the citizens will enjoy the price reduction directly. The removal of the subsidy will relief the government and enable it reinvest the saving on social responsibilities. It will set prices at equilibrium, and allow for free market. Suppliers will now be more motivated to import, and as a result, there will be more supply of Naira, which will further depreciate Naira. This will make the country spend more for every import, making factor inputs more expensive, leading to inflation.

 However, the removal will ensure energy conservation and efficiency, which will be useful to environment. Without the subsidy, unnecessary consumption of petrol will be reduced, which will lead to reduction in aggregate petroleum demand, and in the long run lead to petroleum price reduction. So, even if the price is high, people will reduce their consumption, and may not have significant effect on the total spending.

Despite the historical unrests and protests resulted from past subsidy removal, the country may not experience serious protest this time around, due to the unyielding trust and confidence on the current leader of the country, but the question to ask is, how would the Nigerians cope with the subsequent increase in price of petrol and other commodities, since incomes did not appreciate in the same proportion. Similarly, the resulting inflation will add to the cost of production and unemployment. So, to avoid serious hit on citizens, measures must take place to alleviate the looming catastrophe.

The removal of subsidy should have been systematic and gradual in phases, this will then prepare the consumers and make them adapt to new prices gradually. The continuous saving should then be reinvested in physical social projects that will justify the opportunity cost of the fuel subsidy. The price control measure must be in place and compliance enforced. The price of petrol should be flexible to reflect the volatile crude oil price timely, this will avoid over and under recovery. There must be strict supervision to checkmate cost composition and price compliance.

For example, this week, the NNPC announced that the maximum price of petrol is N145, which is the peak price. Even though the allowance is huge, but it does not mean all filling stations must sell at this price. The price at each filling station must be determined by their specific landing cost and other associated cost, but not above the N145 presently. This means, the price can be far lower than N145, and still viable. This peak price should be reviewed regularly. So, each supplier should declare their cost composition and selling price, and supported with evidence before acquiring a selling clearance, this will help avoid excessive maximization of profit.

In addition, the government should design programme (palliatives) to offset the price shock, for example, provision of monthly subsidy ticket for 60 litres per eligible consumer/car can be provided for at least six months in the beginning. The eligibility to benefit from this subsidy ticket is subject to economic status of the consumer and per vehicle. Ticketing shops can be established in each town, and this should be secured and trackable. For vehicles to benefit, they must be properly registered and renewed with the Road Safety Commission for verification. The beneficiaries must be honest, and only purchase the subsidy ticket if they are eligible, and they should not go beyond the 60 litres per month. The commercial vehicle subsidy quota can be extended to 200 litres a month. The filling stations can cash the served subsidy tickets at the relevant government agency. The transport fare must then be regulated per kilometre, this can change based on the prevailing peak price. The provision of convenient public transport, within and between states and towns must be provided, so that people can start selling their cars and go for these conducive public transport options.

The default long term solution will always be to sufficiently refine the Nigerian crude oil within its territory. This will evade the exposure of the fuel price to the exchange rate fluctuations and shortages in foreign currency reserves. It will also drastically reduce the refinery acquisition price and eventually the pump price. If Nigeria can sufficiently meet local petroleum demand without the need to import, the fuel pump price may reduce to about 30-40%. This can be much lower if government will consider subsidising the refining by then.

Currently, it will cost N138.26 to bring a litre of petrol to a filling station in Nigeria at the current crude oil price and exchange rate. So, it will still be profitable even below N145. So, it is a policy that, no litre of petrol should be sold above N145. Unfortunately, I just took petrol at N150 per litre. And I asked the manager of the filling station, why he sells at higher price than the peak price, and he said he bought it at higher price from a dealer. So, there is need to reduce the chain of supply to reduce too much profit seeking. Allocation or wholesale of petroleum products should only be to owners of filling stations, and they must show evidence of sale at their filling stations before they can be sold again.

Many countries that were providing subsidy have now removed it, for example, Venezuela provided the cheapest petrol in the world as a result of its petroleum subsidy. Despite having the world largest oil reserves, Venezuela stopped providing subsidy, and as a result, the price of petrol in the country rose by about 6000%, which is the first rise in 20 years. Though, 95% of foreign income of the country come from crude oil exports, the country had to use the revenue to subsidise consumption of petrol, which reduced the government capacity to invest in other sectors of the economy. Now Venezuela is facing economic recession, inflation of around 95%, hunger and unemployment.

Finally, since people are used to subsidy, removing it will be very sensitive, as such, the removal must be democratic to engage and convince citizens on the need to remove it. There should be immediate manifestation of resulting benefits after removing the subsidy, and the removal has to be gradual and targeted. It was envisaged that no country will give fuel subsidy in the next 10 years, due to increasing demand for petroleum products and the need to diversify the energy mix. So, the Nigerian subsidy removal should be restructured and revisited to make it systematic, gradual and clearly beneficial, targeted and inclusive. 

Dr. Ahmed Adamu
Petroleum Economist and Development Expert
Pioneer Global Chairperson of the Commonwealth Youth Council
University Lecturer (Economics) at Umaru Musa Yar'adua University, Katsina.

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