Nigeria’s petroleum subsidy quagmire and considered policy options

Economists characterise market failure as an inefficient distribution of goods and services in a properly functioning free market economy. After all, free market orthodoxy establishes the principle that the market forces of supply and demand should ordinarily determine the prices of goods and services.

The logical deduction therein is that a subsidy, in economic terms, clearly exemplifies market failure. And for clarity, within a capitalist economic system, subsidy entails the hypothecation of money by a State or public authority that’s granted to reactivate a business or industry to repress prices for a finite period only.

Nigeria is in focus! One, because the new administration of President Bola Tinubu has signalled a policy intention to scrap the costly and unwieldy – circa N7 trillion or USD15.1 billion- petroleum subsidy regimen. Two, because powerful labour unions are advancing plans to commence disruptive nationwide strikes in opposition to the administration’s stance. Three, because by any objective assessment, the petroleum subsidy is unsustainable, however, any decision to scrap it ought to attract a less costly quid pro quo for the benefit of ordinary people on a minimum wage of N30, 000 (USD 65).

Cutting straight to the chase, isn’t Nigeria Africa’s largest oil producer and an established member of the Organisation of Petroleum Exporting Countries (OPEC)? Why does the country labour under perennial fuel shortages? If the nation’s publicly owned refineries Warri, Kaduna, Port Harcourt and Onne are non-performing, why not sell them, competitively, to best in-class international or local entrepreneurs?

Are the bottlenecks in the downstream sector so insuperable as to imperil seamless delivery of petroleum products to consumers? Do existing pump prices reflect global economic realities? Is the petroleum subsidy regime aiding or hindering effective and efficient distribution of petroleum products?

Fact is, petroleum is the cornerstone of Nigeria’s economy and the country’s main foreign exchange earner. Approximately 90% of Nigeria’s foreign exchange earnings, and approximately 66% of the government’s income emanates from petroleum exports. Through 2017 and 2021, Nigeria earned over $206 billion from crude oil exports; $37.9 billion in 2017, $54.5 billion in 2018 and $45.1billion in 2019 (OPEC). The exceptional outcomes of the COVID- 19 pandemic in 2020, yielded lower returns for the country; $27.3 billion; although that increased to $41.3 billion in 2021. Notwithstanding, crude oil exports constitutes less than a 10% of (GDP).

Whilst Lagos State is an interesting, albeit, immature outlier, Nigeria, is yet to have fully functioning, consistently safe, seamless, technology-enabled multimodal transport connectivity; whether via roads, rail systems, trams, underground networks, air and sea to serve a population of circa 220 million people. Road transport accounts for 90% of the country’s passenger and freight transport according to the National Integrated Infrastructure Masterplan (NIIMP).

Proceeding upon this foundation, the unimpeachable outcome is that the extant perennial fuel shortages nationwide choke the arterial lifeblood of the economy. This imperils supply chains and compounds the country’s unemployment rate that’s projected to rise to 37% in 2023 (NESG). Therefore, the cruciality of petroleum to the national economy cannot be overstated.

For context, an international comparison is pertinent to get a sense of the true cost of the product. As at May 29, 2023, the unit cost of a litre of petrol in Nigeria’s closest western neighbour, Benin Republic, was approximately $1.059; Cameroun, Nigeria’s eastern neighbour, $1.195; UK, $ 1.778; South Africa, $1.168; OPEC member, Gabon, $0.990; and Nigeria, $0.550
(globalpetrolprices.com). The official central bank of Nigerian foreign exchange rates of USD 1 to the naira was circa N462 on May 29, 2023. Comparatively, in naira terms, therefore, a unit of petrol in Benin Republic was approximately N489; and N552.09K in Cameroun. Plus, it was N821 in UK; N539.61K in South Africa. And, in the OPEC member countries, Gabon and Nigeria, the price was N457.38K and N254.10K respectively!

Barely a year ago on July 19, 2022, the Nigerian National Petroleum Corporation (NNPC), the regulatory agency, approved an upward review of petrol prices from N165 to N179 per litre. Self-evidently, from this highly informative, albeit small, sample, the unit price of petrol in Nigeria is amongst the cheapest in the world and instantly creates a disconnect between the real market value of the commodity and the populist regulated prices. This is an illusory reality, patently unsustainable and an evidence of market failure.

Unsurprisingly therefore, the NNPC on May 31, 2023 upwardly reviewed pump prices “in line with the current market realities” to between N488 (USD 1.056) and N555 (USD 1.20). The latter decision has witnessed lengthy serpentine fuel queues criss-crossing the country, added stress on people simply embarking on their daily lives and prompted threats of industrial action by the leading unions.

Plus, Nigeria operates a dual foreign exchange (forex) mechanism with official rates, and the so-called parallel foreign exchange market with licensed forex dealers “bureau de change”. The former is scarce, strictly limited to priority areas of the economy and highly regulated by the Central Bank of Nigeria in part to manage tight forex amidst competing demands. The latter is regulated albeit more flexibly allowing businesses and individuals in need to access the parallel markets.

The challenge is that parallel market rates are more reflectively of the true value of the local naira and are nearly always higher than the official rates. Thus, the unit prices of petrol illustrated above at parallel rates would, certainly be much higher than the CBN rates; a phenomenon which facilitates harmful arbitrage and begs the question as to why there isn’t, after the first quinary of the 21st Century, a singular countrywide forex regime to provide clarity to foreign and domestic investors ditto market participants?!

Whilst an argument can be advanced that the average Nigerian citizen barely partakes of the dividends of democracy in that they lack consistent access to qualitative education, healthcare, clean energy, clean water, power and, of course, fuel. The inference being that they must benefit in some way from the proverbial black gold: crude oil!

President Tinubu

That’s certainly an argument; albeit a philosophical argument. However, the more commanding argument is that fuel prices, at a fraction of the market cost in neighbouring countries and further afield, will accentuate, sharp arbitrage practices and market failure. Because, there is little or no incentive for marketers and retailers to sell fuel below cost price, at a loss, in the absence of a fuel subsidy regime; when they can sell in neighbouring countries for profit. The issue is economics and not politics. Simple!

Global dynamics are equally important here. Nigeria’s four major publicly owned refineries in Warri, Kaduna, Port Harcourt and Onne are neither refining petroleum products for export markets nor for the domestic market. Not only that, between 2015 and 2019, the country spent $37.85 billion on refined petroleum products.

In the same period, the country’s aggregate import bill was $220.2 billion. In short, approximately 17% of the country’s import bill was on refined petroleum products, the raw material of which is crude oil, which she produces. In 2020, Nigeria imported refined petroleum products from The Netherlands ($3.02 billion), Belgium ($1.45 billion), Norway ($659 million), India ($415 million) and UK ($392 million). These are vast sums!!! The country also imports refined petroleum products from Ukraine.

The ongoing Russian vs Ukrainian war has not only cost tens of thousands of lives, it has also imperilled supply chains including petroleum products to Nigeria. Besides, the Dangote Refinery, with a projected capacity of 650,000 barrels per day, of which the Nigerian government is a strategic investor, is yet to come on stream. Brigaded, is the complex and opaque petroleum subsidy regime. It costs the Nigerian economy approximately N500 billion monthly and by end 2022 will cost the country approximately $9.6 billion (International Monetary Fund/Reuters).

The combined effects therein are to constrain whatever limited foreign exchange the country has to support other sectors of the economy including aircraft maintenance, agriculture, defence, healthcare, manufacturing, technology infrastructure et al.

George A. Kelly, characterised a disorder “as any personal construction which is used repeatedly in spite of consistent invalidation” (The Psychology of Personal Constructs,1955). Plainly, that means repeating the same actions with an expectation of different outcomes is irrational. Thus, exporting Nigerian crude oil to refineries abroad, and then re-importing the refined petroleum products in the form of petrol, diesel, jet A1fuel, underpinned by a convoluted and expensive petroleum subsidy regime, is manifestly unsustainable on three formidable counts.

One, it is demonstrably inefficient because the supply chains from Nigeria to the Americas/Europe and then back to Nigeria defies logical coherence and the principles of agglomeration economics. Second, the unintended consequence here is to export jobs to those markets at the expense of the Nigerian economy at a time when the NESG projects a 37% unemployment rate in 2023.

Three, it imperils the domestic economy because scant foreign exchange is used to support a petroleum subsidy regime which not only compounds transaction costs, but spurns negative opportunity costs in that necessary forex is insufficiently utilised in critical sectors like healthcare; clean energy infrastructure; aviation spare parts; upgrading critical defence equipment; data analytics etc.

Ending, the concluding recommendations are;
1.) Urgently review the opaque and costly subsidy regime whilst proactively engaging key stakeholders and unions;

2.) Any policy decision to scrap the petroleum subsidy should, reasonably, factor in effective risk mitigation plans to cushion the effects on vulnerable Nigerians barely eking a living on a moribund monthly minimum wage of N30, 000 or USD 65; 3.) Market forces, counterbalanced, with effective, light-touch and nimble regulatory policies should govern the downstream petroleum sector;

4.) Fuel prices should reflect market realities with a progressive tax regime for larger engines and polluting vehicles, by extension, enhanced fiscal revenues; 5.) Dual forex regimes fuel corruption, create unhealthy arbitrage, which harms market efficiency and, ultimately, consumers;

6.) Like all businesses, refineries are best run by proven, innovative entrepreneurs with the risk capital and performance incentives;

7.) It follows that serious consideration should be given to offloading the static quartet of Warri, Kaduna, Port Harcourt and Onne refineries to market entrants with the drive, verve, innovation and entrepreneurial capacity to make them viable businesses; and

8.) Strategic vision, transformational leadership, political will, tenacity and consensus building are required to embed these proposals which, ultimately, will reset the economy in favour of Nigeria Plc.
Ojumu is Principal Partner at Balliol Myers LP, a firm of legal practitioners and strategy consultants in Lagos, Nigeria.