Reflections on fuel subsidy regime
Between 2011 and now, Nigeria has spent about N20t on fuel subsidies. While over N5t is currently being spent, the Minister of Finance, Budget & National Planning, Zainab Ahmed, said about N7t will be spent in 2023 on the same project.
KINGSLEY JEREMIAH and ADEOLA ADENIKINJU, professors in the Department of Economics and Centre for Petroleum, Energy Economics and Law at the University of Ibadan, in this report provide many reflections on this development in an ailing economy.
Over the years, fuel subsidy has become a very controversial issue in the country. First introduced into the country in 1973 as a palliative to cushion the landing cost of petroleum products delivered to refineries, following the need to carry out Turn Around Maintenance (TAM) on them, the palliative has since been used as a social transfer mechanism to ease the burden of high fuel prices on the masses.
Before its introduction, the price of petrol was fully determined by market forces to reflect the cost of crude, plus the cost of processing it, as well as transportation, and marketing costs. In some cases, local taxes were also factored in.
Hence prices of fuel vary across the country. While they are lowest in towns and cities close to the refineries, they are quite high in locations miles apart from the refineries.
With the rising population imposing a growing demand on the product, the burden of sustaining fuel subsidy year-in, and year-out has become quite heavy.
In 2011, the government spent $8.4b on gasoline subsidies. An estimated ₦10t is reported to have been spent on subsidies between 2006 and 2018. This year alone, an estimated N5t will be spent on subsidies. This, experts say, has made it difficult for the government to have adequate funds for the provision of basic social amenities and critical infrastructure.
In addition, the fuel subsidy scheme has been fraught with fraud and corruption, and the report of a Presidential Committee on Veriﬁcation and Reconciliation of Fuel Subsidy Payments between 2009 and 2011, revealed that the government wasted up to ₦667b (about $4.3b) annually subsidising millions of litres of petrol that Nigerians never used, or even needed. Some of the gasoline could not even be traced.
In essence, the 50 years of the implementation of fuel subsidy has imposed huge costs on the Nigerian economy. The period also coincides with the collapse of the downstream petroleum infrastructure, including the refineries, depots, pipelines, and storage facilities, among others.
For a while, we were net petrol products exporters, the position that Dangote Refineries will soon fill, but Nigeria, like most other West African countries, will soon start importing refined products from Dangote Refineries Ltd.
The sad thing is that the current discussion around fuel subsidy has focused narrowly on fiscal loss and household income loss, while the impact of fuel subsidy on fiscal loss is significant. Also, the impacts of price adjustments on households’ real income may be significant. But the debate is, however, more extensive, and broader beyond the two issues above.
Be that as it may, beyond some of the popular arguments around fuel subsidy, there is sufficient evidence to sh
ow that some of these popular views are sometimes half-truths and provide incomplete pictures of the reality of the fuel subsidy situation.
NIGERIA has the lowest gasoline price compared to her neighbours, and this is even though some of the countries like Cameroon are also net exporters of fuel products. The huge difference provides huge incentives for arbitrage by selling in those countries. The implication is that Nigeria finances fuel consumption in those countries. By showing the per capita income among our neighbours, we can also see that poorer citizens in those countries are paying higher prices for fuel compared to their counterparts in Nigeria.
If they could afford to pay, why is it that some people are arguing that Nigerians would not be able to do the same? Empirical evidence (as confirmed by the table above) also shows that higher fuel prices in those countries do not correlate with high inflation as Nigeria, with her long-standing fuel subsidy scheme has a significantly higher inflation rate than other African countries without fuel subsidy.
The way that subsidy, being the difference between the price paid by the consumer and the cost of supply is implemented in Nigeria is that the Federal Government fixes the pump price for gasoline and then pays the difference between that and the open market price.
Currently, the cost of supply of PMS is around N396 per litre. However, the same litre of fuel is sold to consumers at N165 per litre at the pump. Now, using the definition above, every litre of fuel consumed by Nigerians is subsidised by the Federal Government by at least N231.
But more formally, subsidy for a tradable energy product like PMS, is the difference between the sale price and the marginal opportunity costs (MOC), where the MOC is the export price (FOB), or the import price (CIF). The MOC for an exhaustible commodity like fuel should reflect the costs of production, the user cost (since future generations are deprived of the use of the same product), and the environmental cost to the current generation.
The tradable price (export price or import price) captures the MOC. The implicit role of the exchange rate then becomes a very important determinant of domestic price for any tradable commodity.
This is the reason that even if our refineries are working, the domestic price of fuel should still reflect the MOC, not the average costs of production as non-energy professionals would argue. Otherwise, only public refineries would be operational, and then they would be operating at losses, as has been the case for domestic refineries over the years.
From Table 2, which shows the cost structure for gasoline in the country indicates that there are three major components: direct cost (costs of crude, costs of refining and freight, port, and storage charges), distribution margins, and taxes. In many countries, fuel taxes constitute a useful source of government revenue to fund, subsidise public transportation, road construction/maintenance, and provide social services. In Nigeria, fuel taxes are zero as can be seen in Table 2.
A relevant question is the impacts of domestic refining on final fuel price or subsidy. Domestic production of fuel will knock out about 20 per cent of the actual price of fuel (costs of freight, NPA, lightering, storage, financing, traders margin, etc.). Hence, the actual price of oil should be N396-20 per cent (N396) = N316.80. This is still substantially higher than the N165 per litre at the pump.
Fuel Subsidy has significant economy-wide impacts that are often lost in the discussion around subsidy removal.
ANOTHER general equilibrium impact of fuel subsidy can be gauged through lost investment and employment foregone. It is difficult to directly measure the impacts of investment loss and jobs foregone as a result of fuel subsidy. However, we can make indirect inferences. The example of the telecommunication sector provides a very good comparison. The oil refining sector was a bigger sector than the telecommunication sector in 1981. Oil refining was the 27th largest sector in the GDP in 1981, out of the 46 sectors in the national accounts, while telecommunication was the 33rd largest sector.
However, with the liberalisation of the communication sector from 1999, the sector witnessed an influx of investments and multinational companies (MTN, AIRTEL, Glo, etc.,) and thousands of direct and indirect jobs. By 2017, the two sectors had changed relative positions; telecommunication had risen to become the fourth largest sector, while oil refining regressed to the 28th largest sector in the economy.
Without data on employment and investment in the two sectors, we can infer that given the known statistical relationship between output, and employment and investment, the massive increase in the output of the ICT sectors would be directly related to investment and employment. The liberalisation of the ICT sector engenders competition and market forces to operate and determine economic activities in the industry. The competition and market forces unleash forces that force real growth in investment in telecommunication.
Apart from the effects on investments and employment, MTN is the highest tax-paying organisation in Nigeria. The significant increase in non-oil revenue of the government comes from the taxes from key players in the telecommunication sector, MTN, AIRTEL, etc.
Nigerian citizens have also benefitted from ownership of shares in telecommunication companies quoted on the Stock Market. MTN is currently the biggest company on the NSE.
What the examples of telecommunications have shown in terms of growth in output, employment, investment, tax revenue, and equities opportunities are some of the lost opportunities that the country is missing from the non-liberalisation of the downstream petroleum sector.
Defenders of the current subsidy regime are of the view that subsidy removal would cause inflation, as higher costs of production would be passed on to the final consumers. This is true. However, the increase in the average price level would be proportional to the share of fuel in overall costs of production or share in consumer expenditure. Hence, for the low fuel-intensive sector, the direct impact of higher fuel prices would be low. However, the extent to which the increase in price from higher fuel prices can be passed on to consumers would depend on the nature of the elasticity of demand and supply for the product.
However, what many people fail to appreciate is that the current subsidy regime also fuels current inflation through higher budget deficits that are financed through ways and means and other forms of public debts. Most economists are in agreement that budget deficits financed through ways and means are inflationary. Current data shows that 95 per cent of government revenue is spent on payments of interests on government debts. It follows, therefore, that nearly all non-debt recurrent expenditure is financed by debt, including fuel subsidy. This is inflationary.
Unfortunately, besides the fact that the current fuel subsidy is inflationary, it has additional negative consequences on the economy.
The current fuel subsidy and removal of subsidy are both inflationary. However, a shift to liberalization will ensure that fuel prices like other commodity prices will crawl around a long-term trend rather than by fits and jumps that cause significant price shocks in the economy. This will be a lot easier for consumers to adjust to, and less disruptive of economic agents’ budget constraints.
Both current fuel subsidies and what will occur after subsidy removal have negative equity effects. Nearly 80 per cent of current subsidies are appropriated by the top 20 per cent of the society. The last 40 per cent of the society benefits less than 10 per cent with poor rural folks even with lesser benefits. In the short term, the poor will not only lose their share of the benefits but also pay some share of the inflationary costs. It is this category of society that should be considered in petrol price adjustments. Some forms of cash transfers, or more appropriately channeling more government expenditure to support commodities that the poor consume could be one way of mitigating the economic impacts on the poor. The subsidy recovered from the rich can be used to support the poor.
Another common argument against subsidy removal is that the additional revenue from subsidy removal will be stolen, or misappropriated by the government. This argument does not recognise the essential element of liberalisation.
The current subsidy regime has given so many discretionary powers to government officials that have turned the administration of subsidies over the years into a cesspool of corruption.
The sudden increase in daily petrol consumption from 30 million litres in less than five years to a current estimate of around 100 million litres per day is a testimony of underlying sleaze and perhaps smuggling effects, as fundamental economic drivers do not justify the growth, after controlling for the rise in the price of fuel, downturn in economic activities due to the pandemic, insurgency, decline in transportation activities, among others.
The 2012 House of Representatives report on the downstream petroleum sector shows the network of corruption in the regulated environment, including the foreign exchange sleaze that took place during the period.
With liberalisation, the government’s involvement in the sector will move from direct participation to indirect, as is happening in another network industry, the telecommunication sector. The downstream petroleum sector should be able to attract global players in the sector like MTN, Airtel, Globalcom and others. MTN and Airtel today are among the largest contributors to domestic investment, employment, and tax revenue.
According to the Federal Inland Revenue Service (FIRS), the combined taxes revenue from top 17 companies listed in the Nigerian Exchange Limited (NGX) was N589,6b in 2021. MTN paid N138.03b, second only to Dangote Cement Ltd which paid N173.92b. Total company income tax in 2021 was N1747.99b, while total Petroleum Income Tax was N2006.45b.
In other words, MTN alone pay nearly 8 per cent of total company income tax in 2021.
Furthermore, with liberalisation of the downstream petroleum sector, the government’s direct participation will cease, and hence that source of corruption will be removed. The government will only depend on tax revenue from players in the downstream petroleum sector. Hence, corruption from fuel subsidy management will disappear or be substantially reduced as was the case with liberalisation of telecommunication, and the electricity sectors.
Tunji Oyebanji of the Major Oil Marketers Association of Nigeria (MOMAN), expressed fear that the attempt to continue to control petrol price would negatively affect investment in the sector, stressing that the government has historically been constrained to retain the price due to political considerations, especially since the move has always had civil unrest as fallout.
Oyebanji disclosed that the lack of uncertainty in the sector has already led to divestments, adding that the industry needs significant investment, which could only come from certainty and full deregulation, as well as a level playing field.
Demanding an enabling environment to make the sector drive the nation’s sick economy, Oyebanji said: “We need to put behind us the need to control price. What we need is an agency to come down heavily on anyone who abuses regulations and imposes significant fines as it is done in other sectors like telecommunication. That would address the concern that some people may have expressed.”
An energy professor at the University of Lagos, Yemi Oke, insisted that it is now clear that agitations against subsidy in 2012 were politically motivated.
He said that such political gimmicks would not help any country, adding that petroleum products remained a global commodity that reflects economic realities that may be beyond local politics.
“It was clearly a political game and it’s backfired. The fact that we don’t have people on the streets, campaigning and demonstrating against the current administration shows it was all needlessly politics,” he noted.
Oke said given the realities in exchange rates and other economic indices, improving on local refining of crude oil and subsidising production instead of consumption remains the most sustainable option.
He said: “We are discussing the removal of a subsidy that no one knows for sure how much it amounts to. How much exactly will you be removing when you eventually come around to deregulating?
“The problem really is that because corruption has dogged all efforts at fixing our refineries over the years. It defies every logic that we could be a super-producer and still be here talking about the economics of spending nearly a trillion naira in just over two years for freighting refined products back home for domestic consumption. How can you be a yam titleholder and be depending on other people to eat pounded yam?” Oke questioned.
Taking a glance at what a post-subsidy era economy will look like in the long term, experts maintain that first, there will be an influx of new private companies in the sector that will bring innovation, efficiency, competition, investment, new jobs, and that would pay billions of naira into government coffers as taxes.
“Next, we will have a sector with new and modern infrastructure including refineries, pipelines, depots, storage tanks, and petrol stations. Long queues and fuel adulteration will no longer be a regular occurrence across the country. There will also be less dependence on inefficient fuel tankers to deliver fuel over long distances. Normally, fuel trucks are supposed to carry fuels from the nearest depots to fuel stations in the city or town. The current practice of using trucks to move fuels from Lagos to different parts of the country has destroyed our roads, led to the deaths of innocent Nigerians, and destruction of property.
“In addition, smuggling of fuel to neighbouring countries will no longer be profitable as prices of fuel across the region will closely align. Nigeria will no longer subsidise fuel consumption across the neighbouring countries and provide a source of revenue for their governments through taxes imposed on fuels smuggled from Nigeria. Government-controlled refineries will likely be sold to the private sector or run like private sector companies. Nigeria will no longer spend N13 billion every month on refineries that are not producing and are inefficient.
“Furthermore, removal of subsidies will encourage efficiency in fuel consumption, and promote the switch to green energy in the energy consumption mix of Nigeria. The rich folks will pay for the fuel they consumed, while some support will be provided for the poor, for instance, by diverting more government expenditures to social goods.
“After the initial shocks, the adjustment process in fuel prices will follow those of other normal commodities delivered by the market. Fuel prices will move more instantaneously around their long-term trends rather than proceed in fits and jumps that have caused major shocks in the economy.” in the Department of Economics and Centre for Petroleum, Energy Economics and Law at the University of Ibadan, in this report provide many reflections on this development in an ailing economy.