Friday, May 29, 2015 9:08 AM / FDC
Nigeria, the 7th largest OPEC producer and a stalwart of the oil cartel, was mired in a vicious cycle of a scandalous “crude oil for a refined product” swap arrangement. This set of deals that has left the country hemorrhaging and being sucked by economic parasites in the name of importers of refined products, is one of the greatest travesties of the decade.
Nigeria spends N220bn ($1.1bn) per annum ostensibly to subsidize an average of 750,000 metric tonnes per quarter of refined products. This amount is the equivalent of 4.89% of its budget and 2.04% of its export revenues to subsidize consumption. The opportunity cost of this scheme is a significant shortfall and an accumulation of contractors, salary and cash call arrears.
The last strike paralyzed the nation due to this web of complicit public officers and conniving marketers, to ensure that this sys-tem continues even into the life of the new administration. The blackmailing cartel of downstream importers says that the bone of contention is the exchange rate impact on the shipments of the last 45 days of approximately N159bn.
A cursory look at the subsidy scheme shows that the steep in-crease in the amount spent on subsidies cannot be justified by the population growth, nor the number of cars imported into Nigeria.
What is Subsidy?
Subsidy is a set of government policies in aid of one or more industries, usually a financial benefit to the industry. At the conventional level, it is a form of financial aid or support extended to an economic sector (or institution, business, or individual) generally with the aim of promoting economic and social policy.
Subsidy in the Nigerian Context
Subsidy granted to importers of refined crude products by the government is the difference between the expected open market price (i.e. landing costs plus distribution margins) and the actual retail price (i.e. pump price) of consumers at the fuelling stations. Its sole purpose was to alleviate additional expenses associated with the importation of refined crude products. However, insatiable corruption embedded within the domains of the public and private sectors has brought about subsidy losing its essence as a tool for social re-engineering.
There are two elements to the subsidy issue, the first is the amount spent and its direct, consequential and opportunity cost. The second is the structural weakness in the system which continues to be exploited by regime related cronies to corrupt the system and ensure that Nigerian refineries remain dilapidated and inoperative.
In January 2012, the government attempted to initiate a zero subsidy programme which resulted in a 117% increase in the pump price of petrol to N141/liter from N65/litre. Sever public backlash followed and the pump price was lowered to N97/liter. The sharp decline in oil prices which started in 2014, pushed many oil exporters to embark on austerity measures to mitigate the impact of lower prices on their fiscal revenues.
Ghana partially removed its fuel subsidy while Angola has fully removed its fuel subsidy payment effective September 2015. The Nigerian government on the other hand reduced the pump price of petrol by 10% to N87 in 2015. Several prominent economic advisors have proposed that now is the time to remove the subsidy on fuel given that oil prices are low and the subsidy margin is minimal. Any future increase in oil prices would then be transferred to the consumer.
The current fiscal problem facing Nigeria is further impetus to re-move the subsidy. Between 2006 and 2013, the government spent over N5.42 trillion on subsidy, which was 15.57% higher than the 2014 national budget of N4.69 trillion. For the 2015 budget, a total sum of N220 billion has been allocated to the subsidy. Yet, the economic growth and development resulting from the subsidy is negligible at best. Therefore, it is imperative to analyze the potential costs and benefits associated with a subsidy removal.
What are the Benefits of Subsidy Removal?
The benefits associated with a subsidy removal are usually long term which will be solely determined by how the appropriated subsidy funds will be utilized to support optimal productivity within the economy.
If the subsidy were removed today, the pump price would jump to approximately N130, which is the total open market price when one considers both the landing cost of petrol at N115.77 and the margin for transporters and exporters of N15.49 as of May 10, 2015.1 However, the pump price would be guided solely by global oil prices and would not be at the mercy of oil marketers. Currently, scarcity initiated by the oil marketers due to delayed payments increased the pump price of petrol. The scarcity created an avenue for arbitrage, with the fuel being sold for as high as N600/liter in the black market. The impact of the strike and fuel scarcity was severe, and almost crippled economic activities, as banks and even telecom operators had to reduce their operating hours due to the scarcity of petroleum products.
This situation could be averted if the issue of subsidy is addressed and put to rest. But addressing fuel subsidy is just one part of the hydra-legged problem in the oil and gas sector. The passage of the PIB and a deregulation of the sector are required to fully en-joy an efficient oil and gas industry.
In the long run, subsidy removal will assist the government financially and create a path to addressing the problems in the oil sector. At the core of the petroleum crisis is the state of the downstream infrastructure. The refineries as well as the distribution network were all built between 1978 and 1988. They ran efficiently for five to ten years largely because they were new facilities. However, decades of poor maintenance has led to a steady degeneration of these facilities to a near-zero performance.
Domestic consumption is currently 33 million liters per day and re-fining capacity is 30% of the daily domestic demand. Subsidy removal presents the government with the funds needed to reassess the state of the country’s refineries. Boosting refining capacity to above 50% of domestic consumption could put Nigeria in the position of being both a producer of crude products and an exporter of refined crude products. Subsequently, economic stability will ensue as pump prices will not be determined by external factors arising from the international oil community but rather economic activities within the country.
Are there Costs Associated with Subsidy Removal?
Subsidies are reverse taxes and if removed will reduce the disposable income of consumers in the short term. However, it will result in an efficient redistribution in income, spur a rehabilitation of the refineries and an efficient oil industry in the long run; short term pain but long term gain. More importantly, because there is an inflated import bill due to the subsidy scam, subsidy removal will reduce the pressure on the currency and the naira will appreciate in the medium term.
Subsidy removal has its benefits and is not without costs. What makes fuel subsidy removal good or bad is what the government does with the potential savings if the expenditure cut outweighs the revenue reduction. Furthermore, developing refineries is a costly venture that will only be beneficial in the long term. Medium term measures such as the deregulation of the downstream sector and increasing private investment will help dampen the cost effect of the removal in the short run.
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