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The Nigerian Gas Market: The LPG Mind Shift

Oil & Gas	1560 VIEWS
Oil & Gas
1560 VIEWS

Saturday, March 06 2021 /04:00 AM / By Proshare Research/ Header Image Credit: EcoGraphics

The LPG Mind-Shift

The liquified petroleum or cooking gas (LPG) market is a mind-shifter and game-changer. Nigeria's gas industry will need to grow quickly, efficiently, and effectively if the local cooking gas market is to move the carbon-reduction needle towards carbon-neutrality within the decade and nudge users of wood, coal, and kerosene to switch to domestic gas. The local gas market will have to stand on its haunches and brave the challenges of mid-stream distribution difficulties as it attempts cost-reflective pricing. This is the critical microeconomic reason for this current memo to the market. Proshare's extensive research and public policy engagements suggest that the pricing of gas products could make or mar the O&G industry. If gas is priced in a way that does not reflect cost plus an operating margin, then no new investment in the domestic gas value chain can be expected over the next decade and this would slow down the race towards carbon-neutrality by 2030.

This brings to the fore the need to understand the Petroleum Pricing and Regulatory Authorities' (PPPRA's) slapping of an 'administrative charge' on the sale of LPG in the domestic market. Given the fact that the sale of LPG operates within a price-deregulated market framework, the PPPRA's charge on sales is a technical, market, and administrative oddity, which appears to be inconsistent with global best practices and is suggestive of value-destroying market distortion. The PPPRA's administrative charge claws at the consumer's microeconomic surplus and transfers value from consumers to a government agency that provides no identifiable service-for-fee.

As shown in the illustration below an administrative charge on LPG by the PPPRA would shift the product supply curve northwest and would raise product price and reduce product sales. The combination of these two effects, assuming that the quantity of gas demanded remains constant, would create 'deadweight' economic loss as represented by the triangle e0, e1, and e2 in the policy illustration below. This shows that the PPPRA charge would shrink both consumer and producer surplus (not illustrated in the diagram) as a fall in the product supply leads to a rise in price and a reduction in the quantity of gas demanded hence denying Nigerian consumers the market-determined value of domestic cooking gas that existed before the PPPRA decided to impose an administrative charge in Q3 2020 (this would be the consumer's accrued benefit from cost-reflective pricing of cooking gas before the PPPRA introduced its administrative charge in September 2020).

Chart 1: LPG: Implication of PPPRA's Revenue Mongering

Analysts note that at a time global economies have increasingly encouraged citizens to engage in the climate-friendly use of energy, the PPRA administrative charge introduces to the local gas market what economists have enigmatically called a negative externality. Negative externalities are the unintended or unseen or unmeasured consequences of a government or its agencies' policies or activities designed to influence the price or quantity of a good or service. For example, a rise in the cost of cooking gas would discourage poor communities from using cooking gas to prepare their meals and this, in turn, would encourage families to cook with firewood or kerosene which are less environmentally-friendly forms of energy. The use of firewood would worsen the already debilitating consequences of deforestation (pastoralists and farmers perennial conflict) which would not only lead to climate change but also damage arable farmland thereby causing a rise in the cost of food which in turn would push food inflation up and worsen local poverty.

The narrow fiscal consideration of PPRA's administrative charge ignores the wider and more complex microeconomic outcome beyond augmenting the agency's treasury. Also, since the PPRA budget is fully-funded by the federal government to ensure that its pricing template is unaffected by revenue and operational considerations, its decision to place an administrative charge on a product it performs no function in determining price is alien to global best commercial practices. The agency's intrusion into the price determination of local gas conflicts with the concept of a market-determined price mechanism and sends mixed signals to prospective investors in the sector.

Passage and approval of the petroleum industry bill (PIB) would eliminate the need for the PPRA as a price regulator in the oil and gas sector, in particular, the PPRA has no administrative function in a price-deregulated product market. The gas operators in the system should be regulated by the department of petroleum resources (DPR) which would set operational standards for market participants and allow prices to be determined by the forces of demand and supply.

Steering clear of the cost and price determination function of the market would lead to fewer misgivings about the government's sincerity in encouraging private sector investment in the domestic gas business.

The PPRA may need to sidestep avoidable conflicts that are not shaped by its statutes which prescribes its standard operating procedures (SOPs). The PPRA is not expected to be part of the cost or price formation process for entities doing business in the price-deregulated local gas market, it is that simple, and needs not to be crafted to appear more complex.

The Cobra Effect

PPRA's administrative charge may prompt what behavioural economists call a 'cobra effect' where the medicine is worse than the disease and the official charge creates avoidable disincentives and breaches the codes of fiscal optimization that require that a charge prices-in the marginal value-addition to the marginal cost of the service rendered. Since the PPRA does not provide measurable value-addition in the LPG price discovery process, the administrative charge is sub-optimal and reflects a deadweight loss borne by gas consumers. In other words, consumers get bitten by the Cobra's fangs.

LPG: What the Fortune Cookie Says

The LPG market has immense headroom for growth as gas use in the domestic Nigerian economy is still relatively low. How fast and how large the growth will depend on the administrative and pricing environment that buyers and sellers find themselves. In a market that is price-competitive with no regulatory distortions and the industry-standard operating procedures (SOPs) set by the DPR, the gas market would likely flourish and lead to a diversification of the O&G sector as gas variants become choice sources of domestic and industrial power generation, domestically and industrially.

If economies of scale and scope can bring prices down, then the demand for gas would rise and gas producers would be able to scale up revenues and output over the medium to long-term. This should be the likely outcome in 2021 as the government signs-off on the petroleum industry bill (PIB), and price-distorting regulatory action is nipped at the root. The signing of the PIB should incubate new life in the local O&G sector and allow larger cash flows into the business as investors see private market-influenced opportunities. Actions taken between 2021 and 2022 will shape the contours of the industry over the next decade.

Though the PIB as currently drafted has some conflicts, which may create a more challenging operating environment for the LPG industry, the specific provisions for the creation of the Nigerian Midstream and Downstream Petroleum Authority (the "Authority") at least removes some of the regulatory overlaps that are currently crippling the industry by merging functions of the DPR with the defunct PPPRA