Fuel Price Hike: Deregulation without the word

Oil & Gas
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Thursday, May 12, 2016 6:31 PM / ARM Securities

Yesterday, the Petroleum Product Pricing Regulatory Agency (PPPRA) announced a 56-68% hike in the retail price of PMS to a band of N138-N145/litre. In a follow-up statement, the Minister of Petroleum Resources cited as justification for the price hike: recent rebound in Brent crude prices, continued FX shortages which had impacted the ability of independent operators to import PMS and the reality of average national prices trading well above the official PMS price.




 

 

Backdoor deregulation to bring glad tidings to downstream sector: For the downstream industry, the move to more flexible pricing should provide stronger incentive for private investment in refining and distribution infrastructure. Under this competitive environment, players with scale advantages, good logistics network and crucially greater access to capital and FX like Total are Mobil are our favoured picks among listed petroleum marketers.

 

Taking together with elimination of fuel subsidies in the 2016 budget, the follow-through in adjusting domestic PMS prices to the new global price reality, at the risk of an erosion of popular goodwill, provides strong evidence about the regime change in the downstream petroleum industry from regulated pricing to more flexible pricing.

 

Though the government avoided use of the word ‘deregulation’, likely to avoid resistance from labour unions, the press release notes that independent marketers are now free to source FX from secondary sources for PMS imports with the proviso that the PPPRA template will be accordingly adjusted to reflect the FX cost basis. Furthermore, the new price template indicates a wide price range of (N10/litre) around the open market price allowing for greater price variation than in previous regulated price regime.

 

To our views, beyond implying the end of the previous regime of import allocations, the shift towards more flexible pricing leaves little doubt regarding the full deregulation of the downstream petroleum industry.

 

For the industry itself, the move to more flexible pricing should provide stronger incentive for private investment in refining and distribution infrastructure. Under this competitive environment, major marketers with scale advantages, good logistics network and greater access to capital and FX should assume greater control of the sector under the liberalized pricing environment.

 

From a fundamental standpoint, the termination of the PSF scheme removes pressure from interest expense burdens on the sector players leaving greater scope for earnings expansion. In this regard, our top picks among listed downstream petroleum marketers are Total and Mobil, who currently possess the scale and logistics efficiencies to succeed, and crucially, are likely to receive parental FX support. Complemented by ongoing construction of a 600kbpd refinery by the Dangote group, we believe the movement away from government price reregulation, similar to the opening up of telecommunications and power sector, holds positive connotations for downstream dynamics over the medium to long term.

 

 

Inflationary? Certainly, but to what extent and for how long?: In the near-term, the impact of the sharp upward PMS price adjustment on inflation will understandably be the focus. Nonetheless, recasting most recent episode of fuel price hike in 2012, which ultimately proved to be disinflationary post the initial adjustment, we see only scope for modest uptick in inflation over the rest of 2016. Calibrating the latest hike in PMS price for past episodes of price hikes raises our mean 2016 CPI forecasts 40bps higher than prior to 13.1% YoY (H1 16 average: 12.4% YoY), with much of the inflationary push on CPI level occurring in H1 16.

 

 

In the near-term, the impact of the sharp upward PMS price adjustment on inflation will understandably be the focus, with headline reading currently at a 44-month peak of 12.8% YoY. Nonetheless, recasting most recent episode of fuel price hike in 2012, which ultimately proved to be disinflationary post the initial adjustment1, we see only scope for modest uptick in inflation over the rest of 2016 on account of three factors. First, sharp uptick in February and March CPI readings, largely in response to the raised electricity tariffs and 36% MoM jump in national mean PMS prices to N135.69/litre implies that going forward CPI requires a much stronger shock to sustain MoM increases from current levels.

 

Second, the new retail PMS price is merely 7% higher than the latest national average which combined with likely improvements in fuel supply should temper scale of pass-through via transport costs. In our view, the supply impact could be critical to a net disinflationary effect by year-end, especially if no further shocks materialize. Third, implicit in the new retail pump price, according to the Minister of Petroleum Resources, is a 43% increase in the exchange rate to N285/$ (behind the current parallel market rate of N323/$).

 

Whether this means a pending devaluation is a different matter, however assuming USDNGN rate holds at this level and other components of the PPPRA remain unchanged, future increases in the retail pump price will emanate from upward movement in crude prices. On this front, though Brent crude has recovered from January’s trough (YTD: +9% to $44/bbl) largely on continued talk of output and supply issues in Nigeria and Canada, the global over-supply picture is largely unchanged and we see limited upside from current levels with EIA forecast average of $40.5/bbl over 2016.

 

Net impact of the forecast crude price average and our assumptions regarding the PPPRA template should result in 5-11% rise in the retail pump price by our estimates over the rest of 2016. That said, the initial reaction in urban cities where the old retail price prevailed could drive inflation to overshoot the impact of the 7% effective increase.

 

Calibrating the latest hike in PMS price for past episodes of price hikes raises our mean 2016 CPI forecasts 40bps higher than prior to 13.1% YoY (H1 16 average: 12.4% YoY), with much of the inflationary push on CPI level occurring in H1’16.




 

 

Politics making the policy pronouncement confusing?: Tying the implicit 43% ‘devaluation’ in the PPPRA template and NNPC guidance that petroleum marketers (25-30% of dollar demand) are now free to source FX from secondary sources, with the hike in PMS price itself, it appears that a certain amount of liberalization has occurred at the cross-roads between the FX market and PMS market. Considering the influence of the former on the national economy and the latter’s share of the import bill, this development is certainly not trivial.

 

Tying the implicit 43% ‘devaluation’ in the PPPRA template and NNPC guidance that petroleum marketers (25-30% of dollar demand) are now free to source FX from secondary sources, with the hike in PMS price itself, it appears that a certain amount of liberalization has occurred at the cross-roads between the FX market and PMS market. Considering the influence of the former on the national economy and the latter’s share of the import bill, this development is certainly not trivial.

 

From a perspective of policy assessment, the decision to adjust to market driven fuel price regime, following from February’s 2016’s 40% hike in electricity tariffs suggests that contrary to popular opinion about the socialist tendencies of the Buhari administration, the president might not be entirely averse to adopting policies that lead to market driven outcomes. Such liberalization of critical economic segments would certainly, from a market theory perspective, be positive for the economic reform picture and the investment case for the Nigerian economy.

 

However, there’s precious little evidence that the shift has been bought into fully by the current administration. Indeed, with the reticence to bite the bullet and announce a deregulation of either the PMS or FX market, whispers that the price adjustment and implicit price devaluation therein were ‘forced’ by ongoing negotiations for foreign-currency loans assume more weight. For us, the real issue is the uncertainty lingering in the system for every minute a decisive pronouncement is not made.

 

Certainly, the indecision can no longer be hinged on ‘socialist tendencies’ as the new price is closer to what PMS price would be using current crude oil and parallel market exchange rate (our estimate is N170/litre) than to the previous price of N86.5/litre.

 

Furthermore, regardless of whether the rate fixer is NNPC or CBN, to the extent that a fixed exchange rate is being used at all, the bottlenecks to market pricing determination remain, with potentially uneven benefits to sector players who may or may not have access to dollars at the implicit exchange rate. Perhaps heightening the suspense for populace and sector players alike is that the FX angle of the PMS hike has elicited neither corroboration nor denial from the CBN which, considering the ‘interesting’ nature of its last policy moves, makes us even keener watchers of that space.

 

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4.      Average Petrol Price Rises to N135.69 in Mar'16 from N99.76 in Feb '16    
 

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