Why it is inevitable to take action against fuel subsidies

Oil & Gas
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Tuesday, May 10, 2016 11.50PM / Research 

As signed into law by President Muhammadu Buhari, Budget 2016 has no provisions for fuel subsidies.  

However, the cost of operation for petroleum marketers remains grossly under-recovered due to the reasons, none the least that issue of foreign exchange restrictions. 

While dealing with the almost empty basket of options open to government which has held the foreign exchange liberalization constant, the government must recognize the need to respond by way of reforms to the fuel crisis. 

The immediate concern is to ensure the free flow of supply of fuel for Nigerians while the government perfects plans to change the structure, players and process for fuel business in an economy moving away from crude oil as a major eaner. 

At the industry level, more especially the downstream after series of fuel shortages, it appears inevitable that government will have to adopt an approach that opens the market to forces of demand and supply. 

While this appears simple enough, word on the street suggest that government may favour an approach that allows for a hybrid of sorts or a partial deregulation that ensures at a minimum that supply issues are addressed while the issues related to “true cost” and eventual structure are determined later. 

The issues faced in the sector inclusive of the real cost of the fuel, the supply impact and the fiscal impact on states as explained below, form the basis upon which the government needed to take the action on fuel subsidies.  

The Real Cost of Fuel:

Is the fuel subsidy sustainable in the face of challenges from marketers of the set PPPRA ceiling price of N86.50k/ltr? 

Pricing trend in the past 1 year demonstrates that citizens in areas other than Lagos and Abuja have consistently paid 20 - 50% more for fuel purchased at the pumps. This fact is corroborated by the National Bureau of Statistics (NBS)’s survey which indicates that apart from the Federal Capital (Abuja) and Lagos; citizens continue to pay for fuel at an average price of N150/ltr. 

The survey establishes that the subsidy benefits only a few (urban – metropolitan / few higher income groups) as opposed to the larger citizenry. Unexpectedly market trend indicates that the current approved pump price of N86.50/litre for PMS does not assure marketers of over-recovery if crude oil price continues to trade above $40/bbl. This thus presents an unrealistic price in view of market realities. 

As of today, 80% of the downstream operators are still unable to carry out their business due to unavailability of Foreign exchange at the prescribed CBN rate. PPPRA’s pricing template, as approved, only recognises prevailing CBN Interbank rate which averages N197/$ in Q1 and Q2.  Investigations revealed that the alternative source of FX available to Marketers is the autonomous market rate which presently averages N285/$ as at April 2016. Therefore, to explain the prevailing high prices in certain states, marketers who source FX independently of CBN in order to carry on participation in PMS supply will continue to sell at prices that enable them achieve full cost recovery. 

As such, the false assumption that the current ceiling price adequately covers cost needs to be addressed by providing marketers an alternative to the primary FX market (CBN). The consequence of disregarding this solution will lead to the unsustainable development of NNPC maintaining the role of sole supplier to the detriment of federation revenues.

The Supply Impact:

At what cost has the government cleared the queues?
For a corporation historically known to be inefficient and unprofitable, NNPC maintains 100% responsibility of fuel importation at subsidised pricing using crude oil as a means of exchange. On a monthly basis, the estimated loss for NNPC is approximately N12.5bn.  

To sustain supply therefore, NNPC extended its crude source for products importation from outside the traditional refinery requirement of 445BbLs/day for petroleum products imports, by using federation cargoes which further reduced the ability of the government to earn FX. 

Similarly, at an import bill of $600m/month for PMS, CBNs liquidity to support the importation of PMS is challenged in the face of dwindling crude oil for exports. The limited crude oil output caused by the spate of renewed vandalism and sabotage of oil infrastructure in the Niger Delta (now 420,000bbls/day lost) and increased participation of NNPC in products supply continue to imply limited ability to earn FX for the Federation and potential crippling of the economy. 

An immediate solution is thus the reduction of this crude to products control by NNPC in order to free up crude for federation revenue. Also the movement of marketers to the autonomous FX market will make available approximately $600m of FX via CBN to be used in other sectors of the economy. 

The Impact on Sovereign States (Fiscal):

The Federal Government continues to incur N13.79/ltr under recovery, while States fail in their fiscal responsibilities
Growing subsidy differential is a threat to state debt profile. As at 29th April 2016, under-recovery of N13.79/litre was recorded in the price of PMS, thus the need to urgently address the trend, as Government has no budgetary provision for subsidy payment in the 2016 Appropriation Bill. 

On a monthly basis, deductions from FAAC payments amount to N13.61bn, while State debts accrue to N34bn/month.  If subsidy was removed, a deduction of the estimated subsidy claim will reduce governmental exposure and support States in their fiscal obligations. 

Clearly continuation of under recoveries in any form for PMS limits the ability of the Federation to deliver its statutory functions such as power generation, security, education, health etc. 

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