Archive for January, 2012

Petroleum Subsidy and The Global Economy: The Nigerian Paradigm

Energy prices, to a great extent influence the global economy. For members of  the Organization of the Petroleum Exporting Countries, OPEC, the higher the prices of crude oil necessary for balancing their budgets, the greater their need to keep the commodity’s prices even higher. Subsidies as well as expenditure items — such as the “Arab Spring” palliatives — add to budgetary breakeven prices. According to reports, countries such as Saudi Arabia (US$80/bbl), Nigeria (US$70/bbl), Iraq (US$100/bbl) and Russia (US$110/bbl) all require certain crude oil price levels to meet budgetary provisions. In Nigeria, the recent unrest arising from gasoline subsidy removal, stirred global crude oil markets and caused a crash in the European 10 ppm gasoline market.  But that country’s subsidy regimes have also raised critical issues of sustainability.

Goldman Sachs includes Nigeria in its Next-11 group of countries which could potentially impact the global economy. The country’s outlook was recently upgraded to positive from stable by Standard and Poor’s Ratings Services. A member of OPEC, Nigeria is Africa’s largest crude oil producer and fifth-largest supplier to the United States. However, due to an abysmally low, refining capacity utilization, it currently imports between 80% and 90% of its petroleum product requirement. Import costs (product, freight, value additions, handling etc) and a rather nebulous pricing formula have led to much higher retail prices than if products were locally refined.

Consumption subsidy regimes aimed at mitigating the retail price burden have been in place for decades. The sudden removal, on the first day of the year, then saw gasoline prices spike from about US$0.41 per liter to about US$0.90 per liter. Ranked the world’s 133rd in terms of income per capita by the International Monetary Fund, 63% of its people live on less than £1 (about US$1.5) per day according to the Department for International Development (DFID).

These subsidies have over the past few years become unrealistically high. Figure 1 for example, shows that between January and September 2011, a staggering 30.1% of total budgetary provisions was expended in subsidizing petroleum product prices alone. This substantially exceeds the combined provisions for education, health, housing and defence in the 2012 budget. According to the central bank governor, in 2011 a total of US$16.2 billion — approximately half the country’s foreign exchange reserves — was spent in foreign exchange sales to petroleum product importers and in subsidizing petroleum product prices. During a recent town hall meeting to discuss petroleum subsidies, the governor also revealed that ship-loads of refined product were often diverted to neighboring countries for sale at higher prices by “importers” who would also pocket subsidy payments from the government for the same diverted cargoes.

Figure 2 illustrates an even more staggering point: in 2011, more money was spent subsidizing petroleum products than was budgeted for capital expenditure. With rising public debt and declining foreign reserves, meaningful development becomes such a monumental task. In addition, recurrent-to-capital expenditure ratios (about 3:1) are often skewed by the bloated bureaucracy and its outsized emoluments.

 According to Punch, a Nigerian national daily, each serving Senator of the Federal Republic of Nigeria takes home about US$1.3 million annually — more than three times the salary of the U.S. president — while each serving member of the Federal House of Representatives takes home about US$840,000. There are also issues of corruption. For example, accounts of a US$16 billion power sector reform project reveal that for all that amount, not a single power plant was built; nor was the said amount accounted for. Worse still, the report of a hearing on the project by the legislature was shamelessly buried in a political cesspool.

 The government correctly argues that excising financial waste would enable the provision of infrastructure necessary for attainment of its Vision 20:2020 goals. It promised palliatives to cushion the impact of product subsidy withdrawal. But if the citizenry has been leery, it may be because previous promises proved futile.

The subsidy withdrawal drama has played out across successive administrations but three issues of denouement are noteworthy:

1. Phased Withdrawal

There is a limit to the “corrective shock” an economy can sustain without compounding problems. If Nigeria’s productivity for example, is adversely impacted by a one-step (immediate and total) subsidy removal, then the country could be burdened with more problems than it initially set out to address. In addition, a government severely challenged by the increasingly daring terror of the Boko Haram sect can ill-afford further conflicts let alone with trade unions and civil society groups.

Beyond withdrawal of subsidies, internal controls which encumber efficient product supply also need to be eradicated and provisions made among the most vulnerable for amelioration of withdrawal effects. Strictly adhered to, a phased withdrawal of subsidies along with structured milestones, would not only make for impact and conflict mitigation, but also lead to better product delivery.

2. Refining Capacity

The lack of adequate domestic refining capacity is a major driver for the high petroleum product prices. To spur investment in domestic refining, part of the withdrawn subsidy may be deployed in the R&M subsector as initial guarantees for refining margins. This would be a shift of subsidy from consumption to production. Such guarantees were successfully applied to the country’s upstream subsector a few years ago when low, global crude oil price regimes discouraged capital expenditure. The Refining and Marketing (R&M) subsector creates by far the most jobs in the oil and gas value chain.

Nigeria has a total installed crude oil refining capacity of 445,000 barrels per day; but at less than 30%, its aggregate refining capacity utilization over the past decade is abysmally low. (See Figure 3 below). 

The country plans to increase that installed refining capacity by 300,000 barrels per day within three years, possibly making it a net exporter of refined products. However, a country that can hardly utilize a third of its 445,000 barrels-per-day installed refining capacity would surely be incapable of utilizing any proportion of an additional capacity. Adequate investment in the country’s R&M subsector will remain elusive unless issues of product pricing, corruption, security as well as adequate supply of refining feedstock are addressed. Of the 18 refining licences issued more than 7 years ago, none has so much as received a final investment decision.

3. Restructuring

Finally, the country’s oil and gas sector is in dire need of total restructuring. Transactions in the sector have been largely opaque. Issues of corruption and the environment (oil spills as well as gas flaring) go begging. Accounting records of the country’s state-controlled oil company (which largely oversees oil and gas activities) are rarely, if ever published and the colossal failure of its refining processes is symptomatic of the sector’s ills. The requisite matériel, personnel and will to carry out effective regulation are clearly absent; subjects of regulation are even relied upon for logistics and critical evaluations.

The Petroleum Industry Bill (PIB) which was supposed to provide an operational framework for that restructuring has been mothballed in the legislature, amid accusations and counteraccusations of bribery; and investment funds have sought more favorable climes.

All said, while the subsidy regimes are clearly unsustainable, the withdrawal process could have been more skillfully handled. There was a perception of insensitivity to it and the palliative measures seemed more of a patronizing afterthought than part of any well-planned process. If the planning and palliatives horse had been placed before the subsidy withdrawal cart, a much greater proportion of civil society groups would probably have been onboard.

Powered by Netfirms