Nigeria’s Petrol Subsidy Debacle

April 4, 2022

Nigeria’s Petrol Subsidy Debacle

Political expedience means Nigeria’s economic reform momentum has been somewhat disrupted and subsidies on premium motor spirit (PMS) will remain, at least until mid-2023 when it will be the burden of the next administration. Recent events have put the subsidy debate back on the front burner. In the first quarter of 2021, global crude oil prices averaged $102.97 per barrel (pb), on the back of heightened geo-political tensions which culminated in Russia’s invasion of Ukraine. However, Nigeria is unable to maximise the fiscal benefits from what should ordinarily be an oil windfall as vandalism, ageing infrastructure and inadequate investments in oil fields continue to ensure that output remains significantly below the country’s OPEC quota (1.8mbpd). So, while revenues are expected to rise, subsidies are expected to absorb a significant portion of it.

According to the NNPC, Nigeria spent ₦1.4 trillion on petrol subsidies in 2021 while circa ₦4 trillion is expected to be expended in the 2022 fiscal year. The threefold increase in subsidy will further widen the fiscal deficit and increase the debt burden. As at December 2021, Nigeria’s total debt stock stood at ₦39.5 trillion ($95.76 billion) and the Federal government is expected to borrow another ₦8trn in 2022 to augment its spending. We also project that the debt service to revenue ratio will rise further to 94%.

Deregulation of the premium motor spirit (PMS) market has been proposed as the way out of the subsidy debacle. However, the spike in the prices of fully deregulated petroleum products such as aviation fuel, kerosene and diesel, has to a certain degree, put the reality of the free market in proper perspective. As at March 8th, the average cost of diesel and aviation fuel had risen to ₦625/litre and ₦630/litre to reflect the spike in global crude oil prices. A deregulated market for petrol should see pump prices reflect movements in global crude oil prices, the prevailing exchange, marketers’ margins and other fees. A report by BusinessDay estimates a landing cost and pump price for petrol of about ₦309.87 per litre and ₦333.099 per litre respectively without subsidy as of February 25. Full deregulation of the PMS market, at current oil prices, is likely to result in an even higher pump price for petrol which would intensify the prevailing inflationary pressure and further erode the purchasing power of Nigerians.

The Case against the PMS subsidies

As stated earlier, Nigeria’s dire fiscal reality means the subsidy regime has simply become unsustainable as we will be effectively be borrowing (₦8trn in 2022) for consumption. The other arguments against subsidies rest largely on the efficiency gains that an inevitable move towards a free market presents. Subsidy removal will free up funds that could be deployed more productively to capital investment, or at least to narrow the fiscal deficit. At N4trn, petrol subsidies will amount to 80% of Agusto & Co’s aggressive revenue projection of 5trn in 2022. Increased spending on infrastructure should, in theory, have a stimulating effect on economic growth in the medium-to-long term. This should more than compensate for the negative impact on disposable incomes.

Market pricing is crucial to the deregulation of Nigeria’s downstream oil industry and is essential to the viability of the new profit-oriented state oil company “NNPC Limited” as currently configured in the Petroleum Industry Act. Price liberalization is crucial to attracting investments in local petroleum refining, which considering the fuel shortages Nigerians have experienced recently, is consistent with Nigeria’s energy security objectives. Domestic refining will eliminate fuel imports which accounted for approximately 20% of forex demand in 2021 according to the CBN. This significant reduction in forex demand pressure is positive for the fortunes of other forex-dependent sectors such as manufacturing and trade.

Given the average price of ₦412 ($0.99) per litre in neighboring countries ($1.06 in Cameroun, $0.87 in Chad, $0.85 in Togo republic, $1.01 in Benin Republic, $1.19 in Ghana) compared to ₦165 ($0.4) per litre domestically, the subsidy regime presents a massive incentive for smuggling across the border. This incentive has also triggered increasingly greater demand for fuel imports into Nigeria due to the huge arbitrage that exists for smugglers, further inflating the subsidy bill.

 

The Case for PMS Subsidies

The argument that has been consistently peddled is that the existence of petrol subsidies is necessary to keep transportation costs low, which in turn, keeps the prices of consumables affordable. This is also largely viewed by a huge section of the populace as the only benefit that the clichéd common man enjoys from Nigeria’s status as an oil-producing country. Labour unions have hinged their resistance to subsidy removal on the belief that cost-reflective PMS-pricing would risk unleashing a wave of severe inflationary pressure which would further erode purchasing power and disposable incomes, plunging even more Nigerians below the poverty line.

The empirical evidence points to this argument being largely founded on conjecture as figures from the NBS show that food prices have more than doubled in the past two years while the price of petrol increased by only 32% from ₦125 per litre in March 2020. Advocates of the subsidy scheme insist that the level of inflation would have been far worse if petrol subsidies were removed. It is important to note that the transportation of food items across the country is done primarily by diesel-powered trucks while intra-city movement is carried out mostly by petrol-powered vehicles.

The sound arguments in support of subsidy removal notwithstanding, many have asked why the government is only seeking to carry out reforms when oil revenues have plummeted, knowing that the burden will fall squarely on the poorest Nigerians, but failed to do so in the years of plenty.

 

Subsidy Removal – Lessons from Ghana

Ghana was confronted with severe fiscal limitations in 2004 (spending about 2.2% of its GDP on fuel subsidies) as a result of a surge in oil prices, and was compelled to stop subsidizing petroleum products. This was after several failed attempts (in 2001 & 2003) to do away with subsidy scheme. The government launched the poverty and social impact assessment (PSIA) initiative for fuel in collaboration with all stakeholders which concluded that subsidies mostly benefited the wealthier members of society. The government eliminated fuel subsidies in 2005 and imposed price ceilings in accordance with international prices, resulting in a 50% increase in fuel prices. It also began a campaign explaining why the price increases were necessary and proposed mitigation measures at the same time. Fees in government-run primary and junior secondary schools were abolished while a program to improve public transportation in addition to raising spending on the existing Community Health Compound Scheme, which focused on delivering healthcare to the poorest areas was put in place. Greater support was also given to an existing rural electrification scheme and the minimum wage raised 58% from $34 to $54 between 2004 and 2007. The removal of petrol subsidy was also centered on a price mechanism (keeping domestic prices in line with global prices) controlled by the National Petroleum Authority (NPA) – an independent governing body. This also absolved the government of any direct blame for the resultant rise in inflation and in the event of politically unpopular fuel price increases in the future.

Despite labor union opposition, the public generally accepted the measures as a consequence of proper and visible compensating measures, transparency in the subsidy removal process, and a public information campaign. Between May and November 2008, Ghana froze price caps and implemented mitigation measures centered on energy conservation. Even when the oil price dropped in late 2008, Ghana continued to lower fuel taxes. In 2015, Ghana announced the complete removal of fuel subsidies at a time when oil prices plunged 76% to $28pb from $117pb in 2013.

The success of the Ghanaian experience was hinged on the effective sensitization of the public as to exactly who stood to gain what (in the short, medium and long-term) from removing petrol subsidies which was critical for minimizing resistance from vested interests. Removing subsidies without public backlash is possible if the compensatory spending is transparent, immediate, effective and pro-poor. Separating economics from politics, by the creation of the NPA was also crucial in preventing political pushback, especially in the face of enormous fiscal constraints.

Separating the politics from the economics in Nigeria just 11 months before a general election would be impractical. A proposed stipend of ₦5,000 per month for 40 million of the poorest Nigerians, while being pro-poor, is unlikely to compensate for the inflationary effect of cost-reflective petrol pricing. It also raises questions bordering on transparency as to who will be part of the ‘40 million Nigerians’. With Nigeria’s debt service to revenue ratio projected to reach 94% in 2022 and subsidy spending expected to eclipse our projections for CAPEX in 2022 (₦3trn), it is unequivocally a question of when and not if subsidies should be removed. The real cost of subsidies is the opportunity cost of consuming what we should be investing. The best time to have removed petrol subsidies in Nigeria was 10 years ago. The next best time is now. Waiting until mid-2023 could plunge Nigeria over the fiscal cliff. We simply can no longer afford it.

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