Monday, January 02, 2012

Nigerian Fuel Subsidy Removal

The Nigerian government has over the last three decades subsidized the price of refined petroleum products consumed in the country.  What started as a stop-gap to meet supply shortfalls that occurred during scheduled Turn Around Maintenance of the Eleme, Port-Harcourt and Warri refineries soon became the norm as the Nigerian National Petroleum Cooperation (NNPC) seemed incapable of managing the operations of these refineries leading to perennial fuel shortages and scarcity.   As the population of Nigeria grew, so did the demand for refined petroleum products even as two additional refineries were built in Kaduna and Port-Harcourt.

With a combined installed refining capacity of about 445,000 barrels a day, Nigeria’s four refineries are enough to meet the daily consumption requirement, currently estimated to be about 325,000 barrels per day, with room for exportation.  

Over time, the officials of the NNPC charged with managing the refineries soon discovered that by keeping the refineries in a perennial state of disrepair, they could award refined product supply contracts to their cronies and proxies and pocket the profits.  In order to stave off public criticism of the scheme if they charged the market rate for the imported products, they decided to subsidize the cost and successively set the pump rates, never mind the arbitrage opportunity this provided hoarders of the products, who took advantage of the endemic scarcity, and smugglers and diverters who saw the opportunity to charge multiples of the cost price if they sold the products in neighboring African countries.  In 2011, the NNPC is estimated to have spent over $8.00 billion on subsidized imported refined petroleum products because the four refineries in Nigeria barely operated at about 15% of full capacity (the Petroleum Minister, Diezani Alison Madueke, claims between 50% and 60% capacity utilization in a "Townhall meeting" in Lagos about two weeks ago).

There is no telling that removing the subsidy on imported petroleum products makes sense.  However it does not take care of the intrinsic problems of corrupt enrichment of selves, cronies and proxies by the managers of the refineries and the perennial scarcity. In fact, it will only mean that importers of the refined products have a license to charge higher prices for their products, affording higher returns to their patrons in the NNPC, who will consequently have a higher incentive to keep the NNPC refineries in disrepair and non-functional.

The way around the issue of the mismanagement of Nigeria’s oil sector is for the government to totally divest its equity stake in all the joint ventures it has with the various operators in the industry.  These interests should be sold off in the stock market encouraging a wide base participation and equity distribution with a cap of say 1% to 2% of the total equity stake as the maximum any individual or entity can hold.  In addition to this, the Nigerian government needs to liberalize the ownership of refineries by issuing more licenses to allow as many private enterprises as possible to set up refineries all over the country.  This will not only stem the perennial fuel shortages, it will foster competition and reduce prices as the incentive for operators who want to remain profitable will be to hone their operations to be as efficient as possible.

Fully divested of its equity stakes in the industry, the government will through its agencies provide regulatory and oversight control of the industry and raise revenue through licensing fees, tariffs, duties and taxes.  This will in one fell swoop take care of the current inefficiencies and massive corruption in the system.

This proposal however will take about a year or two to achieve, as the required physical and organizational infrastructure will have to be in place and operational before subsidies are abolished.  That the Jonathan administration has chosen to abruptly end subsidies on January 1, 2012 without any structures in place guarantees a hard landing and will wreak untold economic and social hardships on the common Nigerian folk.  This limited understanding and analysis of the issue risks for the Jonathan government a high political premium particularly as it comes at a period when Nigerians are disenchanted with the harsh economic downturn and serious security issues currently facing the country.