The fuel subsidy question

Fuel nozzle.

Fuel nozzle.

Prof Chijioke Nwaozuzu

06 June 2015, Sweetcrude, Port Harcourt – The new Nigerian government headed by General Muhammadu Buhari will have to take a close look at the policy issue of deregulation of the petroleum downstream sub-sector, and the attendant removal of fuel subsidies. On the 1st of January, 2012 the Dr Goodluck Jonathan’s administration announced the removal of subsidies on petrol and set up a Subsidy Reinvestment & Empowerment Programme (SURE-P) to manage the accruing revenues.

The role of SURE-P is to provide essential services and deliver infrastructure development to Nigerian people through robust and country-wide structures. Further negotiations with the Unions led to the current pump price of petrol. The price of diesel has been since deregulated.

However, the debate continues as to when a fully deregulated regime would be achieved and how government should proceed with such a policy. From what I read in the newspapers, it would appear that the proponents of this policy rightly believe that the sector should be FULLY deregulated at some point. So, let us look at the different interpretations of subsidy, the challenges being faced, and what else needs to be done.

Some experts believe that domestic pricing for petroleum products should be tied to international prices, considering that these products are traded internationally. This view is in alignment with the views of most economists, since domestic pricing should take account of the opportunity cost of the 445,000 barrels of crude designated by the Nigerian Government for domestic processing and consumption. The Bretton Woods institutions (World Bank, IMF, IFC, etc) all expect even crude oil producing and exporting countries to align domestic pricing of products accordingly. Based on this perspective, any difference between international and domestic pricing of petroleum products should be considered as ‘subsidy’.

The opponents of this view argue that citizens of oil producing countries should enjoy lower domestic prices for petroleum products relative to international prices. Therefore, domestic pricing should be tied to the local cost of producing a barrel of oil. After all, the citizens were ‘gifted’ crude oil by their Creator and should benefit through relatively lower fuel prices. They also argue that most oil producing countries are developing countries with lower GDP per capita.

For examples, according to the CIA Fact File the GDP per capita for some countries relative to Nigeria as at 2014 are as follows: Nigeria ($6,100), South Africa ($12,700), United Kingdom ($37,700), Australia ($46,600), US ($54,800). So, the proponents of this perspective wonder why prices of domestic fuels in Nigeria should be the same as in the UK, US,
Australia, etc. They further argue that the Nigerian labor market (wages / salaries) are not tied to the international labor market. Therefore, an attempt to price petroleum products in line with international prices will put enormous strain on the purchasing power of Nigerian citizens, widen the gap between the poor and the rich, and push more citizens below the poverty line.

The average cost of producing the deltaic onshore oil fields from where the 445,000 barrels (for domestic refining) are allocated is about $7.50. If hypothetically the average export price of Bonny light is $60.00 barrel, the core decision for government would be to decide whether to tie the domestic prices of fuels to $7.50 per barrel (for domestic refining), or to tie it to $60.00 per barrel (for imported fuels), or even find a middle ground between $7.50 & $60.00 per barrel.

From an economic stand-point, subsidies are thought to distort competition depending on the absolute size of the subsidy as well as its size relative to the cost of the activity being subsidized. However, provision of subsidy is not entirely a bad thing, depending on the goal/s behind it. Subsidies are regarded as an important policy tool for promoting business development and for addressing social problems and market failures.

Economic policy provides five main justifications for subsidies, as follows: growth promotion, income re-distribution,
correction of externalities, provision of special goods, and for increasing economic returns. Subsidies could be classified into two categories based on purpose, such as ‘resource allocation purpose’ (e.g. for externality correction, reducing costs, etc) and distributional purpose (e.g. addressing regional inequalities, income redistribution, etc).

However, there are six main instruments for effecting subsidies, such as direct cash transfers; tax concessions; provision of cheap credit; regulatory subsidies (where government uses regulatory instruments to subsidize particular groups; ‘benefit-in-kind’ subsidies (where sales by State-owned companies are made at lower-than-market prices); and ‘purchase subsidies’ (where government makes purchases at higher-than-market prices).

Even the industrialized and developed countries have recognized the importance of the application of certain subsidy measures to address problems in some specific areas or sectors of their economies. For instance, countries like Australia introduced the Petroleum Product Fuels Subsidy Scheme (PPFSS) under the State Grants (Petroleum Products) Act since 1965 targeted at reducing pump price of petroleum products in rural and remote areas. The US Government provides subsidies for the agriculture sector. 21% of all State Grants in the UK is directed at rural development. Also, the European Union Guidelines on State Aid also provides that aid may be granted by its Member States where there are serious economic, social, geological, or environmental problems; to promote the development of areas where the per capital income levels are low, or where there is serious unemployment; or to facilitate the development of certain economic activities or of certain economic areas, provided the aid does not affect trading between Member States.

*Prof Chijioke Nwaozuzu, a Downstream Petroleum Policy Expert and Deputy-Director at Emerald Energy Institute for Energy & Petroleum Economics, Policy, & Strategic Studies, University of Port Harcourt. Email: Tel: 070 6874 3617 (SMS Only).

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