Lifting subsidies: Fuel price liberalisation remains a work in progress

While Nigeria is the 14th-largest crude oil producer in the world and has the 10th-biggest proven reserves, the legacy of petrol subsidies has left a gaping hole in public finances. The partial lifting of these subsidies in January 2012 has given the government more room for manoeuvre, but dealing with the consequences of massive corruption in fuel imports and broaching the issue of further increases in domestic pricing will bring challenges of its own in 2012.

STRUCTURE: Established in the 1980s, subsidies on domestic fuel have increased in line with oil prices and consumption. While price support for diesel was withdrawn, support for petroleum – premium motor spirit (PMS) in particular – has remained. The Petroleum Products Pricing Regulatory Agency, an independent agency established under the presidency in 2003 and transferred to the Ministry of Petroleum Resources in 2011, regulates the supply, distribution and pricing of petroleum products domestically. Based on import-parity pricing adjusted for import and distribution costs, the agency held pump prices at N65 ($0.42) a litre until the end of 2011. With an average market price for petrol of N142.55 ($0.91) a litre, total subsidies amounted to N77.55 ($0.50) a litre in 2011 – providing for retailers’ margin of N4.60 ($0.03).

Sub-market prices have exacerbated growth in domestic demand by encouraging waste and excessive use, and contributed to its significant structural inelasticity. With very few alternatives to petrol ( cooking gas is only available in some urban centres, while alternative energies are unavailable), Nigerians have grown accustomed to cheap fuel, which is viewed as one of the few public goods on offer in the largest crude producer on the continent.

PLAYERS: Price subsidies have particularly benefitted large petroleum consumers and downstream importers, who have been encouraged to import more PMS. With the four existing refineries running at less than a quarter of capacity, the economy imports some 80% of its fuel consumption. While state-owned Nigerian National Petroleum Corporation (NNPC), through its subsidiary Pipeline and Products Marketing, retains a monopoly over domestic fuel supply, it licenses importers and distributors acting as regulator, producer, distributor and competitor in the retail market.

Seven of the largest marketers – NNPC Retail, Mobil, Total, Conoil, Oando, African Petroleum and MRS Oil – account for over half of all subsidy payments. Yet a wide array of importers and marketers have been active recipients of subsidy payments. Subsidies have also encouraged smuggling to neighbouring countries, all of which charge a domestic price in excess of $1 a litre, more than twice the 2011 Nigerian retail price.

The IMF stated in its 2011 Article IV Consultation: “Given rampant rent-seeking behaviour and smuggling, a significant portion of Nigeria’s fuel subsidy benefits accrue to people in neighbouring countries.”

CREEPING DRAIN: Rises in international oil prices have contributed to a growing pricing spread compensated by subsidies, as average prices have increased significantly from $30 a barrel in 2000. The total budgetary burden has grown from an estimated $1bn in the 1980s to roughly $9.3bn in 2011. When oil prices reached an average of $101.78 a barrel in 2008, total subsidy payments jumped 128.92% to $5.17bn, according to the Federal Ministry of Finance (FMF). Subsidies dropped in the two following years to a total of $4.31bn in 2010, but spiked again in 2011 when oil prices averaged $113.98 a barrel, increasing 97.24% year-on-year (y-o-y) to reach $9.3bn in 2011. Accounting for roughly 4.18% of GDP and 30% of the federal government budget, this significant fiscal drain proved unsustainable for the public purse.

The cost of subsidies has been exacerbated by some downstream operators’ market manipulation. It has emerged in 2012 that some oil marketers are engaged in a variety of means to overcharge the Nigerian government for subsidy payments: falsifying purchase dates to quote higher international prices, or not importing the amount for which subsidy payments were claimed, for instance. While the total amount of subsidies should have been $9.3bn in 2011, it was discovered through a parliamentary investigation report in April 2012 that almost $14bn was actually paid. As the total cost had risen some 129% y-o-y in 2011, no corresponding increase in volumes had been recorded, a fact the report attributed to collusion between marketers and government officials. By mid-2012, a full N451bn ($2.89bn) of the N881bn ($5.64bn) budgeted for 2012 fuel subsidies had already been spent covering arrears in subsidy payments from 2011. The probe found that a total of N1.1trn ($7.04bn) had been transferred to fuel importers, including the NNPC between 2009 and 2011.

Amounting to more than the 2012 budgets for education, health, social protection and housing combined, the subsidy had become a significant burden on public spending by the start of 2012, just as foreign reserves and the Excess Crude Account were being squeezed. Although long floated as an aim, the surprise lifting of subsidies in January 2012 created a shock effect on the economy as a whole.

PARTIAL LIFTING: Plans for full liberalisation of the downstream oil market were enshrined in the government’s 2012-15 Medium-Term Expenditure Framework and Fiscal Strategy, its fiscal policy blueprint. The aim is to reinvest the proceeds from the lifting of fuel subsidies, which are expected to reach N1.4trn ($8.96bn), into refineries and infrastructure projects such as roads and power plants, as well as providing a social safety net for the poorest Nigerians under its Subsidies Reinvestment and Empowerment (SURE) programme. The rationale behind the move was that subsidies created disincentives for domestic refining and forced the government to subsidise transport and distribution costs for a select group of marketers.

The NNPC estimates that if its refineries were running at just 66% of their combined 450,000-barrel-per-day refining capacity, the resulting output would be sufficient to cover domestic needs.

Lifting the subsidy would also prove crucial to the government’s efforts to reduce its spending on recurrent expenditures, which accounted for 74.4% of the 2011 budget. “The federal government was spending as much on subsidies as its entire capital expenditure budget in 2011,” Nwanze Okidegbe, the chief economic advisor to the president, told OBG. “If we reinvest our savings from the subsidy cut into bridging our infrastructure deficits and providing social safety nets through palliatives such as the SURE programme, this will prove to be a much more sustainable solution in the long term.”

PRICE RISE: Despite this general indication, the government surprised many by fully liberalising the price of PMS overnight in January 2012, raising pump prices from N65 ($0.42) to N138 ($0.88) a litre – the largest single price hike in Nigerian history. Criticised by civil society groups for a lack both communication and interim support mechanisms for the most vulnerable, this “big-bang” approach was designed to neutralise political opposition to successive price hikes. However, significant popular opposition ensued, with two of the country’s trade unions – the Trade Union Congress and the Nigeria Labour Congress – organising nationwide strikes, which affected banks and businesses at the beginning of 2012. The country’s main oil union, the Petroleum and Natural Gas Senior Staff Association of Nigeria, also threatened to follow suit.

As tens of thousands of people gathered to protest the impact of the subsidy cut on transport and living costs as well as more fundamental issues of corruption, governance of the hydrocarbons sector and top public sector pay, the government was forced to give into concessions. Following eight days of protests, subsidies were partially reinstated at 49% of their previous level, and pump prices were lowered to N97 ($0.62) a litre. This amounted to a total annual subsidy reduction of around $3.2bn, close to 4% of total private consumption of $121.8bn in 2011.

However, this was just a temporary move, and the government is expected to fully liberalise pricing by 2015. A continued decline in oil prices in the second half of 2012 could place additional pressure on the government budget to further liberalise PMS prices but would also cushion the blow to consumers. Should the Petroleum Industry Bill be approved by the National Assembly at the beginning of 2013, all subsidies will automatically be eliminated.

INFLATION & GROWTH: The increase in PMS prices caused an acceleration in inflationary pressure in January 2012, creating cost-push inflation and also a rise in inflation expectations. “While the partial removal of fuel subsidies has had an impact on inflation, everyone has put up prices even if they don’t rely on fuel: for example, truckers who use diesel as opposed to fuel still increased prices in the first half of 2012,” said Thabo Mabe, the CEO of Unilever Nigeria. Annualised inflation jumped from 10.3% y-o-y in December 2011 to 12.6% in January 2012, remaining at or above 12% thereafter (reaching 12.9% in June). Higher food and energy costs have been the key drivers of inflation growth, with food prices increasing 1.2% month-on-month in May and 0.5% in June, according to Standard Chartered, which found that core inflation (excluding food) rose to 15.2% y-o-y in June 2012.

Stock brokerage First Securities Discount House (FSDH) expects inflation to go up further to around 14.5% by September and projects that it will subside somewhat thereafter. Although lower global oil prices have reduced the impact of imported inflation, domestic cost-push inflation remains an issue. While the CBN is expected to maintain high benchmark monetary policy rates, at around 12% for the rest of 2012, to control inflation, the removal of subsidies has resulted in a slump of roughly 25% in imported petroleum, according to FSDH. This has reduced some downward pressure on the currency.

The subsidy cut also affected consumer demand. The African Development Bank estimates in its February outlook that the price increase will lead to a 5% reduction in the average household income, in addition to the impact of rising inflation on real wages.

CLAWING BACK: In the face of significant overspending on subsidies in 2011, two probes in 2012 have sought to claw back payments for fictitious fuel imports. The FMF fired the two firms responsible for auditing subsidy payments and appointed McKinsey to advise the government. While an ad-hoc House of Representatives investigation in April found significant overpayment of $6.8bn over three years to 2011, a presidential committee headed by Access Bank’s CEO, Aigboje Aig-Imoukhuede, and formed in July has begun forensic investigations into the excess payments as part of an effort to recover illegal transfers. This committee has alleged fraudulent payments of some $2.38bn in 2011 alone. These probes have caused fuel importers to stop imports since the start of 2012 in the face of uncertainty and arrears in subsidy payments. The NNPC was left as the sole fuel importer in the first half of 2012 and claims it is owed some $7bn in subsidies. By July 2012 it emerged the NNPC was paying for some of its fuel imports through an opaque system of swaps, trading crude oil shipments for fuel imports, yet details of the scheme are unclear. The government has stopped paying arrears in subsidies pending resolution of the overpayments. While a supplementary budget would theoretically be needed to cover the fiscal year 2012 subsidy payments, the FMF expects recuperated funds could yet cover the bill.

Although additional budgetary space was created by the partial lifting of subsidies, Nigeria’s fiscal position faced significant downside risks in 2012 on the back of subdued global oil prices. While the reform process is ongoing, with further liberalisation expected in the short term, the federal government’s success in clawing back payments will likely prove key to the political acceptability of further PMS price increases. This, in turn, will prove essential in lightening the load of recurrent expenditures on the public purse.