Fooling Around With Petrol Prices

Government will continue to pursue full deregulation of the downstream petroleum sector. However, given the hardships being suffered by Nigerians, and after due consideration and consultations with state governors and the leadership of the National Assembly, government has approved the reduction of the pump price of petrol to N97 per litre. The Petroleum Products Pricing Regulatory Agency (PPPRA) has been directed to ensure compliance with this new pump price

That was President Goodluck Jonathan on January 16th, 2012 backing down from the earlier announced N141/litre that would have all but eliminated the subsidy paid on petrol by the government.

Until yesterday, that price of N97 has remained the same. But what is petrol without crude oil? Here’s what the price of crude has behaved like since January 2012:

Screen Shot 2015-01-18 at 23.45.48Strictly speaking, what the Nigerian government does with petrol prices in Nigeria is not a subsidy per se. Whatever the price of crude oil – no matter how crazy that graph moves – or even the value of the dollar, the Nigerian government guarantees that you will pay a set price for it. To put it in the language of the street, the government undertakes to ‘chest’ the difference between the N97 it says you should pay and whatever the real price is.

On the day that President Jonathan announced the N97 price, the price of Brent Crude was $110 per barrel. On March 8th it was $128 per barrel. Picking another random date – May 1st 2013 – it had dropped to $98 per barrel. By June 18th 2014, it was selling for $115 per barrel.

You get the gist – Brent crude is priced daily and the price is hardly ever the same on 2 consecutive days. It’s a market which responds to demand and supply and the price gives us a rough idea of what the market is like in a given period. These days the price is under $50 per barrel which is partly because there is more oil in the market than is being demanded. And no one knows what the price of oil will be in 6 months or 1 year. Could be lower than $50, could be higher.

So that you don’t buy petrol at N97 today and then N120 tomorrow and then maybe N100 the day after, the government has this ‘chesting’ policy which insulates Nigerians from what is going on in the real world. This kind of thing doesn’t happen elsewhere as you know – if the cost of transport goes up, the person selling tomatoes in the market will increase the price – no ‘chesting’. And when you go to the market, you pay what the price is. There are not many things from which people are shielded from reality in this way but then, the story of fuel subsidies is complicated – Nigerians, with good reason, feel it is the only thing they get from successive feckless thieving governments.

***

The reason why subsidies are a bad idea are pretty simple to understand. Consider Aliko Dangote, a very rich man indeed. He can afford almost anything he wants including lots of cars. Let us say he has 20 cars in his house. Each car has a 100 litre tank. Every week he buys a full tank of petrol in each car to run errands and all sorts. This will cost him N194,000 per week. But what if the actual price of petrol is N127 per litre and the government has chested the N30 difference. This means that the government pays N60,000 every week towards fuelling Dangote’s cars. We can agree that Dangote is not suffering from a lack of N60,000 – last I checked, he was down to his last $24bn.

If you are poorer than Dangote and you have just 15 cars, the government pays N45,000 every week towards fuelling your car. If you are hustling with just one car, all you will get is N3,000 per week from the government. And so on. It is clear to see that the richer you are, the more you benefit from the government’s chesting of the petrol price difference. Now, that N3,000 of course means more to you than the N60,000 does to Dangote – which is exactly the point. Doing subsidies this way is quite wasteful and the richer you are, the more you benefit which is turning things upside down from the stated goal of helping those who need help the most.

This is why now is the best time to remove subsidies. Because the price of crude oil has fallen so low to the point that the government is not paying much subsidy (90k per litre according to the PPPRA website in December), you can end subsidies and get away with it. This is what the new President in Indonesia, Joko Widodo, has done. By some very good timing, he was able to cut subsidies and the prices actually fell from what the government set it at. This will save his government around $16bn per year which he plans to use to build some infrastructure and also roll out the Indonesia Smart Cards for health, education and welfare transfers to the poorest citizens in the country. In theory, now that the cards are in the hands of the poorest people, if and when oil prices go up again, the government can make payments to those poor citizens who will be most affected by petrol price increases while leaving the rich people like Dangote to pay the full price. It is hard to argue that this is not the right way to do things.

India’s new Prime Minister, Narendra Modi also took advantage of falling oil prices to scrap petrol subsidies in October last year, freeing up around $11bn per year. Again, the plan is to better direct the money to those who need it and not the blanket approach of price fixes.

***

I am a firm supporter of the APC. I am hoping and praying (and doing whatever little I can) to make sure they win the Presidential elections next month and oust the PDP. But the nature of politics and politicians is that they are guaranteed to do things that you find annoying or can’t defend. The APC have recently been taunting the government over petrol prices. No less a person than the Lagos State Governor, Babatunde Fashola has been at the forefront of the calls for lower petrol prices. Governor Fashola is a very smart man so a charitable reading of this is that he has been playing politics hoping to put the PDP on the back foot. Fair enough. The problem is that the government has now taken up the offer and actually dropped the price. There is no winner here – if the APC win next month, this is already a trap. They are going to have to either put the price back up or remove the subsidy entirely. Neither will be popular and that would mean a complete turnaround from their previous position in only a matter of weeks. (At least they will have the excuse of finding something ‘unexpected’ when they take over to justify their volte face).

As for the PDP, well they are in a hole already so I won’t advise anyone to enter a digging competition with them. They know how much of a mess the country’s finances are currently. There is no way Nigeria can afford to start paying subsidies again. The markets have given them some serious breathing space by cutting the cost of the subsidy – the amount of chesting they have to do – without any effort from them that would normally require a lot of political capital. Perhaps they reckon they can afford it for 2 months and once they win, they will simply put it back up again.

At a time when the national budget is in tatters with a massive hole in it, where is the sense in this? Already, the government is on course to borrow a record amount of money this year which means that we are guaranteed to start spending more than N1trn a year on debt servicing from next year (currently around N990bn). Not forgetting that this year’s budget has only 9% of capital spending in it and capital budgets are the first thing to cut when things are really tight. There is no country anywhere in the world I am aware of that grew by spending the bulk of its budget on recurrent expenditure – we are jogging on a treadmill as a nation. Going nowhere fast.

 ***

It’s all well and good to ‘enjoy’ the price reduction but let no one be fooled – the bill is coming and it is coming soon. No one should take this is some kind of right because oil prices have fallen. You did not pay more when prices went up so demanding some kind of price reaction based on market forces is a bit ludicrous.

All of a sudden people are saying what if the landing price is below N87? Doesn’t that mean the government is taxing petrol? This is a bizarre argument. The government does not import petrol itself. It asks people to import and then based on what it costs them to import, it pays them the difference between their cost (plus a profit margin) and the N97 it has set. If the landing costs are below N97, then there is simply no subsidy to pay. But because the price is fixed and not market driven, surely marketers cannot be expected to volunteer to reduce prices themselves? There is no tax. The importers simply make a bit more money.

There is also the silliness of assuming that because crude prices are saying one thing today, a price reduction in petrol is justified immediately. It does not work that way. In economic jargon, there is something known as Asymmetric Price Transmission otherwise known as the ‘rocket and feathers effect‘ that is, prices go up like a rocket but come down like a feather. It is a fact of life for which there need not be any collusion at work.

By reducing the price of petrol, the government has now volunteered to pay subsidies where it does not need to. Any right thinking Nigerian ought to be worried about that especially coming from a government that has not been known for sound financial management. Even when Nigeria was earning $110 per barrel, the budget was running a large deficit. Surely now that prices have halved suggest that there is no money to throw around for anything?

I do not like the current government at all but I also do not want them to bankrupt the country before they leave next month in the name of tossing N10 to Nigerians.

 

FF

 

P.S At the time of Occupy Nigeria, I supported the move to keep the subsidy in place for 2 reasons

1. I thought that since it was something the government badly wanted, it was an opportunity to draw some concessions on reforms from them in exchange. The economic argument against subsidies were the same then as now and I believed in them then too.

2. I also did not fully grasp the scale of the corruption around the subsidy programme until after the protests when the investigations and hearings began.

I have since changed my mind and I now think the subsidies should go. It was one thing mainly that caused me to switch my position.

During the hearings, I was reading different things about the whole mess and came across a checklist that was used to approve subsidy payments to importers. It was designed by a leading Nigerian accounting firm and the checklist had 30 different steps i.e. each step needed to be completed and signed off before the payments could be made. Some of the steps were as mundane as asking if the ship bringing in the petrol was sighted at the port and whoever did the sighting signing and dating that part of the checklist.

I am an accountant and building checklists to improve processes is something I have had to do in different jobs. If you hired me to improve the subsidy system, a checklist like that is one of the things I would have done with distributed verification across different parties who could be held responsible in case of something going wrong.

And yet, people were paid subsidies for ships that never came to Nigeria. It is one thing to say get paid for 1,000 litres of petrol when you only brought in 800 litres. That is malaria and it can be cured with chloroquine or something. But when you are getting paid for imaginary ships and passing a 30 step checklist (including someone attesting that they saw the imaginary ship), that is cancer – things need to be cut off.

I believe that there is still a lot of stealing going on. Perhaps we are no longer paying for imaginary ships (or as many as before) but we will only know when the next scandal breaks. Our record of punishing people for stealing is not very good to put it mildly so I doubt the people who were stealing have suddenly become model citizens.

Let the subsidy go. The whole thing. And there is no better time to do it than now.

 

 

 

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24 thoughts on “Fooling Around With Petrol Prices

  1. Brilliant and simple at once. Tough to do. Thanks for making economics easier for ‘dummies’ like us.

    Meanwhile the recent price movement can’t be rockets and feathers oh. The drop was rapid, maybe we need to start lookin at a rockets and meteors effects theory. ☺

  2. I think it calls the 2015 budget assumptions into question. At $65/bbl NOI hoped oil prices which were close to $50/bbl would rebound in H2 which is why they retained a subsidy in budget even though they would not be paying anything at N97. But now that they are reducing it, it means they are no longer believing that rebound will materialize which means even that budget is now inconsistent. Ngozi is announcing austerity everyday and now you’re doing a measure which is anything but austerity. It’s just designed to win votes. If Ngozi still has any credibility she should quit after that move. I think its kitchen sink time for these guys, what use is fiscal consolidation if you lose an election. I’m even surprised they did N10 only.

    More interesting is this, subsidy is payed out of ECA. You’re now roping yourself into a hang-noose after bearish oil markets extricated you. Expect more populist measures before that Vals day

    PPPRA stopped updating its website with the expected pump price in December. Coincidence?

  3. Thank you for this.
    “…but then, the story of fuel subsidies is complicated – Nigerians, with good reason, feel it is the only thing they get from successive feckless thieving governments.”
    This sums it all up. Removal of the subsidy programme requires trust, something the present government lost in 2012. Modi and Widodo have it in loads.
    An APC government – insha Jesus – will get the chance to do the needful. I hope they don’t squander it.

  4. Pingback: Fooling around with Petrol Prices | uyasundayjohn's Blog

  5. FEYI

    When you mentioned FASHOLA, you left out

    1. LAGOS consumes more than 60% of the PMS subsidies

    2. During the hikes crises of 2011, FASHOLA created an enabling environ for the strikes practically becoming the HOST GOV to them issuing politically correct statements in support of the protesters

    3. Even though all the COMMISSIONERS of FINANCE of all the stateshad agreedfor the subsidies to go as approved by their GOVS – AMAECHI and OSHIOMOLE played similar politics as we all saw on TV

  6. Without hard facts, you are only speculating that subsidy payments have increased. Is it not possible that the landing price of PMS is below the December price of N82.41? I even dare say it is now as low as N72. It was N76 in the first week of January and has been on the decline since, surely you have a network of friends in the downstream sector you can consult with before making plenty assumptions. In any case, the savings in subsidy payments since December could also be funding this price reduction. Is it political? Surely. Can the money be otherwise spent? Surely, but then again the common man enjoys this tangible benefit of a N10 saving/litre which is what your party advocates. Social equity, no? Without energy subsidy payments in the UAE, (5th highest energy user per capita), it’s almost impossible for that country to achieve the significant Industrialisation and economic progression it currently enjoys. Yes its Downstream players are bleeding due to Government price caps, but it is for the greater good of their economy. Without the necessary crude processing infrastructure in the country, surely subsidy removal would be premature before getting this in place. Your Presidential references are funny, please let those men complete their respective tenures and then their policies will be judged. Anyway a host of APC leaders clamoured for the price removal, and they have gotten it. BAT, Saraki and Fashola can all drive their fleet of cars at a lower cost. I agree that subsidies should be removed but not before there is concrete evidence that we can self produce. We should also be careful in what we wish for, as Dangote is rebuilding his own refinery, the whole cement industry scenario might be replayed here. And don’t for 1 sec think that GMB will change any policy that is benefitting a fellow Northerner. You write from the safety of London, unfortunately you can’t enjoy this PDP largesse.

  7. You also failed to mention that the budget for fuel subsidies have reduced from N971bn in 2014 to N291bn in the proposed 2015 budget. At $60/barrel for crude, break even price for PMS is N97. Budget is pegged at $65/barrel, its seems NOI knows what she’s doing as it is quite reflective. But I trust APC supporters to reach all sorts of imaginary conclusions. All will be tolerated till Feb 14.

    1. This is quite funny. Are there 2 seperate budgets? Or why pretend like subsidy exists in a world of its own?
      The subsidy is in the same budget where revenues have collapsed by 50% and we are paying almost N1trn in debt servicing.

  8. FEYI

    I just shared your article; it would be nice to know what your fellow APC supporters feel about this article. Furthermore, it is nice to note that YOU AND I stood on the same part of this argument in 2011 – that subsidies should be removed yet you of all people are all too aware that your advice to GEJ to remove it fully at this time would be tantamount to political suicide even as the 2012 episode presented all the opportunity for othets to bring out the dagger – and I am guessing you would like him to fall for this BANANA PEEL?

  9. “Not forgetting that this year’s budget has only 9% of capital spending in it ” A budget that will not see any TAM for refineries or finance new ones. You want the subsidy payments to be withdrawn so that “Dangote” and his likes don’t benefit, what about the masses? You can’t critcize Aganga and then make such proposals. The baby will not be thrown away with the bath water. Until such a time as the downstream fuel market sees investment in refineries, subsidies must stay.

    “I believe that there is still a lot of stealing going on.” Unfortunately without any facts, this is an empty belief. The reduction of subsidy payments in line with the fall of global crude prices shows an interaction with the market. I wonder why you have a problem with people stealing, after all you support Tinubu and Atiku. Truth is you are supporting a party that has economic views that are not aligned with yours. This is just the beginning, excuse Fashola all you want, but he along with the rest of the party do not have a proper clue. Interesting to see Buhari paying homage to Babangida today, but somehow his campaign is based on Anti-Corruption.

    1. Even after I used the example of Indonesia and India and explicitly stated how subsidies can be better targeted at the masses you still say ‘what about the masses?’

      You’ll see what you want t

    2. Even after I used the example of Indonesia and India and explicitly stated how subsidies can be better targeted at the masses you still say ‘what about the masses?’

      You’ll see what you want to see.

  10. Reblogged this on Agbólóhùn and commented:
    I had an article penned last week, it’s still in draft – I had just read about what Jokowi was doing with subsidies from The Economist and it was perfectly in line with a coffee shop discussion I was having in Accra with a friend… a modified version of Brasil’s Bolsa Familia which eliminated subsidies and gave the money directly to the poor people. And then the news broke yesterday…

    In this piece from Aguntasolo.com all the points I was going to cover are well explained so I’m reblogging here. Interestingly we even had the same views at the time of the #OccupyNigeria protest. I’ll do my piece later (or maybe not… we’ll see). While you’re at it follow @doubleEph. He’s really good.

  11. Pingback: Bricklayer’s Explanation of N10 Reduction in Fuel Price | Naijanomics

  12. The promises made to Nigerians for the -until recently- N97 have largely been unfulfilled in the time frame enunciated. Our refining infrastructure are still derelict. Also I for one believe that the malaise bedevelling the subsidy regime is in its gross mismanagement than in the concept behind it. And like you noted the thieving manoeuvring of the checklists by these importers and the incapacity for justice to be done on behalf of the people is disheartening to say the least. If we’ll cut off every corruption-ridden apparatus of state then Nigeria would be aromatic in a jiffy. From a more social perspective to a total removal of subsidy the implications on our basic infrastructure-deprived and economically-vulnerable citizens will be too immense and I’ll confess I’m not optimistic at the ‘magical economic turn-around’ that singular move as being touted would produce. Even our government’s wage bill in the ‘austerity budget’ makes it clear that we’re not really ready. Basic important issues need to be addressed and sincerely fixed before we yank subsidy off. As usual it’s another brilliant piece, Egin.

  13. Nice piece.always learning new stuff from here…rockets and feathers theory…hmmm….anyday I meet you just know that I owe you 2 bottles of orijin

  14. Very well put. I have the dubious honour of being involved in setting up SURE – P. There was very little point to the subsidy arrangements prior to the current lull in the crude price. The sand is running out of the egg timer and I just hope that we have a new government because the current one is totally incapable of avoiding the looming car crash you describe so vividly.

  15. Pingback: The Bricklayer’s Explanation of N10 Reduction in Fuel Price | NAIJANOMICS

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