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Policy Brief on The Nigerian Fuel Subsidy Puzzle: Facts, Fallacies and the Way Forward


The issue of the appropriate pricing of petroleum products in Nigeria, of which fuel subsidy is an integral part, has been one of the most contentious public policy issues since the 1970s. Before then Nigeria was self-sufficient in domestic oil products supply and was exporting 100,000 barrels per day of refined products because the country had four working refineries then, (GBM, May 12, 2016). Nigeria has not only stopped exporting refined petroleum products but is in fact importing them giving rise to the highly contentious issue of fuel subsidy. Thus, the problem has been with us for about 41 years and remains unresolved. It is a consumption subsidy on grounds of affordability.

There is no universal definition of what constitutes a fossil fuel subsidy, although the World Trade Organization (WTO) has developed a general definition of subsidies that is accepted by 164 Member States and that forms the basis for understanding fossil fuel subsidies. Among international organizations, there is considerable consensus on what fossil fuel subsidies consist of and how to measure them. However, the Nigerian National Petroleum Corporation (NNPC) considers it a “Loss or under recovery”, to imply selling below the landing price of premium motor spirit (PMS). Based on this the NNPC awards itself fuel subsidies. But, the price gap and the quantities involved are all highly contentious.

This Policy Brief is an outcome of the 2019 Public Lecture of the Society, delivered by Professor Akin Iwayemi FNES, FNAEE of the Department of Economics and Centre for Petroleum Energy Economics and Law of the University of Ibadan, Ibadan

Purpose of this Policy Brief
The purpose of the policy brief is to convince the policy cycles that fuel subsidy is major obstacle to sustained growth in the light of the fiscal crisis the country is facing. Fossil fuel subsidy reform is recognised as a vital component of the transition to a sustainable future. The urgency of resolving the fuel subsidy problem and the need to adopt the preferred alternative course of action outlined in Iwayemi (2019), serve as an impetus for lessons of experience and appropriate policy actions. Drawing on the knowledge and policy options generated by Iwayemi (2019) and others, this policy brief is intended to embark upon meaningful fuel subsidy reform and also build on the WTO declaration.

The global community is unanimous that promoting the production and consumption of fossil fuels through subsidies is incompatible with the Paris Agreement on climate change. Recent examples demonstrate that subsidy reforms, combined with compensation mechanisms, are feasible. The next steps towards a sounder and more efficient approach to fossil fuel subsidies are compulsive for Nigeria.

Key Observations

In the early 1970s, the Nigerian economy experienced a stroke of good fortune when crude oil became a highly prized commodity in the global economy. The consensus then was that crude oil exploitation was going to be a veritable game changer, politically, strategically and economically. There was latent optimism both in the government and the general population that oil was going to provide the silver bullet that would end most forms of underdevelopment. The general expectation was that the oil sector development would change Nigeria’s development narrative from poverty to economic prosperity.

However, after more than six decades of crude oil exploitation, the consensus is the squandering of hope and riches (over US $300 billion) as suggested in the following:
• unfulfilled expectations of a strong and dynamic economy;
• insignificant diversification of the economy;
• absence of notable improvement in living standards;
• high poverty level and greater income inequality;
• the subsidy does not benefit the target audience;
• a notable example of fuel-subsidy-related corruption is 2012 forensic audit which revealed corruption in subsidy claims;
• inflation is currently over 11%, rising from 11.27%; and
• Nigeria has the largest number of extremely poor despite decades of fuel subsidy. This shows the ineffectiveness of subsidized pricing of fossil fuels in achieving a lower incidence of poverty. The evident is even stronger with kerosene the fuel used more by the poor selling at more than double the official prices because of the ineffectiveness of subsidized kerosene pricing going to the intended beneficiaries.
• The emergence of low human development indicators including low level of happiness derives mainly from inefficient management of the economy and flawed implementation of development policies by the successive governments.
• The main causal factors are structural rigidities in the economy and lack of fiscal restraint by the three tiers of government.
• Though there appears to be a drop in corruption under the Buhari government through the near-full implementation of the whistle-blower and Treasury Single Account (TSA) that puts all federal government money at the CBN, corruption associated with fuel subsidy payment remains unabated.
• NNPC’s subsidy payments to itself based on the disputed current consumption of 56 million litres of petrol a day compared to 30 million litres a day in 2012 raises suspicion in an organization perceived by the public as opaque in its financial dealings.
• For instance, the escalation in the demand for petrol from 30 million litres a day in 2012 when the economy was booming, to 44 million litres per day during recession in 2017 and 56 million litres in 2019 despite the weak recovery from recession gives room for doubt as to the veracity of NNPC consumption data since subsidy is calculated based on the volume of petrol consumed. This trend in a period of recession is highly unbelievable.
• The public controversy between the NNPC and the Minister of State for Petroleum which blew up a few years ago is suggestive of the public suspicion about transparency and accountability of corporate governance in NNPC.
• Most importantly, the subsidy is a huge burden on the public debt. It is robbing the budget of huge resources for capital investment that could generate growth and create jobs. Because the petroleum sector is the dominant factor in government revenues and external trade.

Oil-driven redistributive politics, entrenched in successive constitutions since 1979, coupled with flawed macroeconomic management of oil revenue volatility, helped to produce the paradox of a natural resource rich country where most of the people are poor. Furthermore, it is responsible for the lack of fiscal buffer, which partly explains why the economy could not absorb the shock that accompanied the collapse in oil prices in 2016 and 2017 which ended in a five-quarter recession, whereas, in 2008, the economy was able to weather the storm of the global financial crisis of that year due to the huge fiscal buffers. Thus, emptying the Excess Crude Account (ECA) is not a wise decision for the country.

Clearly, fiscal federalism driven by “the entitlement syndrome embedded in the 1999 constitution, and underpinned by the monthly sharing of revenues from the federation account, has exacerbated the lack of fiscal discipline at the sub-national levels. Majority of state governments have minimal interest in internally generated revenues which require more accountability.

Economically-efficient and environmentally-responsive fuel pricing policy has been confronted by two key challenges. In many of the oil exporting countries, few policy issues pitch good economics against good politics as fuel subsidy. First, the entitlement syndrome linked to citizens’ expectation of a share of the oil cake in an economy richly endowed with oil resources and secondly, the political difficulty associated with reconciling the heterogeneity of interests of key stakeholders in the sub-sector.
The difficulty facing elimination of the subsidy trap derives from coalition of interests that are against efficiency-oriented reform of the sub-sector. They include the powerful petroleum industry labour unions and those who benefit from fuel subsidy payments.

Also, the political sensitivity of petrol subsidy reform derives from the inability of the government to reconcile the heterogeneity of interests in the sub-sector which include: PPPRA (price regulator), Department of Petroleum Resources, (DPR, also a regulator); fuel suppliers, distributors and importers, including the major marketers, the independent marketers and dealers; tanker owners (National Association of Road Transport Owners - NARTO); National Union of Petroleum and Natural Gas Workers, NUPENG) and Petroleum and Natural Gas Senior Staff Association of Nigeria (PENGASSAN); Nigerian Labour Congress; Civil society organizations and consumers (households, business enterprises and the state).
“Where have all the hundreds of billions of dollars of oil revenues gone?” is a question that has resonated across the years, given the country’s low human development indicators and infrastructure service failures.

Policy Recommendations

There is growing consensus that phasing out fossil fuel subsidies is an essential part of the green economy transformation, by sending a right price signal to the market about the true cost of energy and by creating fiscal space that could be used to implement green economy policies across key sectors. In theory, fossil fuel subsidies have important policy objectives. In reality, they have a negative impact on the environment, absorb substantial fiscal resources, fail to benefit targeted groups and encourage excessive consumption of energy. The economic price of petrol when the marginal supply (litre) comes from import is the import parity price. According to PPPRA fuel subsidy stands at about N10 trillion between 2006 and 2018, which highlights the high social opportunity cost and fiscal burden that fuel subsidy has become over the years. Governments can use the revenues saved from fuel subsidy reform to redirect public investments to clean energy and augment public expenditure for research and development in green technologies. For instance, tax incentives could make investments in clean technologies more attractive while government funds could reduce the risk profile of capital-intensive green technologies.

Subsidy removal has significant distributional consequences but compensation measures for vulnerable households and businesses can help cushion them against the adverse impacts of rising fuel prices following subsidy removal, but they are not a panacea and need to be adapted to a country’s particular circumstances. They also need to be implemented with complementary measures – such as broader energy sector improvements; an effective communication campaign to inform the public about the objectives and expected impacts of reforms; and a supportive administrative apparatus to ensure smooth implementation. Unfortunately the average citizen is skeptical about the genuineness of the government to effectively implement compensation schemes that will minimize the income shock that are associated with the withdrawal of petrol subsidy.
Yet, good economics needs to be backed up by good politics and credible communication strategy for successful exit from the subsidy trap. Significant price differential between Nigeria and with neighboring countries in the ECOWAS region, Nigeria has the lowest prices for petrol. The price differential between Nigeria and the countries in the region fuel the high level of products smuggling from Nigeria to neighbouring countries in the region to the detriment of Nigeria’s fiscal equilibrium, growth and development.

Market forces can provide a reliable mechanism for efficient allocating energy resources in Nigeria in these circumstances, in particularly, if the following strategies are followed:

1. Ensuring transparency and consistency in liberalizing and deregulating the market with the ultimate aim of establishing an efficient and market-oriented energy sector that allows prices to reflect demand.
2. Incentives to induce supply competition must be provided with the objective of improving the quality and quantity of energy output as well as exert downward pressures on the cost of energy services delivered at the end use.
3. Strengthening of regulatory and market institutions to ensure a competitive fuel market that takes due cognizance of the interests of consumers and producers.
4. Use of product prices should incentivize consumers and producers to make efficient and environmentally responsive energy choices.
5. Internalization of the environmental costs of fossil fuel development.
6. Reform fiscal federalism by creating a socially efficient and incentive compatible revenue allocation formula. The sharing of natural resource rent must recognize the significant negative economic and environmental impact imposed on the resource-endowed states. The new fiscal federalism must solve the problem of information asymmetry that create moral hazard problems in the current revenue allocation system.
7. Allow a level playing field in the petroleum products market to correct the bias in the existing system, which undermine efficient inter-fuel substitution.
8. A transition period of 12 months commencing from the third quarter of 2019 to link domestic price to international price.
9. Elimination of price control completely at the end of the period, third quarter 2020.
10. Automatic fuel price adjustment on quarterly basis to reflect changes in world oil prices and the exchange rate.
11. Full deregulation and privatisation of the petroleum products market by 2020.
12. Open access to depots, pipelines, import terminals and other distribution facilities currently owned by the government.
13. Fuel import liberalisation and imports based on an auction system.
14. Strengthening PPPRA to perform its price regulatory functions effectively and efficiently.
15. Product prices to reflect road user charges, and environmental pollution.
16. Imposition of an oil import premium to reflect the security implication of fuel import dependence.

Concluding Remarks
In conclusion, achieving a sustainable downstream oil future is central to affording a more prosperous economic future for all Nigerians (poor and non-poor) and that should be the country’s overarching policy goal.
How to transform our oil and gas resources into sustainable wealth creation and economic progress for all should be the priority rather than ideological fixation on subsidy retention, a policy trap through which we have burnt huge amount of money in inefficient and environmentally degrading ageing vehicle stock and “I better pass my neighbour” generators.
A more prosperous Nigeria requires a paradigm shift that will ensure the use of the savings from subsidy removal to fund investment in infrastructure and human capital development, and social investment programme for the well-being of current and future generation.

Posted in News by Admin
Fri, September 06, 2019


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