The Price of Cheap Petrol

Olatunde Akande

Nigeria has abolished one fuel subsidy. It is now debating whether another, aimed at production rather than consumption, might work.

Economists are fond of reminding people that there is no such thing as a free lunch. Nigeria’s petrol market offers a more combustible version of the same lesson: there is no such thing as cheap fuel.

There is only the question of who pays for it.

For decades the answer was the state. Nigeria exported crude, imported much of the petrol refined from it and paid part of the cost of selling that petrol cheaply at home. By 2023, fiscal pressure, arbitrage and smuggling had made the arrangement increasingly difficult to sustain.

Three years later, subsidy has returned to the economic conversation, but with an intriguing change of address. The proposal now being debated would support production rather than consumption. Domestic refineries would receive crude on preferential terms, with the intervention capped, independently audited and tied to domestic supply. Lower feedstock costs, the argument goes, should encourage refining and ultimately make petrol cheaper.

The government’s objection is straightforward. Nigeria has already borne considerable economic and political costs in removing petrol subsidy. Reintroducing a price concession would surrender public revenue and could recreate distortions the reform was intended to eliminate.

Both arguments deserve something better than slogans.

Consider a barrel of Nigerian crude worth $80 abroad. Sell it to a domestic refinery for $60 and no subsidy cheque leaves the treasury. No importer submits a claim. Yet $20 of potential public revenue has disappeared.

An accountant may struggle to find the subsidy. An economist will not.

That does not necessarily make it a bad policy. Governments routinely surrender revenue to encourage activities they want more of. Tax holidays, agricultural credit, export incentives and industrial grants are variations on the theme. The relevant question is not whether government has distorted a price, but what the distortion buys.

There is an important distinction here. If an $80 barrel includes freight, handling or other costs that need not arise when Nigerian crude is supplied to a Nigerian refinery, removing them is not necessarily subsidy. It may simply be efficient domestic pricing. Selling the same barrel materially below its economic value is something else.

Removing a cost that was never incurred is efficiency. Surrendering economic value to change commercial behaviour is subsidy. Between the two lies much of the serious policy debate.

Nigeria’s petroleum industry has certainly changed. The country now possesses the 650,000 barrel-a-day Dangote refinery. Smaller modular plants exist, but none approaches its scale, while the state-owned refineries have yet to establish sustained commercial production. For practical purposes, Nigeria currently has only one commercial-scale domestic producer of petrol.

That makes a production subsidy unusual. At least initially, it would flow overwhelmingly to only one producer.

Preferential crude could nevertheless improve refinery economics. Predictable feedstock may increase capacity utilisation and encourage investment. Smaller plants or new entrants might eventually acquire meaningful scale. Imports of refined products and demand for foreign exchange could decline. Today’s highly concentrated domestic refining market might eventually become more competitive.

But industrial policy requires a counterfactual.

It is not enough that subsidised production increases. The relevant question is how much additional production, investment or competition the subsidy creates that would not have occurred without it. Otherwise, the government risks paying for an outcome the market was already going to deliver.

That question is particularly pertinent when the dominant producer has already built its refinery and Nigeria is already considering reforms to domestic crude allocation and pricing.

Here lies the first paradox. Supporting the producer that works may help Nigeria build a larger domestic refining industry. It may also strengthen its dominance unless competitors emerge. Meanwhile imported petrol, which industrial policy understandably seeks to displace, provides much of the competitive pressure on domestic prices.

Nigeria must somehow reduce dependence on imports without reducing the competition that keeps domestic prices honest.

There is another route to competition. Nigeria already owns substantial refining capacity. Were the state-owned refineries operating reliably at commercial scale, the domestic market would look rather different: preferential crude would not flow overwhelmingly to one producer, and imports would not provide quite so much of the competitive discipline.

That suggests a broader question. If the objective is a competitive domestic refining industry, should policy concentrate on making crude cheaper for the producer that already works, or on creating more producers that do?

Preferential pricing also creates a quite separate policy-design problem: arbitrage.

Give one barrel two prices and somebody will eventually discover both.

Whenever the same commodity carries materially different domestic and international prices, an incentive arises to capture the difference. That risk exists regardless of who participates in the scheme. It is a consequence of the price structure itself.

Independent reconciliation of crude allocations, refinery intake, inventories and output could make diversion harder. Caps could limit fiscal exposure and penalties raise the cost of abuse. But auditing only changes the probability of detection; it does not remove the economic incentive created by two prices.

The wider the gap between the preferential and market prices, the greater that incentive becomes.

Nor does verification solve every problem. An audit can establish whether subsidised crude reached a refinery and whether the refinery produced what it claimed. It is less capable of determining how the resulting economic benefit is ultimately divided among the state, the refinery, marketers and motorists.

That is usually the work of competition.

And there is another complication.

A refinery does not turn a barrel of crude entirely into petrol. It produces diesel, aviation fuel and other byproducts, some of which can be sold at market prices domestically or abroad. A discount on crude therefore applies to the whole barrel even if the policy objective is cheaper petrol.

Following the barrel is only half the accounting exercise. The other half is following everything that comes out of it.

Suppose discounted crude produces cheaper petrol for Nigerian motorists but diesel or aviation fuel from the same barrel is sold at market prices or exported. Has Nigeria subsidised cheaper petrol, or partly subsidised the refinery’s other products? If the refinery retains the market value of those products, should some of that value be netted against the concession on crude?

These are not accounting curiosities. They determine who ultimately captures the subsidy.

Which leads to pass-through. A $10 reduction in feedstock cost does not automatically become $10 of consumer benefit. Some may become refinery margin. Some may be absorbed in distribution. Some may reach motorists. And cheaper petrol need not translate proportionately into cheaper transport fares or tomatoes.

Producers pass savings to consumers most reliably when competition forces them to. In a market with essentially one commercial-scale domestic producer, that matters greatly.

If the concession is large enough to make petrol materially cheaper, how much of its value would ultimately accrue to the producer and how much to consumers? And if imports are required to discipline the domestic price, how far can Nigeria reduce import dependence before it also reduces the competition that keeps prices in check?

There is a further wrinkle. If government grants a crude discount but also requires a specified amount of that discount to appear in the pump price, it must somehow determine the appropriate pass-through. That requires assumptions about yields, costs and margins.

At what point does industrial policy become price regulation?

The government’s preference for market pricing starts from a different premise: allow petroleum prices to reflect economic costs, preserve public revenue and avoid recreating incentives for arbitrage.

There is strong economic logic behind this. Broad fuel subsidies consume fiscal resources and distort prices. Crude is also a public resource. Selling it below its economic value potentially means fewer resources for federal, state and local governments to spend on competing priorities, from infrastructure and debt service to wages, health and education.

Any assessment of preferential crude must therefore count forgone revenue as carefully as it counts cheaper petrol. The two approaches have different transmission mechanisms. Preferential crude seeks a relatively direct one: lower feedstock costs should reduce refining costs, which should reduce petrol prices and perhaps other costs downstream.

Market pricing works more indirectly. Removing subsidy preserves fiscal resources, improves price signals and supports macroeconomic stability, which should create better conditions for investment, productivity and growth.

Neither journey is instantaneous.

Macroeconomic gains do not arrive at the kitchen table by direct debit. Neither does a cheaper barrel of crude.

Households experience economic policy through wages, employment, transport costs, food prices and purchasing power. The pump price is therefore an incomplete measure of either approach.

Nigeria’s deeper problem is not principally an inability to make petrol cheaper. Governments can make almost anything cheaper by requiring somebody else to absorb part of its cost.

The harder question is what makes petrol expensive and which components of that cost can genuinely be reduced rather than merely transferred.

Feedstock is only one component.

Financing, pipelines, storage, transportation, exchange rates, taxes, distribution and refinery efficiency all eventually find their way into the pump price.

A dollar permanently removed from those costs is more valuable than a dollar temporarily hidden by subsidy. That provides perhaps the most useful test of the proposal.

If preferential crude merely lowers today’s pump price and requires continuing discounts to sustain it, the intervention may ultimately amount to a different mechanism for subsidising consumption.

If temporary support however creates additional investment, capacity, efficiency and competition sufficient eventually to remove the need for the concession, it begins to resemble successful industrial policy.

The important word is additional.

How large would the discount be? What production or investment would occur because of it that would not otherwise occur? What would be the annual opportunity cost to the public purse? How would the value embedded in other products from the subsidised barrel be treated? How much would reach consumers? And under what conditions would the support end?

That is the arithmetic of industrial policy.

The government’s caution is understandable.

Nigeria has already undertaken the difficult task of moving away from a subsidy regime and has little incentive to recreate its old weaknesses under another name. But the emergence of substantial domestic refining presents a different economic landscape from the one in which the old subsidy was born.

Nigeria spent decades subsidising petrol partly because it could not refine enough of its own crude. It now faces a more sophisticated problem: how to exploit the advantages of a giant domestic refinery without replacing dependence on foreign refiners with dependence on one local one.

The old argument asked who should pay to make petrol cheap.

The better one asks what makes petrol expensive and which of those costs can actually be removed.

If preferential crude merely transfers part of the cost from motorists to the public purse, the cost has not disappeared.

If better refining, competition and logistics actually remove that cost, something more valuable has happened.

There is no such thing as cheap petrol.

There are only different ways of paying for it.

•Olatunde Akande

Development Finance and Investment Professional