Subsidy: Time to Bite the Bullet

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 petroleum refineries

With the slump in crude oil prices to a 13-year low of below $28 on January 20, 2016, the federal government did not provide for the payment of subsidy in 2016 budget as the expected open market price (EOMP) of petrol had dropped below the official pump price. Ejiofor Alike, however, reports that as oil prices rally above $45 per barrel, the government has braced up to pay subsidy. Analysts believe that the permanent solution is to remove subsidy

The plummeting crude oil prices, which started after the price hit a peak of $115 per barrel in June 2014, took the worst dive on January 20, 2016, as continued concerns about the glut in the international market pushed the prices below $28 per barrel, the lowest in 13 years.

While West Texas Intermediate (WTI) crude contract settled below $27 a barrel, its lowest since May 7, 2003, the price of Brent crude, which is the global oil benchmark, dropped to $27.88 a barrel, the lowest since November 24, 2003.

With the slump in the crude oil prices, the cost of refined products at the international market also dropped and the landing cost of refined petrol also slumped below the official pump price, thus eliminating the subsidy elements.

At the peak of the slump, the federal government recorded over-recovery in terms of prices of petrol, which marketers are expected to pay back as the official price for which they sold petrol was higher than the expected market price, in view of the low cost of crude at the international market.

The drop in the price of crude oil was a blessing and curse to the federal government as it eliminated subsidy, which had gulped over N1 trillion yearly and at the same time, drastically reduced the proceeds from crude oil sales.

With the government not incurring any expenditure on subsidy, no provision was made for the payment of subsidy in this year’s budget.

Since the official government position was that it had not removed subsidy, there was concern that the expected anticipated rise in the price of crude after the April 17 meeting in Doha between the members of the Organisation of Petroleum Exporting Countries (OPEC) and non-OPEC might have agreed on output freeze, would potentially increase subsidy, which was not budgeted for in the 2016 budgetary appropriation.

The Minister of State for Petroleum, Dr. Ibe Kachikwu had said that the May 2016 price review would reveal what the pump prices of petrol in the country would look like.

Subsidy Returns

As the prices of crude rally above $45 per barrel, thus raising the landing cost of petrol above the official pump price, subsidy element has returned to the pricing template.

The federal government recently confirmed that it is now paying between N12.62 and N12.88 as subsidy for every litre of petrol consumed by Nigerians, according to the updated pricing template of the Petroleum Products Pricing Regulatory Agency (PPPRA).

The latest template showed that the gradual rise in subsidy was necessitated by the recent increase in crude oil price to about $47 per barrel.

For every litre of petrol, the federal government would pay subsidy of N12.88 to the private markets, while the Nigerian National Petroleum Corporation (NNPC) gets N12.62 for selling below the expected open market price.

According to the latest PPPRA template, which will cover the second quarter of 2016, the EOMP of petrol is N99.38 per litre for independent and major oil marketers and N98.62 per litre for retail outlets belonging to the NNPC.

EOMP is the price the product is supposed to be sold in Nigeria if there is no subsidy and no price regulation.

However, marketers have contested PPPRA template, saying it does not reflect the actual market fundamentals.

This is obviously why petrol is not sold for official price in Nigeria except in Abuja, Lagos and other major cities.

According to the PPPRA template, the expected open market price is based on the current exchange rate of N197 to a dollar, which the marketers have also faulted as dollar has risen far above the official rate.

The marketers argue that with the high cost of dollar, the expected open market price of petrol is higher than PPPRA’s official estimate in the template, hence most marketers sell above government’s official price.

With the current official price of N86 per litre at NNPC retail outlets, the federal government is paying N12.62 per litre as subsidy on the product and N12.88 per litre as subsidy for other oil marketers’ price of N86.50.

A breakdown of the template revealed that for NNPC retail outlets and private marketers, the landing cost of petrol imported into the country is N84.32 and N85.08 per litre respectively.

The distribution margin, which includes retailers, transportation, bridging fund and dealers’ margin among others, stand at N14.30 for both the NNPC and other marketers.

This brings the current expected open market price to N98.62 and N99.38 for NNPC retail outlets and other marketers respectively.

Are Nigerians paying double subsidy?

Even though the federal government pays subsidy to ensure that Nigerians access product at official price, it is only in Abuja, Lagos and other major cities that marketers sell at official pump price, apparently due to the presence of the regulatory agencies.

In the hinterlands, petrol is sold at N100 per litre and above even when there is no scarcity of product.

With petrol not selling at official price even after subsidy is paid to marketers, there are concerns that marketers receive double payment from the government, on one hand, and from Nigerians who buy the product, on the other hand.

But marketers argue that the PPPRA template, on which the federal government relies for determining the pricing, does not reflect the actual market fundamentals for appropriate pricing of product.

For instance, the pricing template is based on the exchange rate of N197 but the traders access foreign exchange at higher costs, which are not captured in the pricing template.

After the marketers have paid the actual cost of product at the international market, there are other cost elements they incur before the product arrives in Nigeria, which are captured in the PPPRA template.

These cost elements include lightering expenses, financing, jetty depot throughput, storage charge, Nigerian Ports Authority (NPA)’s charge and Nigerian Maritime Administration and Safety Agency, (NIMASA)’s charge.

As the product lands in the country, the PPPRA allocates distribution margin to arrive at the expected open market price before determining subsidy.

These margins include, retailers’ margin, transporters’ margin, dealers’ margin, bridging fund and marine transport average.

However, the marketers argue that these cost elements, which are determined by the PPPRA, do not reflect the current market realities that determine the cost of imported product.

The marketers have also faulted the template on the grounds that it does not capture all the expenses incurred in the course of importation of product into the actual.

In order words, the marketers’ position is that while the cost elements captured in the template do not reflect the actual fundamentals in the market, there are also many hidden costs, which are not captured by the pricing template.

Some of these costs include: union levies, high cost of demurrage, extortion on the highways, unofficial payments to security and government officials, among others, which are not captured by the PPPRA, and which make the expected open market price published by the agency unrealistic.

To this end, petrol is hardly sold at the official price outside Lagos, Abuja and other major cities, despite the payment of subsidy to marketers.

Though it will be a hard decision to take, analysts believe that the way to go is to remove subsidy. This will bring to an end the raging controversy over how much to pay, allegations of double payment, and end the reccuring fuel scarcity.