Transaction costs impact businesses and economies all over the globe. It is defined as the cost of operating within a market, or “the costs, other than the money, that are incurred in trading goods or services”, including, but not limited to the cost of information. Information is indeed power in all respects. The right information, in the right hands, at the right time, can reduce the impacts of moral hazard and adverse selection in business and economic operations.
The Nigerian Government in 2011, publicized the consideration of a proposal to eliminate fuel subsidy from its annual budget. As expected, this proposal has been the subject of critical analysis and discourse, on both television and radio talk shows, social networking sites, and most recently, the National Assembly. One major issue, worsening this Nigerian quagmire of policy and decision making, is the availability, veracity and integrity of information.
It remains unclear to Nigerians what the estimated daily demand of PMS is. How much do we consume each day? What part of this demand is produced and supplied locally? What is the short-fall quantity that requires importation? What quantities were actually imported and paid for? Were quantities verified? It further remains unclear what the actual (sunk) cost of fuel subsidy for 2011 is – N1.3 trillion? N1.5 trillion? or what? The definition of fuel subsidy in itself seems to appreciate in vagueness by the day.
In this regard, and with the available information on current PMS retail price, current landing cost and ex-depot price (via PPPRA website), a scenario analysis has been run, with a permutation of numbers, in an attempt to demystify the concept of fuel subsidy and the method of evaluating its cost to government.
The analysis is seen here: The Arithmetic of Fuel Subsidy
great work with the figures. my only issue is: doesn’t the exchange rate and cost of borrowing matter in the equation? or not so much? or do the PPPRA’s figures cater for that?
@Joachim exchange rate is already factored into the under recovery
KD, u’ve been able to represent clearly what some folks know but haven’t been able to communicate. Well Done!! Also note that subsidy N1.3M is total across PMS and DPK. Information on PPPRA’s site shows total subsidy on Kero is about 20% of that of PMS so u might want to deduct it from thw N1.3M before division.
It is clear some fella is collecting subsidy even on PMS refined in our refineries which are currently at 75% production. Well done sir.
Great work Kunle. I wish we all had more to work with on this deregulation issue.
Just a few things I presume you missed out in your analysis which I think you should include:
1. The FG also subsidizes HHK. The amount under recovery for that is even higher than that for PMS – 104 to 109 Naira per liter. Daily consumption of HHK is estimated at 10m liters per day. This one is controversial.
2. Your figures are for November 2011. Oil prices vary, so does the exchange rate. So it’s important to include a note to the effect that amount under recovery could vary from day to day. I ran figures in March and the amount under recovery for PMS was 77.32 at the time.
Local production for me is the issue that we need to unpack here. Unfortunately, there isn’t that much information, and I doubt there will be… Well not until things heat up real bad.
But there are scenarios which suggest that local production will be artificially low:
1. Round tripping: If you have 10m local liters of HHK. What are the incentives for declaring it as local (no recovery payments) vs. just “round tripping” the products and making a cool 1.1bn? This is why I believe there’s a lot of local products still in the subsidy category just taking advantage of the opportunity for arbitrage. I mean, even if the refineries where actually working at 80% for example, what is the incentive not to collectively declare 10% and cash in on the subsidy bazaar?
2. Infrastructural challenges like pipeline age/safety, evacuation capacity (roads) etc.
3. Greed. Assuming even that the guys running the local refineries are not the “sharp guys”. That the guys importing are. Assuming that these sharp guys operate based on the same type of greed we see the world over. They will know that working refineries will cut their share of the subsidy cake. So hey, can they invest in sabotaging local production?
I started my research on deregulation in March 2011 based on this article here:
Ever since then, I have been convinced that deregulation before local capacity development is the right sequence of implementation of downstream development policies. I still hold that view. Keeping subsidies whilst trying to improve local production is humane, but I’m afraid that it’s as feasible as asking a womanizer to keep saying his prayers whilst a naked Tiwa Savage is alone with him in his room. The Nigerian petroleum downstream guys, including the Nigerians who work for the regulator PPPRA are not just wired to look the other way whilst the juicy opportunity of subsidy arbitrage tempts. Unfortunately so.
But the kick against the policy is perhaps the most useful part of the debate. Analyses like the one you just put up and the suggestions you have made are as critical as the policy itself. If anything, it presses for more transparency on an issue that has benefited a few and could potentially inconvenience many.
If the GEJ administration desires to change policies that have, by and large, been exploited to take Nigerians for granted, then the ideal approach is to do it in a way that does not take Nigerians for granted.
I think we can safely assume that local production is 0%. If any refinery was working, we’d probably have heard of it. As for the right thing to do, GEJ has all the necessary documents on how to best approach this issue (which is to deregulate and build refineries as a way of removing subsidy) but he apparently is not interested in doing things the right way.
As it is, the government has made a lot of noise about the number of refinery licenses out the (issued by the OBJ administration) but have refused to put in place policies to stimulate the building of those refineries.
We all know (I believe) that a private local refiner has to make a profit and the only way I see that happening is for the government to sell crude to local refineries at a much reduced rate. However, it seems the government is not ready to go this route. The only other option would be to increase the price of the refined product and I have a strong feeling this is what the government is trying to achieve so as to lure investors into refining locally.
I have seen figures of between 18 to 60 percent utilization for local refineries. We can’t safely assume that they are at zero.
The proposal for reduced oil prices to private investors will fly if investors can build their risks on Government commitments. Unfortunately, investors still trust the market more. You can’t blame them. This is why Dangote and Otedola promptly asked for their money back after Government back pedaled on deregulation in 2007.
@Arinze and @Bubu, thanks for the pointers. Running those numbers is some task. Will need to exclude HHK volumes accordingly…but like you said, there is much uncertainty to the quantity of daily demand also. Looks like we have a bottom-line consensus being a requirement for transparency in these dealings and transactions…. @bubu, your last line sums it up …”the ideal approach is to do it in a way that does not take Nigerians for granted”
Thanks for reading and contributing.
Nice one Kunle! have posted on fb already. It decidedly gives a logical answer to the subsidy removal question.
Good Analysis. I would like to point out two things though.
First of all the the local demand is probably a lot lower than that. The truth is we are not just subsidizing fuel for Nigeria but for Niger, Benin republic and Togo as well. The presence of the subsidy combined with porous borders makes it more profitable to import through Nigeria. The kerosene fiasco earlier in the year is proof of that I think.
Secondly, assuming that we can somehow boost local refining before removing the subsidy is a bit over ambitious. We know that the government does not know how to run refineries. They have tried for 20 – 30 years and failed. Private refineries are the way to go but cannot work if the government sets the price. The subsidy needs to go for that to happen but more importantly the PPMC, PPRA and all those other agencies that pick and choose the prices and who can import or refine etc need to go as well. Removing the subsidy alone with all those other things still in place will just lead to higher cost of PMS. The struggle should not be for or against the refinery but for the removal of the government controls that try to determine everything arbitrarily.
Actually Nonso, private refineries can be built without removing refineries. After all, the crude is drilled in Nigeria and government has its own quota. All they have to do is sell crude to local refiners at a reduced price making it possible for them to produce @ below 65 naira per liter. That shouldn’t be so much of a problem to calculate since production costs are fairly constant and transportation costs should be negligible. The government can also buy up whatever is produced (to reduce the possibility of it being sold abroad)
Very nice scenarios KD, It is now for those in charges to show how they arrived at the N1.3tr for 2011. One thing is certain, the figures do not add up. The lack of access to data [estimated, accurate or inaccurate from all sources] is alarming. No one knows exactly our daily consumption, yet Govt pays out billions daily. So far, govt’s argument in favor of subsidy removal falls flat – The cost of subsidy is too much, tell us what it would cost if we were not importing. It does not benefit the poor because of corruption, whose responsibility is it to fix corruption. It is just sad that instead of confronting a clear surmountable challenge, Govt would rather use an easy way out – punish the weak and let the powerful cabal walk free.
@Bubu: “Keeping subsidies whilst trying to improve local production is humane, but I’m afraid that it’s as feasible as asking a womanizer to keep saying his prayers whilst a naked Tiwa Savage is alone with him in his room.” that got me rolling on the floor, a naked Tiwa Salvage? Hahahahaha….. That is if the only option left to him is to remain in the room. He can also ask Tiwa to put on her clothes, he is done with games and will not fall for her [I hope i can resist Tiwa sha]. I do not agree that we can’t meet local demand without removal of subsidy. Before we started importing, we were meeting demands locally. Before we started meeting demands locally we were importing. Let’s not make excuses for govt incompetence or inadequacies.
I will make an offer to the govt. Clear the mess and corruption in fuel importation, tell us the actual cost of subsidy without corruption and then comeback and lets decide if we can afford it or not.
As an aside, I keep hearing from those in Govt that Govt is VERY broke. Maybe they need to come clean on this too. 🙂
Actually, Stan, fuel subsidy does not benefit the poor simply because poor people consume significantly less fuel than the middle or upper class. This fact makes fuel subsidies a socially unjust intervention. Corruption is the opportunistic culprit here.
This begs the question: What is the social objective of a fuel subsidy scheme?
The flat – fixed retail price – subsidy scheme on the supply side of the downstream sector is also akin to rubbing oil on your body and taking a seat by the fire clearly aware that the people around you want to throw you in that fire.
If there should be subsidy, why don’t you subsidize the consumption?
But the arithmetic gets even more interesting:
The statutory transfer to the NJC in the federal budget for 2011 was 95bn. This is actually the final institution that should apply the disincentive to corruption… Whereas subsidy presents a 1.3tr incentive. And we wonder why everyone is gravitating towards the “naked Tiwa Savage”.
My opinion is that the fuel subsidy, by it’s design, is a huge piñata dangling in front of Nigerians, but only the rich and well placed have sticks big enough to really wack it. The rest of us only like it because of the crumbs we get to pick up or the hope that we will one day wield bigger sticks…
On feasibility of options to rectify this mess…
That Government is inneficient is a fact, not an excuse. And one must be clear that Government in this case is the entire institution thereof, regardless of the administration that sits atop of what is regarded as the most corrupt civil service in the world. And to make the point that institutions reflect the values of the people, Nigerian businesses are some of the least ethical in the world, even in transactions where Govt is not involved.
So, given the options in front of us, I think feasibility is a real factor and this shouldn’t be evaluated from the perspective that someone else is executing. We should be asking: What can we realistically do, given our unique context?
What can you realistically expect from a womanizer with a naked Tiwa Savage in his room… alone?
You have further highlighted the issues that have been unclear and the entire Nigerian society keeps asking for clarifications on…
1) How much of refined products are we actually consuming in this country? How can you pay for a product at any price it is sold and any quantity you are told you consumed?
2) How much is the local production? that should be the easiest value to get, but in actual fact thats the most shadowy value in Nigeria, refineries have meters, number of tankers which loaded products are known, how come its so hard to say how much the local refineries are producing? throwing around %ages makes it more ridiculous.
Finally, the question should be: Should fuel subsidy be removed, my answer is in two fold; Economically, YES it should be removed. It makes no sense to subsidise corruption, using public funds to satisfy a cabal. However, taking into consideration how irresponsible the Nigerian political class has shown themselves to be any savings by any government is rapidly frittered away by the successive government (ask NOI how come we are back at where she picked us from in 2003).
The modalities for its removal is what is critical, the proceeds from the removal should NOT be returned to the federation account where it can be shared as usual, it should be placed in a special account for specific, predetermined projects, backed by a law from the National Assembly. The projects don’t fly, the money stays stuck… Until that is done, I will be on streets with other Nigerians fighting against the removal of the fuel subsidy.
Well understood but how does removal of feul subsidy ease our problems if the refineries are not producing PMS?
Thank the author very much for this wonderful post. Great job!