Revisiting Nigeria’s petrol price/subsidy dilemma

I wrote this originally in 2011 as entry for an essay competition titled “Strategies for Taking the Benefits of Oil Subsidy to the Highest Number of Nigerians“. I never heard back from the organizers but as I was looking for material on an article I’m working about the current fuel price dilemma, my mind wandered to this old one. While my thinking has evolved over the last decade from the simplistic ideas in this article, the core tenets remain valid: The Nigerian middle class must stop ‘playing the ostrich’ with fuel prices and allow petrol pricing join kerosene and diesel in the fully deregulated camp. The Nigerian government must be courageous enough to directly attack the false idea that we can somehow pay a subsidized price and deny the existence of blanket subsidy. Nigeria should move forward to create more targeted welfare interventions to help the poor cope with the downside of rising oil prices. Hope you enjoy it!

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The decision by President Goodluck Jonathan to deregulate the downstream petroleum sector which would entail removing the fuel subsidy is not a precedent. Over the last twenty years, various administrations, civilian and military have attempted to do so with varying degrees of failure. This renewed attempt provides an examination of the reformist credentials of this government as well as its ability to carry the populace along.

A subsidy is an assistance provided by the government either directly in the form of cash transfers or indirectly via a reduction in taxes or prices paid for the consumption of certain goods and services. (The Economist, 2006) Thus, an oil subsidy can be referred to as assistance provided via price reduction to citizens for the consumption of petrol, diesel and kerosene[1].  They primarily serve to cushion the public from the negative welfare effects of higher international oil prices. (Granado et al, 2010). Subsidies however present several conundrums, when poorly designed they result in leakages to other groups not targeted, the so called ‘free-riders’ in public economics. Furthermore, with increasing volatility in international oil prices, they result in substantial fiscal costs which constrain the ability of governments to meet other objectives; infrastructural, macroeconomic and social. Moreover, aided by weak regulation they provide perverse incentives for rent-seeking distortionary practices which enshrine inefficiency in the oil industry. Lastly, as stated by the Minister of Petroleum Resources, it does not reach the rural poor. (Thisday, 2011)

Thus, governments must seek a trade-off that ensures a Pareto-optimal outcome which will require a range of proactive strategies to be treated in the rest of this essay. To begin with, Nigerians (regardless of income level) view cheap fuel as a divine right derived from Nigeria’s position as a major crude oil exporter. This perception is responsible for the present universal subsidy, but ideally subsidies are designed for target groups usually the poor NOT for everybody. The present oil subsidy is a blanket one paid to oil importers inclusive of other costs arising from importing and distribution. Therefore, any plan to distribute the benefits of the subsidy to the highest number of Nigerians will entail an overhaul of the present system by removing the subsidy from the importers end and directing it to the ‘have-nots’ end.

An ideal solution would be complete deregulation with compensation provided for lower income groups via safety nets such as targeted cash transfer schemes. In developing countries like Nigeria, these are non-existent and infeasible to develop in the immediate period, thereby ruling out a ‘shock therapy’ approach to subsidy removal. Rather, a gradual approach is the first best strategy to distributing the subsidy benefits in the absence of welfare transfer systems. (IMF, 2008) This is partially being done as the government only intends to remove the petrol subsidy and not the kerosene subsidy, while that of diesel used intensively by higher income groups was discontinued in 2009.

Firstly, government can re-direct the savings from the removed subsidy by increasing the minimum wage for low-paid government workers ONLY. Today, the Nigerian Government today is the biggest employer of labour and this increase will help only the lowest earning class in addition to minimizing inflationary pressure[2].

Secondly, government should re-direct the savings towards the acquisition and implementation of mass urban transit in main cities in Nigeria like the Bus-Rapid Transit BRT scheme in Lagos. Crucially, these buses run on diesel which is already deregulated and lend themselves easy to subsidy targeting as those who most likely use them are the poor. This builds no inflationary pressure and the subsidized transport costs immunize the poor from the impact of high fuel prices[3].

Thirdly, government can provide an indirect transfer by via free meals to students who attend public schools again more likely to be from poor families. The externalities involved here range from; creating a sizeable market for local farmers, to employment opportunities for culinary firms and quality nutrition for Nigeria’s future.

More importantly, as Nigeria is a crude oil exporter, it is of great importance that the construction of new refineries as well as the re-vitalization of the existing refineries be high on government’s priority. The price of imported fuel is no longer a direct function of supply side or production costs but increasingly a function of aggregate global demand fired by the economic growth of China and India. (Hamilton, 2009) Thus, a substantial part of the factors accounting for this price is speculative as to whether global supply is threatened. These vagaries can be eliminated by the establishment of refineries locally in Nigeria in addition to eliminating the thorough-put fares of international shipping and distribution. This can be hastened by complete deregulation of the downstream oil industry in addition to tax concessions to investors.

Penultimately, post-deregulation, the new price setting regime should be a fully liberalized setting with no intervention either via a band or price cap. Rather, a competition commission should be set up to investigate and detect collusive or non-competitive behaviour with stiff clear penalties for defaulting oil firms.

And lastly, it cannot be over-emphasized; government MUST deliver on its ‘Transformation agenda’ using the savings from the subsidy reform particularly with regard to low income groups via provision of health and education to the poor.

In summary, for subsidy reform to meet the ‘Paretian’ requirement of the ‘greatest good for the greatest number’, the strategies can be grouped into three; short term palliative measures for the lower income groups, medium term development of local refineries plus the strengthening of regulatory capacity to hinder cartelization and the long run delivery of social and economic infrastructure.

Bibliography

Books

The Economist (2006), “Guide to Economic Indicators: Making Sense of Economic Indicators”. (6th Edition). (London: Profile books)

Journal articles and Working Papers

International Monetary Fund (IMF), (2008), “Fuel and Food Price Subsidies: Issues and Reform Options” (Washington). Available at www.imf.org/external/pp/longres.aspx?id=4293.

James D. Hamilton. (2009), “Understanding Crude oil prices”, Energy Journal 30(2) pp.179-206

Javier Arze del Granado, David Coady, and Robert Gillingham (2010), “The Unequal Benefits of Fuel Subsidies:  A Review of Evidence for Developing Countries”. IMF Working paper WP/10/202

David Coady, Robert Gillingham, Rolando Ossowski, John Piotrowski, Shamsuddin Tareq, and Justin Tyson, (2010), “Petroleum Product Subsidies: Costly, inequitable, and Rising”. IMF Staff Position Note, SPN/10/05

Newspaper Articles

Thisday, 16th November, 2011, “ Benefits of fuel subsidy removal outweigh cost”. Available at http://www.thisdaylive.com/articles/benefits-of-fuel-subsidy-removal-outweigh-cost/102895/


[1] Oil as the title of this essay refers is interpreted to mean diesel, petrol and kerosene.

[2] This was carried out in Jordan which began gradual removal of petroleum product subsidies in 2005, culminating in full price deregulation in February 2008. (Coady et al, 2010)

[3] This was implemented in Gabon where 27 buses were added to the Libreville transit system, where a substantial part of the Gabonese populace resides.

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