http://nao.nigeriaanew.org/fuelsubsidydec232011.html
Fuel Crisis in Nigeria: The 1001 Look at the Issues and Options

By Debo Dosu

Rather than rehash the long-standing history of this chronic impediment (among many) to the welfare of Nigerians, I will begin this write-up by outlining the issues surrounding the current fuel crisis. Nigeria's fuel crisis has become an "a generation is going and a generation is coming, but…remains forever" one. Fuel as used in this article refers to petroleum products, except otherwise indicated.

A. VIEWPOINTS FROM THE TRENCHES

Government Definition of the Problem
As the first co-principal player in the fuel palaver, the government holds the ace in addressing it. According to commentaries by top government representatives, the fuel crisis is due to two factors:

1.      Sabotage activities of unpatriotic elements surrounding the production/importation and distribution of fuel in Nigeria such as hoarding, smuggling and damage to government-owned refineries.

2.      An unsustainable amount of funds is needed to keep subsidizing fuel supply.


Government Solution
In simple terms, the government proposes to deregulate the petroleum sector. But one must be careful to examine what the government means by "deregulation". In his fuel crisis resolution speech of June 2000, President Obasanjo gave one definition:

"Deregulation means that the government will stop interfering in the oil industry. Marketers will be free to IMPORT and sell at prices that are no longer determined by the NNPC. One direct consequence is that prices of fuel will vary from fuel station to fuel station….With deregulation, adjustment of prices will not always be upwards, prices may fall from time to time."

In essence, the government would no longer be responsible for any part of the price of the imported fuel. In other words, this so-called deregulation is effectively an IMMEDIATE JUMP in the domestic price of fuel to match full import and distribution costs.

Citizen Definition of the Problem
The other co-principal player in the fuel crisis is the grouping of average citizens. Represented by the vocal Nigeria Labor Congress (NLC), social critics, and religious leaders among others, it feels the ultimate effect of a fuel crisis and not only has a big influence, but must be the main consideration in addressing it. From the citizen perspective, the fuel crisis is due to:

1.      Inefficiencies and mismanagement of government operations, which in plain terms refer to the inability to keep all three government owned refineries functioning at full capacity.

2.      A sinister plan by the government to force its proposed solution, contorted under the tutelage of the IMF, World Bank, etc, on the populace by creating artificial scarcity

3.      Plain government corruption.

Citizen Solution
The citizen solution to the fuel problem is driven by the following viewpoint: Crude Oil is God-given to Nigerians, the only cost of supplying its derivate (fuel) should be the cost of refining, transportation and distribution plus a minimum amount charged for crude oil extraction. The most articulated proposal is by the NLC:

1.      Repair all refineries.

2.      FG/NNPC should hire all products storage spaces in Cotonou for imports and supply to Lagos, Ogun, Oyo and contiguous states.

3.      FG/NNPC must use strategic and innovative steps to halt the problem of intractable products supply and distribution.

4.      Lagos Ports to be used for source of bridging products to Lagos

5.      FG/NNPC in the spirit of ECOWAS cooperation should contract to exclusively use Abidjan refinery and pay a refining fee.

But what is the true nature of the fuel problem from which a realistic solution can be distilled?

B. AN ECONOMIST'S VIEW: GOVERNMENT AND CITIZEN ARE BOTH HALF-RIGHT.[url]http://nao.nigeriaanew.org/fuelsubsidydec232011.html
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First the problem definitions
On the one hand, government-controlled activities are usually saddled with inefficiency and mismanagement. Unlike the common viewpoint, this is not because governments are made of "wicked" individuals. The primary reason is that exercising control over market transactions require enormous amounts of information. For the government to perform as well as the market, it would not only have to have the required information, but must be able to replicate how the market uses the information. This is an impossible task, and is the singular reason why both the citizenry and the government are both half-right about the problem of petroleum subsidies in Nigeria.

The citizenry is half-right in that lack of information and weak laws/law enforcement enable fuel to be intercepted by middlemen who exact illegal profits from consumers. In the extreme, these middlemen and their collaborators are billing government for subsidies on fuel that was never supplied. It is the incentive for these rents that breed corruption, and what the government refers to as sabotage. So, the government is also half-right. However, it really has nothing to do with attempts to bring the government to disrepute per se, although it could be exploited for that end. For such middlemen, it is first of all a trade-off between illegal profits and the probability of being brought to justice. They are simply exploiting inherent weaknesses of government-controlled activities to make profits.


What about the proposed solutions?
Taking the citizen solution first, it incorporates two elements that may not be immediately clear. First, the that government should endeavor to supply all fuel needs by increasing production/imports. If there is no change in the system of fuel production/importation and distribution this implies that government would have to meet the demands of smugglers and citizens alike. It would also have to continue carrying the burden of subsidizing fuel ad infinitum. The second aspect of the citizen solution is to tackle the diversion of fuels through a comprehensive monitoring of the entire distribution system. Again, this solution will not resolve the problem. Law enforcement in Nigeria is not mature enough to take on this task and indeed no country has the system to perform this task. Just look at the problem of illegal immigration and drug smuggling around the world. Let's assume that all avenues for smuggling can be plugged, does this make for hitch-free fuel supply? Again the answer is NO. To see this point, take a look at National Electricity Power Authority (NEPA) where electricity smuggling across national borders is a physical impossibility. Inherent weaknesses of government controlled activities, i.e. inefficiencies and mismanagement from both corrupt practices and inability to perform like a true market will imply continued epileptic fuel supply just as sure as we have epileptic power supply.

To summarize, the citizen solution is like knocking our collective head against the wall, it is only half-right. It is a double loss for both government and citizenry alike. Government will keep playing father Xmas to rich middlemen, while supply bottlenecks continue to strangulate economic progress.

Thus, the government's proposed solution is to remove the subsidy entirely, and deregulate the market. This sounds like the ultimate solution, but, like the citizen proposal, is only half-right. What are the implications of the government's proposal, which effectively implies an ABRUPT jump in fuel prices and continued dependence on fuel IMPORTS.

Economic Disruption and Damage to Citizen Welfare: A sudden fuel price hike will lead to immediate cost-push inflation in the economy. The argument put forward by President Obasanjo in his June 15 2000 remark that:

" an assessment of this sector (transport) reveals that the fuel component of transport operation varies from 2-7 percent. Therefore, there is no rational basis for the recent 50 percent hike on transport fare"

reveals an intuitive, but partial and misleading view of how fuel price changes work through the economy. The problem with that view is a neglect of what economists refer to indirect economic consequences of price/policy changes. The focus of President Obasanjo's statement was on the direct effect. However, with goods like fuel indirect effects are often several orders of magnitude larger than direct effects. Consider the effect of a fuel price hike on a person who relies on transportation income for a living. In deciding what he must charge for his services he would not only consider the costs of fuel but its effect on his take-home or profits, as well as opportunity/replacement costs of transport equipment. His take-home would be based on his need to meet his obligations: food, health etc. Ditto for transport equipment costs since these costs encapsulate his future sources of income. Prices for all of these will be affected by new fuel costs. Thus, a fuel price hike affects some activities directly and then ripples through the economy. The ultimate effects would be determined by the price hike, availability of alternative fuels and how essential these fuel-driven services are. Given that majority of Nigerians are already living on the borderline (an average per capita income of about 40 thousand Naira per year and 60 percent living below the poverty line) most of these services are already at their barest minimum. Nigerians cannot endure another round of serious belt-tightening that deregulation as proposed by government will entail. In the simplest terms, the government is saying that citizens would have to pay an additional 120 billion Naira for fuel annually. The question is, where is this going to come from?

Exchange Rate Effect: The government's proposal relies on massive IMPORTS and turns a blind eye to a crucial factor, the exchange rate. It is in fact this factor that has rendered all previous government efforts at "appropriate pricing" ineffective. However, its effect under the proposed deregulation will be different. In the current system, depreciation of the Naira increases the Naira value of profits that middlemen can make by smuggling, while at the same time increasing the implicit Naira subsidy by government. The proposed system will eliminate these two problems and create another by subjecting fuel prices to the unstable exchange rate situation in Nigeria. Every time the Naira depreciates, as it will continue to do, (see Central Bank of Nigeria commentary on recent depreciation of the Naria) fuel prices will have to follow. The same goes for changes in international crude oil prices. Whenever there is a price jump in the world market, fuel prices will also increase. For the avoidance of confusion, these two forces are also at work in countries with deregulation, but in most of these countries, a relatively stable exchange rate obtains and governments have strategic fuel storage (both crude and finished product) that are used to cushion the effect of crude price movements over short periods of time. These stabilizing effects are completely absent in Nigeria either in the current system or in the proposed system. Thus, if the petroleum sector had been deregulated in June 2000, according to government plans, fuel prices would have increased by up to 50 percent, if changes in the exchange rate and crude oil prices are taken together. In another sense, the need to source foreign exchange for fuel imports by itself can exert pressure on the exchange rate and cause its depreciation. All this will compound the welfare and economic disruption effects highlighted above.

Environmental Effect: In the attempt to cope with fuel price increases, people will either do without energy services or look for alternatives. For cooking which is an absolutely essential service, experience has shown that Nigerians turn to coal, sawdust, fuelwood and charcoal. I am especially reminded of the price hikes of the Babangida years when trees planted on sloppy areas of Ibadan for erosion control purposes disappeared overnight in the desperate search for cooking fuels. Fuelwood and charcoal use contribute to deforestation and desertification. In this respect, Northern Nigeria is especially fragile because the vegetative cover is already on the margin and desertification is expanding southward. These alternate fuels are also less clean and more cumbersome to handle, generating many harmful byproducts. These byproducts in turn lead to health problems and contribute to national and global environmental problems.

Political Upheaval: The Nigerian citizenry can readily discern the impact of a sudden fuel price jump on their welfare. This will be resisted until government can find a way to ameliorate the unavoidable welfare effects of such action. Again according to Prof. Gana "It is a most wicked and unfounded lie for anyone to think that an elected and popular government like ours could turn around to deliberately punish those that elected us." The problem is that deliberateness or not of the punishment is not the issue here, but that government's current proposal will PUNISH the citizenry while multinationals, and profiteers smile home with their bounties. Let the government that has an ear, hear – the current proposal will lead to a political upheaval (as it always does) that will make nonsense of whatever the Obasanjo government has achieved so far.

In some way both citizenry and government proposals for resolving Nigeria's fuel crisis are coins with one genuine and one fake side.

C. MANAGING THE TRANSITION[url]http://nao.nigeriaanew.org/fuelsubsidydec232011.html
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FACT #1: Nigerian government and citizenry alike cannot afford to keep subsidizing profiteers forever.

FACT #2: The economic, social and environmental effects of an abrupt fuel price hike cannot be justified. In fact, it would produce such upheavals as to ground the wheels of state to a halt.

Therefore, the real challenge in resolving the fuel crisis is  MANAGING the transition. What then are my recommendations?

The thrust of my proposal for a sustainable solution is to:

1.         Privatize the entire fuel sector from refining to the pump.

2.         Build a 1-2 year transition period into the deregulation process to minimize the adverse effects on citizen welfare, and turn Nigeria into a petroleum product exporting country rather than an importing one.

The elements of my proposal are as follows:

1.      A 3-6 month program to transfer the fuel depot/trucking/pipeline system to 4-5 consortia of private companies with at least 30 percent Nigerian participation (20 percent government). These consortia will be responsible for zones of the country allocated to them according to location of facilities. They will be the ones that link up with marketers to ensure delivery of products to the right fuel pumps. The privatization exercise could be done using the auction process recently used for GSM licenses under the following carrot and stick rules.

1.                  Companies must submit cost profiles under assumptions on various parameters that might affect costs, including fuel import/refinery delivery, for each zone of the country for which they submit a bid.

2.                  Government would eliminate the following taxes and surchages (1) NNPC workers insurance and medical – N1 per litre (2) Tax – N3.10 per litre (3) Surcharge N2 per litre .

3.                  Government would apply normal company taxes but no consumer taxes e.g. VAT on petroleum products for now.

4.                  Performance contracts would be signed between companies and government with respect to prices of fuel, regular supply and handling of workers under the current system. This performance agreement should include liabilities for fuel shortages lasting more than 3-days, 1-week and so on in any zone. These agreements would be subject to review every three months until full pricing takes effect (see below the recommendation on full pricing).

2.      A simultaneous 6 months-1 year process of privatizing the three government controlled refineries to three consortia of private companies under similar set of rules as above. Rules for this process should include:

1.                  3-6 month plan for complete overhaul and production from allocated refineries.

2.                  2-5 years plan for additional capacity additions. Since the capacity of each of the three refineries is between 100-200 thousand bpd, bidders could bid for these refineries or a new 100 thousand bpd capacity.

3.                  A 3-year tax and import tariff waivers for refinery parts and new refineries, and generous conditions for land allocation for refinery expansion or new construction. With respect to the latter, government would facilitate the negotiation process between landowners and refiners.

4.                  Performance contracts on the operation of the refineries should also be signed and subject to revision until full pricing takes effect (see below the recommendation on full pricing).

3.      Government should maintain current subsidies till the end of the privatization program lasting between 1-2 years. If the proposal in (1) is completed within 6 months immediate improvements in fuel supply will be achieved. After the transition period subsidies should be removed and a government/citizen body set up to monitor the consumer price index for 6 months. Depending on the extent of price increases resulting from the subsidy removal a special provision to cushion the effects through increases in wage rates, reduction in other taxes, increases in transportation allowance, etc should be implemented.

D. CONCLUSION[url]http://nao.nigeriaanew.org/fuelsubsidydec232011.html
[/url]In conclusion, the fuel crisis in Nigeria is an embarrassing one and deserves to be addressed with urgency, but also with thoroughness. It is imperative that government pay attention to citizen welfare effects, first of all, and the long-term fallacy of an IMPORT dependent fuel supply policy. There is no reason why Nigeria should not be selling fuel to the entire sub-Saharan Africa and beyond. This is because we have an advantage over imports from Europe since taxes and transport costs included in the import prices will be eliminated. We will not only be expanding Nigerian exports but helping to improve the economy of fellow oil-poor ECOWAS countries without having to subsidize anything. I have a feeling that the government which resolves this problem in Nigeria without excruciating welfare pains will remain with Nigerians for a longer time than usual and vice versa.