Professor Omowumi O Iladare
PREAMBLE:
There is no doubt, the removal of petroleum subsidy in Nigeria is burdensome.
However, empirical evidence suggests that the level of petroleum subsidy, representing a great proportion (25%) of the fiscal budget of the Federation is not sustainable and has jeopardized infrastructure development—energy, road, and medical, over the last two decades. There also seems to be some sentiments out there in the public, suggesting that President Bola Tinubu (PBT) removed petroleum motor spirit (PMS) subsidy when he became President of the Federal Republic of Nigeria, on May 29, 2023. Such sentiment, in my own opinion, is a misrepresentation of facts entrenched in the Petroleum Industry Act 2021 (PIA 2021), which scrapped the Nigerian National Petroleum Corporation Act, Petroleum Products Pricing Regulatory Authority (PPPRA), and the Petroleum Equalization Fund. This op-ed argues that, notwithstanding the short-run pain subsequent to petroleum subsidy removal and impact on energy affordability in Nigeria, the benefits of the removal of petroleum subsidy far outweigh the extant hardships, in the long run.
FUNDAMENTALS OF PETROLEUM PRODUCTS PRICING MECHANISM: AN OVERVIEW
Classical microeconomic theory underlying the market pricing system suggests that two fundamental laws, the law of demand and supply, are communally dependent. The two laws which have two distinctive elements, which are communally linked are the price factor. The price factor determines the quantity of petroleum supplied and demanded, and the non-price factors, create a change in petroleum products demand and supply at different possible prices. A change in any of the non-price factors, including the body language of a political leader can lead to significant disequilibrium in the market system at any point in time. Thus, to those economies with willful disregard for these fundamentals, the consequences can be significantly detrimental. Interestingly, majority of the participants in the downstream petroleum market in Nigeria, over the years, learned or unlearned, have tended to be averse to these fundamentals. Now the chicken has come to roost, the disregard for these fundamentals has induced significant welfare losses and discomfort.
Further, it is important also to understand that the structure of the market for petroleum motor spirits in Nigeria is majorly anticompetitive, which tend to have attracted government interventions, the PMS subsidy for nearly two decades. For example, the wholesale PMS market over the last ten years has a monopoly structure with absolute barrier to entry or at best, dominant-firm structure with a high barrier to entry feature. The retail market, on the other hand, though not a monopoly (a single seller), is a dominant firm oligopoly, with a significant market power to influence end-users’ prices at the pump, with impunity. The anti-competitive market structure still exists in the downstream petroleum market in Nigeria, despite the enactment of the PIA 2021.
What – ought – to – be expectations after the PIA 2021 Act in the downstream have not happened, perhaps, because of political expediency, prebendalism and transactional leadership mindset governing the PIA implementation process. Certainly, Forex market instability has restricted the fulfilment of PIA expectations, yet there is light at the end of the subsidy removal transition tunnel. There is no need to dwell on spilled milk. But I am hopeful that PBAT will be conscious of these errors as he reconstitutes the Board of Directors of the Petroleum Authority. Petroleum subsidy removal does not imply absolute absence of regulation in an anticompetitive market structure with near absolute vertical barrier to entry at the wholesale market level and significant horizontal market power at the PMS retailing market level.
SUBSIDY REMOVAL TRANSITION: THERE IS LIGHT AT THE END OF THE TUNNEL
The original aim of petroleum subsidy in Nigeria was to keep fuel prices low for consumers. Unfortunately, the subsidy policy ended up strangulating the economy of Nigeria bringing it down to its knees. Empirical evidence suggests the original intention was handicapped because the administration of the subsidy program was generally inefficient, opaque, riddled with corruption, and prohibitively expensive. Further, that subsidy payment enhances excess domestic petroleum products demand and fosters illegal exports of petroleum products is not conjectural. The removal of petroleum subsidy is expected to release the government from unsustainable expenditures in billions of dollars per annum, and the benefits of the removal of subsidy far outweigh the present hardships, in the long run. For example, targeted social safety net programs, investments in public transportation infrastructure, promotion of energy efficiency and conservation, and increased use of CNG and biogas are, plausibly, explorable options that petroleum subsidy removal brings to bear.
The efficacy of direct transfer payment to ameliorate petroleum subsidy removal debacle is doubtful. It is always better to give hooks for fishing than fish for immediate family consumption. The planned palliative strategies of the government to cushion the effects of subsidy removal and help the most vulnerable people during this period must include ameliorating the cost of transporting farm products to local market centers in each of the local governments in Nigeria. Of course, the more money in the household hands in the form of disposable income, the easier it would be to navigate through the pain induced by subsidy removal. I have already argued against direct transfer payment and not in support of wage increase because inflation remains high. Suspension of levies, VAT, or other taxes on energy and foodstuff in the marketplace for a while, even if not a perpetual suspension, will be helpful.
Subsidy removal is a transition that requires invoking the fundamental of the market system as the legitimate driver to reach the light at the end of the tunnel without compromising the sustainable development goal, energy for all at an affordable rate. I venture to say that it is plausible to systematically argue that removal of petroleum subsidy is a potential catalyst to achieving this goal as well the net-zero targets for 2060 in Nigeria. However, two factors are very critical in the petroleum subsidy removal transition dynamics. The two factors are–forex rate and international crude price dynamics. If the demand for PMS does not change, then the market clearing price must go up. Inflation is not the reason for the rise in price of PMS at all, it is a contributor to rising inflation. What is at play here in the downstream market in Nigeria now is barrier to entry due to these two factors in addition to the non-price factors of PMS demand in Nigeria. Consumers’ willingness and ability to pay for PMS matter a lot too.
Unfortunately, the PMS wholesale and retail markets are imperfect and fundamentally anticompetitive as I mentioned earlier, in Nigeria. The power of a dominant firm in an oligopoly market structure creates market failures, which must be properly regulated. It is a very anti-competitive market structure designed to maximize profit and minimize consumer surplus in the process. This is why I continue to assert subsidy removal does not imply the absence of regulation in an imperfect market, see the PIA provision 32 (e). The petroleum subsidy removal transition to a low barrier-to-entry market structure in the petroleum downstream is not a sprint but a marathon, dynamic and not static. The presence of a dominant firm, which seems to have assumed the price-setting role because of its market power in the PMS retail market must be recognized. Of course, the absolute barrier to entry in the wholesale market in Nigeria has been reduced to a high barrier to entry because a few participants in the wholesale market are emerging.
The functional roles of the Petroleum Authority and the Federal Consumer Protection Agency are critical in the transition to an efficient petroleum product market in Nigeria. The two institutions must not fold their arms or sit down and look while the dominant firm in the retail market and wholesale market unilaterally influence the market price of PMS to set at above the market clearing price. Thus, until more PMS importers are licensed to participate independently along with the dominant firm in the wholesale market, price modulation is a plausible alternative to a dominant firm unfiltered pricing mechanism. I am not in any way suggesting the adoption of price modulation in perpetuity, but, perhaps, until the effect of the exchange rate on PMS pricing is not as tormenting as it is now. Price modulation is more transparent, less impactful on consumer surplus, and the impact is more predictable than the dominant firm pricing without regulation.
Thus, to ameliorate the short-term discomfort of petroleum subsidy removal transition, the Petroleum Authority must step up the plate in the interim, invoke its mandate as stipulated in the PIA 2021, Provision 32 (e), and apply market fundamentals to turn the performance wheel of the downstream petroleum market until it can turn itself to optimize producers’ surplus and consumers’ surplus equitably in Nigeria.