THE FOLLY OF FUEL SUBSIDIES 08052006

Deregulation was touted as a process that would allow oil marketers to import fuel on their own account for sale rather than their almost total dependence on NNPC funded imports.  The resultant freer market would encourage competition and petrol prices would presumably come down.  In addition, private participation in the refining of crude oil locally would be stimulated and the problem of petrol shortages would be a thing of the past.  Indeed, the excess from the output of the new refineries could be exported to boost our foreign earnings.  

To this end, the government quickly licensed about 20 or so private initiatives for the establishment of local refineries and signaled its decision to remove the subsidy component in domestic petroleum pricing in order to create a level playing ground for all stakeholders.  Indeed, it was government’s expectation that a sales tax of about N1.50/litre would be levied on the pump price.  In a ‘noble’ attempt to prevent double taxation, the government abolished toll gates on all federal highways and the dozens of tollgates which had been constructed at great expense were hurriedly demolished, again, at great cost, and the huge media cost incurred to convince Nigerians of the need for deregulation created more leakages for government revenue!

Two years down the line, we dare to ask whether or not the government can claim that the downstream sector of the petroleum industry is still deregulated.  The simple but true observation is that deregulation is anathema to the prevalence of subsidy in a free market, but our current reality is that subsidy has now returned on a grand scale in petroleum pricing!  Indeed, the sum of N270bn (about 15% of the total 2006 federal budget of N1.7 trillion) has been set aside for petrol subsidy.  Whao!  So, what has happened to the touted advantages of deregulation and all the energy, attrition between the NLC, the civil society and the government, and the huge sums of money expended on selling the concept of deregulation to Nigerians? 

The simple truth is that deregulation is in a coma as it pertains to the downstream sector; the major oil marketers continue to depend on the NNPC for their fuel stocks with little or no direct imports of their own!  The government authorities also announced last week that up to 15 licences for the construction of petrol refineries may be revoked for lack of visible commitment on the part of the promoters!  Meanwhile, the erstwhile income derived from the operation of tollgates up to year 2004 has been lost and indeed the current scenario of increased subsidy provides no room for the petrol tax of N1.50/litre projected to take the place of the lost income from tollgates!  Furthermore, the expected increased competition and lower prices have remained a mirage as prices have risen rather than fallen!

So, what we now have is a loss, loss and loss situation with the deregulation project in the last two years!  But wait a minute, how could such an elaborate and presumably well researched and articulated government project come to such abysmal failure within less than two years leaving us all worse off at the end?  The national economic team and their collaborators maintain, inspite of obvious deepening poverty in the land, that we should exercise patience for their policies to percolate the system and send us to early graves!  We recall that a decimated middle-class, a bastardized naira and deepening poverty in the land are the national rewards for our misplaced patriotism for our endurance during the SAP implementation 20 years ago!  We alerted readers of this column in several articles that a situation where the CBN directly provides over 80% of all foreign exchange traded in the market and simultaneously controls the naira supply in the market will create distortions in the economy such that with rising export earnings, we will be constrained to inject increasing huge naira sums into the economy and exacerbate the liquidity position in the system.  

The WDAS (Wholesale Dutch Auction system) recently introduced by the CBN has not changed its monopolistic stranglehold on the foreign exchange market and nothing much has changed as far as excess liquidity, high interest rates and a naira under pressure are concerned.  In spite of the new WDAS, the local pump price of petrol will continue to be fuelled by increasing crude oil prices on the international market and consequently increase in the value of subsidies that would need to be set aside annually to keep a lid on domestic petrol prices!  The current year’s subsidy of N270bn may become N500bn (almost 30% of 2006 federal budget) or more each year if the crude oil prices continue its upward trend above $70/barrel and a fortuitous market development which should improve our external reserves, and by extension our naira value and the economic welfare of the masses may become an albatross on our nation!  Inadvertently, our pains and losses will continue to be a welcome boon to smugglers of petroleum products and our immediate West African neighbours who have become extended beneficiaries of our petrol subsidies.

The resultant effect of an uncontrolled cash expansion is a high CBN’s Minimum Rediscount Rate (MRR) of 14.5% and the current collateral of commercial interest rates above 20% as the CBN battles to place a lid on money supply to restrain inflation and paradoxically protect the naira from depreciating in the face of overwhelming increases in our foreign reserves!  Fortunately, the situation is not as hopeless as it seems; indeed, deregulation is viable and should bring in its train, more private refineries, more competition, lower prices and better services; but the CBN would have to stop the obtuse practice of unilaterally converting the nation’s dollar revenue to naira before sharing the naira sum to the three tiers of government.  If the monthly distributable dollar revenue is paid to beneficiaries with the instrument of dollar certificates, this system will banish the phantom of excess liquidity and consequently bring down MRR and commercial lending rates to below 10%.  

In addition, a scenario where increasing dollar certificates on offer chase limited naira will improve the value of the naira significantly, such that the higher the international crude oil price, the higher will be our foreign reserve potential and the stronger will our naira be against the dollar.  For example, if crude oil sold for $40/barrel two years ago, this would imply a naira price of N4,000/barrel with our exchange rate at, say, N100=$1;  however, if crude oil price goes up to $60/barrel and our foreign reserves quadruples, giving us up to, say, 30 months imports cover instead of the erstwhile 6 months or so cover, we should expect our naira to strengthen by up to 50% of its earlier value to about N50=$1 and the same barrel of crude oil to cost not more than N3,000 (N50 x $60) i.e. the  price of petrol would actually fall domestically inspite of the international price rise and the government can safely impose a sales tax of up to N500/barrel and still keep the price lower than when the exchange rate was N100=$1.  Meanwhile, the stronger naira would have made smuggling much less attractive for the operators; petrol subsidy would have been exorcised, deregulation will thrive and the sun will shine at last on the economy!