Managing the Modulation
of Petroleum Product Prices in Nigeria By Dr. Emmanuel Ojameruaye In the first part
of this paper, I described the new concept of modulation of the prices of petroleum
products based on the statements of the Minister of State for Petroleum
Resources, Dr. Ibe Kachikwu.
As I was about to publish the paper in the morning of December 30, the news
broke out that the Petroleum Products Pricing and Regulatory Agency (PPPRA) had
“modulated” the price of PMS at N86 per litre in
NNPC filling stations and N86.5 per litre in
non-NNPC filling stations for January to March 2016. I was
almost thrown off balance by the news because I was expecting monthly
or weekly modulation or adjustment of the pump price of all the major petroleum
products (petrol, diesel and kerosene). Then on December 31, it was made
official and the new pricing templates for PMS (premium motor spirit or gasoline
or petrol), AGO (automotive gas oil or diesel) and LPFO (low pour fuel oil) were
posted on PPPRA website. Two new pricing templates were posted for PMS – one
for NNPC (NNPC retail outlets) and the other for “OMC” which I assume stands
for “other marketing companies” (non-NNPC retail outlets). The template for
HHK (household kerosene) was blank with the words “update coming soon”. In
this second part of the paper, I will analyze the new pricing template for
PMS and suggest ways the new pricing policy (“price modulation”) can be
managed to avoid or minimize the pitfalls of the past subsidy regime. Before commenting
on the new pricing template, I would like to congratulate the minister and
the PPPRA for mustering up the courage to announce the new modulated price of
PMS which eliminated subsidies on PMS, at least for
now. The timing of the announcement was also very good, not only because it
is the beginning of a new (and financial) year but more
importantly because it is was done when the prices of imported petroleum
products are at their lowest level in recent times. So long as the price of
crude oil and import prices of petroleum products remain low (at less than
about N65 per litre) and the naira exchange rate
remains stable at about N200 to 1US$, the modulated price of PMS can remain
at N86.5 per litre and there will be no subsidy! An
examination of the published templates showed that: a) The modulation of
prices applies to PMS only, at least for now; b) PPPRA is yet to decide
whether to modulate the price of kerosene or not; and c) The price of AGO (diesel)
remains deregulated (not subject to modulation) because the template shows
“maximum indicative benchmark open market price” and there is no retail price
unlike that for PMS. In other words, retailers are free to sell diesel at
any price they choose. In order to
identify the changes made in the PPPRA pricing template for PMS, I have shown
in table 1 in the appendix the components of the pricing templates for PMS
posted on December 24 and 31 respectively. The following are some of my observations,
questions and conclusions arising from an analysis of the table: I.
The “elimination” of subsidy in the December 31
template was due largely to the reduction in the “other landing costs” items which was achieved administratively. The import
price of PMS decline marginally from N67.34 per litre
to N65.5 per litre (i.e., by N1.84 per litre) during the one week period[i]
while the “other landing costs” was reduced from N10.62 to N4.98 per litre (i.e. by N5.35) and the distribution margin was
reduced from N15.49 to N14.3 pr litre
(i.e. by N1.16). (See Chart 1 in the Appendix).
Thus, the reduction in “other landing costs” accounted for about 64% of elimination
of the N6.45 “under-recovery” (subsidy) and generation of N1.40
“over-recovery” (tax) in the December 31 template. The fall in import price
and reduction in distribution margins accounted for 22% and 14% respectively.
Is there scope for further reduction or outright elimination of some of “other
landing cost” items and the distribution margin items in order to achieve a
lower pump price or higher “over-recovery”? This is a
question that calls for a detailed unbiased analysis and audit. II.
The traders’ margin of N1.46 per litre
in the December 24 template was eliminated in the
December 31 template. Why was this margin included
in the template in the past and why is it now so easy to eliminate it? Are
these traders not the same dealers who are paid
N1.75 per litre under the Distribution Margin
section? This could very well be a case of double counting or predatory
pricing or gouging. Imagine the amount of money the federal government paid
out on account of this “traders’ margin” in the
previous years! If we assume daily import of 30 million litres
of petroleum products, it amounts to almost N16 billion
annually! III.
Lightering expenses have been
reduced from N4.7 to N2.02 per litre,
storage fees from N3 to N2 per litre, Jetty Depot thru’Put charge from N0.8 to N0.4 per litre.
What was the basis for the previous rates, and what is the basis for the new
rates? Why has it taken this long to review and bring down these rates? IV.
The December 31 template shows an increase in the
margins for retailers (from N4.6 to N5 per litre), dealers
(from N1.75 to N1.95 per litre) and transporters
(from N2.99 to N3.05 per litre). What is the
rationale for the increase in these margins? Are these not
the same retailers, dealers and transporters who have been hoarding petroleum
products and gouging consumers? Is the increase meant to compensate
them for the loss of subsidy payments or is it “token subsidy” through the
back door? I think that in order to build trust and confidence in the price
modulation, the government needs to explain the rationale for the increase in
these margins when other components of the expected open market price have been reduced. V.
We note that the official exchange rate of N197 to
1US$ was used in both templates to compute the import price even when the
parallel market rate was hovering between N240 and N280 to the $ at the same
time. In economics we know that in an economy like ours, the official
exchange rate is not a true measure of the real value (or shadow price or
opportunity cost) of the currency. In fact, the “real” value of the currency is
closer to or equal to the parallel market rate. Thus it can be argued that
the import price computed at the official rate is not the “real” cost, hence
the expected open market price (EOMP) is not the “real cost” to the economy
of a litre of PMS. To obtain the real cost
(equilibrium price which can clear the market), we
must use the average parallel market rate. Let us assume that the average parallel
market rate as of December 31 was N250 to 1US$. Using this rate will yield an
import price of N83.12 per litre, which is N17.62
more that what is stated
in the table (N66.5). Assuming that the other landing costs and distribution
margins remain unchanged, the “true” EOMP for PMS (OMC) will be N85.1 +
N17.62 =N102.72 per litre. In order words, if we
want to be technical, the modulated retail price should be about N103 per litre which will mean an increase of about N16 above
previous regulated price of N87 per litre, but
still less than the N120 to N180 most consumers were and are still paying in
many filling stations. Of course, if the government can bring down the
parallel market rate, then the “true” EOMP will drop. VI.
It is difficult to justify the two prices for PMS by
retail outlets. The only difference between the NNPC and OMC templates is the
N0.31 per litre finance charge “awarded” to OMC but
denied NNPC. Even if the government decides not to grant
the N0.31 per litre financing charge to NNPC, the
table shows that the total cost (EOMP) of PMS for OMC is N85.10, thus they
can sell at the same price of N86 per litre as NNPC
and still pay an “over-recovery” of N0.9 per litre
to government instead of the N1.22 per litre in the
table. Allowing the OMC to sell at a higher price than NNPC stations
is like awarding another subsidy of N0.5 per litre
to them. You can trust that they will not pay the full “over-recovery” of
N1.22 per litre to government. The differential is
clearly unnecessary and can be seen as another so
“subsidy” to placate the OMCs. Having two regulated retail prices for the
same product will no doubt lead to distortions and encourage arbitrage and
other sharp practices. Even though NNPC is a public enterprise, it should
operate as a profit center and pay dividends to the federation account.
Accordingly, the playing field must be level for NNPC and the OMCs. NNPC
retail outlets should sell at the same price as those of the OMCs. VII.
It is unclear whether the government represented by
the minister/NNPC/PPPRA consulted with key stakeholders, especially labour union leaders, during the process of computing the
modulated prices and before the announcement. However, given the fact that
the Trade Union Congress (TUC) and some interest groups have complained and
called on the minister to clarify the concept of price modulation, one can
safely conclude that there was little or no consultation. It is also not
clear whether the government consulted with the importers, traders, shippers,
NPA, owners of jetties, dealers, transporters and retailers before adjusting
their charges and margins in the new pricing template. It is important to
have wide consultation during the price modulation process to avoid any
backlash and attempts to thwart the policy. Having compared
the new PPPRA pricing template for PMS with the “old” one, I will now make
the following recommendations to improve the efficiency and effectiveness of
the system and avoid the pitfalls of the old subsidy regime.
2. It appears that
the frequency of modulation will be quarterly, at least for now, because the
new pricing template will apply for the period January to March 2016. It is
not clear if the template will be adjusted within
the three months if there are significant changes in the import price of PMS
or other components of the EOMP. Given the volatility of the spot market prices (hence import price) of petroleum products (see
Chart 2 in the Appendix) it is possible to have significant differential
between the modulated price (EOMP in the template) and the import price
during the course of a quarter. Wide variations can lead to significant distortions,
sharp practices and excessive subsidy or tax. In order to minimize such
variations and distortions, a shorter frequency for price modulation is recommended. For
instance, NNPC can start with monthly modulation for the first six months,
then biweekly for the next three months, and then weekly for another three
months and then terminate with complete deregulation of prices within a year. 3. As I have stated
previously, the “dualization” of the price of PMS
(NNPC and OMC) is unnecessary and will be counterproductive in the end.
Accordingly, the price dichotomy between NNPC and OMC retail outlets should be abolished so that there is a uniform modulated
retail price. 4. It is not clear
for how long the modulation process will continue. In my view, the price
modulation should not be seen as an end but as a
means to an end, the end being a completely deregulated (subsidy-free)
petroleum products market. The price modulation policy should
be seen is a “half-way house” between the subsidy regime and a
deregulated market. Like the subsidy regime, price modulation is not economically
efficient, although if properly managed it will be superior or better than the
subsidy regime. In fact, we cannot expect price modulation as currently
conceived to cure all the ills of the subsidy regime but it can minimize the
pitfalls. The most economically efficient system is a deregulated
(subsidy-free) market. However, given the potential for
market failures in the Nigerian petroleum products market due in part to the
oligopolistic nature of the market, the government can step in by
establishing “maximum indicative benchmark open market prices” or open market
price bands for various products and monitoring the retail outlets to ensure
compliance as well as for product quality control and imposing stiff
penalties for violations. 5. It is doubtful if
NNPC and DPR will be able to enforce the modulated prices. There are already
reports that many filling stations throughout the country have ignored the
N86.6 per litre announced by PPPRA and are still
selling PMS at between N100 to N180 per litre. Many
OMCs will try to game the system by selling at a higher price than the
modulated prices and by bribing DPR/NNPC officials and law enforcement agents
who may be deployed to monitor the stations. Some
unscrupulous monitors may engage in sharp practices such as “commandeering”
filling stations and confiscating their fuel. It is therefore important to
involve civil society organizations and labour
unions in monitoring filling stations and reporting erring stations to “consumer
protection offices” that will deploy special “incorruptible” officers to
investigate reported cases, and impose stiff penalties. 6. NNPC should be the sole importer of all
petroleum products, at least during the first year of price modulation
(2016). This will reduce the landing cost and allow for better management of
imports. It will also help to avoid a situation where the private importers
can use their oligopolistic powers to hold the government and consumers to
ransom. The marketers can then buy fuel from NNPC at the depots in the ports
or at the inland depots throughout the country. This will make it easier to
“punish” marketers found to be involved in sharp practices including product
adulteration, hoarding and gouging by denying them the opportunity to buy
products from the depots. Furthermore, if private markets are allowed to
import fuel they are likely to use the parallel market rate in determining
their import price, and hence the retail price. VIII.
The federal government must take immediate steps to
increase domestic production of petroleum products. In this regard, the ongoing
rehabilitation of existing refineries is commendation as well as efforts by the
private investors to start private refineries. However, the government must
identify the bottlenecks and address them immediately. It is a fact that the
subsidy regime has been a major obstacle, which is why all forms of fuel
subsidies must be abolished as soon as possible to
provide a level playing field for investors. Investor want to know when the
existing subsidies will be abolished to enable them
plan when to complete their refineries and start production. Therefore, the
federal government must announce a date when all forms of subsidies will be removed. I believe that all forms of subsidy can be abolished by the end of this year through stepwise
price modulation process that will prevent “shocks”. IX.
I am not unmindful of the political
risk of announcing that the subsidies will be abolished by the end of the
year because of the “emotive nature” of the subsidy issue. Luckily, the
current low prices of crude oil and petroleum products in the world market
provides a perfect opportunity to eliminate the subsidies with little or no
inflationary impact, if the government is able to prevent a significant
depreciation of the exchange rate and minimize the difference between the official
and parallel market rates. In this regard, the government must consult with
the labour unions and other
groups opposed the removal of fuel subsidies and embark on a massive public
awareness campaign to explain the rationale and benefits of removing the
subsidies. In any case, most consumers have not been benefiting from
the subsidies because they pay prices far higher than the regulated
(official) pump price and in some cases above the EOMP. X.
The government must take
appropriate measures to ensure exchange rate stability and minimize
the differential between the official exchange rate and the parallel market
rate despite the drop in oil revenues due to the fall in oil prices. The
differential should not be more than N10, i.e. if the official exchange rate
is N200 to 1$, the parallel market rate should not
be more than N210 to 1US. This will help to prevent smuggling of petroleum
products for the purpose of “round-tripping” and some other sharp practices
in the petroleum products market such as diversion of funds obtain at
official rate to import fuel into the parallel market. XI.
Finally, the federal government must abolish the
petroleum equalization fund (PEF) and consequently the “bridging fund”
component in the pricing template. The PEF was established
in 1975 to equalize the cost of transporting petroleum
products from depots to filling stations and ensure that petroleum products
are made available at uniform prices throughout country. In a modern
market economy like the type we are trying to build in Nigeria, there is no
place for a fund like the PEF as it will only lead
to distortions, inefficiency and cross-subsidization. It is an unnecessary
bureaucracy! We cannot mandate the same price for a commodity throughout the
country irrespective of distance from source. Why must petroleum products me
treated differently from other products? All other products
in the country do not have uniform prices and there is no equalization
fund to ensure that other products are sold at uniform prices throughout the
country. The prices of other products in the various cities and villages are determined by the interplay of market forces and
transportation costs. Even the price of electricity now varies by location
and type of consumer throughout the country. Market forces (including
transportation/delivery cost) should be allowed to
determine prices of all commodities, including petroleum products, in all
locations. In most developed and emerging market economies, prices of
petroleum products vary from one city or location to another, and even from
one filling station (retail outlet) to another within the same city or
location but usually the differential is so small that most consumers can
afford ignore it. For instance, if PEF
is abolished and if the price of PMS in Port Harcourt
(where there is a refinery) is N86, it is unlikely that it will be more than
N88 in Enugu, or N87 in Kaduna (where there is a refinery but crude has to be
pumped there) or N88 in Sokoto or N89 in Maiduguri. Dr. Emmanuel Ojameruaye Phoenix, Arizona State, USA January 3, 2016 Appendix Chart 1:
Composition of the Expected Open Market Price (Total Cost) of Petrol Table 1: PPPRA
Pricing Template for PMS, December 24 and December 31, 2015
Note: Exchange
rate used is N197 = 1US$. Conversion rate used is 1MT = 1,341 litres Source:
PPPRA website. Chart 2: Price of
Petroleum Products, North European Market, Spot Barges, fob Rotterdam US$/Litre Source: OPEC Bulletin
November 2015. Original data in US$/Barrel coverted to US$ per litre by
dividing by 42 (I barrel = 42 litres) Endnotes OPEC
crude oil basket price also declined from $32.13 per barrel to $31.45 per
barrel during the same period. i See Ojameruaye, E (2013) A Second-Best Framework for Petroleum Products Pricing in Nigeria. Nigerian Journal of Social and Economic Studies. Vol. 55 No. 1, 2013: 191- 195. OPEC crude oil basket price also declined from $32.13 per barrel to $31.45 per barrel during the same period. ii See Ojameruaye, E (2013) A Second-Best Framework for
Petroleum Products Pricing in Nigeria. Nigerian Journal of Social and Economic Studies. Vol. 55 No. 1, 2013: 191- 195. |