“Price Modulation” of the Downstream Sector …Taking the Bull by the Legs

LAGOS, Nigeria, Capital Markets in Africa: The downstream petroleum sector on 11^th May, 2016 received a major policy turn that seemed to have altered the age long dynamics of the industry as the Nigerian National Petroleum Corporation (NNPC) announced the removal of petroleum subsidy and provided new pricing guidelines, designed to be cost reflective in line with market dynamics. Whilst the new policy has shifted off the Government, a major burden of subsidy payment which over the years pressured fiscal finances; the ambiguity surrounding the current decision, however – should it not be a full-scale deregulation – could continue to potentially impede the development of the downstream petroleum sector. There is no gainsaying the need for a total market-determined pricing of the pump price of petrol (as in the case of diesel), in order to fully open up the sector for the needed investments and development it seriously requires. Afrinvest Research has always advocated for a market system in the petroleum sector and foreign exchange administration to guarantee efficiency.

Amidst the various macroeconomic challenges confronting the country stemming from the crash in global crude oil prices since H2:2014, major economic indicators have suffered debilitating setbacks. The exchange rate has depreciated by 33.6% in 2015 YTD at the parallel market while forex scarcity has impacted on business operations leading to losing of jobs. Pressure on consumer prices has driven inflation to 13.7% as at April 2016 from 2015 average of 9.0% even as the cost of credit further increased when the MPC in response raised MPR to 12.0% from 11.0%. The overall impact is a drag on economic activities as the GDP decelerated to 2.8% in 2015 on the average against the average growth rate of 5.9% between 2010 and 2014. The current Government may have leveraged on these weak macroeconomic indicators (tracing the bulk to corrupt politicians and institutions) and its moral capital in gaining power, the overwhelming deterioration of the revenue, in our view may have forced the popular government to take the unpopular decision of petrol subsidy removal.

While we laud the courage and tenacity of the Minister of State for Petroleum – Ibe Kachikwu – in taking this crucial decision we have termed “the inevitable”, we fear that it may be described as “Taking the Bull by the Legs “than “Taking the Bull by the Horns “especially in terms of pricing as we expect the NNPC to hands-off pricing regulation in the near term. In this report, we explore the various issues surrounding subsidy removal going down the memory lane while also analysing the problems associated with the previous regimes. We analyse the implication of the policy to fiscal policy, households, business sector (Oil & Gas), the economy & financial market and conclude with our expectation of the monetary policy response.

What the NNPC has done…Removing Subsidy using Price Modulation
The Ministry of Petroleum Resources has decided to liberalise the sector and remove import quotas which had hitherto barred most business ventures from playing in the market. As a result, regulations around supply have been lifted to attract more interested players into the downstream space. This is expected to spur activities which would have a significant influence on petrol prices as the oil & gas sector tilts towards a perfectly competitive market. In addition, the issue of forex unavailability which had prevented marketers from bringing in products even after being awarded quotas has been resolved following the new PPPRA template which now recognizes exchange rate at a more competitive price of N285.00/US$1.00.

With the new template, the new pump price of petrol was estimated at N138.15/litre with the PPPRA guiding petroleum marketers to sell at a price band of N135-N145/litre. Accordingly, the price modulation template is expected to vary from time to time in line with movement in global oil prices and exchange rate volatility. The PPPRA will thus review the template as at when due to reflecting new market conditions. With time, the government hopes to hands-off the pricing template and allow market forces to determine the appropriate pump price of petrol.
 
Chronology of Subsidy Payments and Issues
Although there are many staple necessity products in the country that should require one form of government subsidy or the other, the overbearing necessity nature of petrol seems to be of priority to successive governments in Nigeria given its relationship to several other products in the economy. In fact, more often than not, every rise in the pump price of petrol has been accompanied by an increase in headline inflation. Although the argument for the continued need for subsidy on pump price of petrol has been that Nigeria produces crude oil and so the citizens should buy petrol at subsidized prices, yet the fact that the product is hardly ever domestically refined makes it susceptible to crude oil prices and exchange rate volatility.

Our analysis of the downstream petroleum sector in Nigeria reveals that the sector has remained largely regulated since inception with every government’s efforts (Since Obasanjo’s regime in 1999) to deregulate or liberalize melted with very stiff resistance from the people. In our view, the current government is left with no other option than to do the needful of eliminating the payment of subsidy in order to increase the supply of the product while also taking out all the artificial demand, prevent diversion and install normalcy in the system. We are tempted to believe that the path the Petroleum Ministry is currently treading on is to totally deregulate the sector to ultimately allow market forces to determine the pricing of petrol. This is indispensable for fiscal balance at this time of low government dollar receipts and increased borrowing.

The picture of continuous payment of subsidy seems very scary for the survival of the economy when analyzed from previous data on subsidy payments. Available data from the CBN and PPPRA suggest that between 2010 and 2013, subsidy payment on petrol accounted for an average of 31.3%of total fiscal revenue, 24.8% of total expenditure and approximately 100.0% of the fiscal deficit. For instance, subsidy payment accounted for approximately 88.0% and 72.0% of the fiscal deficit in 2012 and 2013 respectively. In 2015, the total subsidy payments of N680.0bn was also higher than the budgeted amount of N633.5bn for capital expenditure and 11.8x (N57.7bn) more than the actual. More disturbing is the fact that in the current fiscal year, if the subsidy payment on petrol remains at last year’s levels, it would be 1.1x higher than the budget estimates for the Ministries of Power, Works & Housing and Transportation.
Thus, what has been done is to technically take off the burden on government and strengthen the market system in fixing price and instilling efficiency in the sector. We believe the current policy, if sustained, will potentially stabilize the industry demand by expunging all the artificial demand from sharp practices and black marketers, increase the supply as players are incentivized to bring in products at market competitive prices.

Source: Afrinvest (West Africa) Limited