Federal Government Eliminates Fuel Subsidy: heralds of a Liberal Market

Ayodele Oni

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The Group Managing Director of the Nigerian National Petroleum Commission (“NNPC”), Mr. Mele Kolo Kyari recently announced the end to the subsidy currently applicable to the price of Premium Motor Spirit (“PMS” also known in Nigeria as Petrol or Fuel) (more commonly known as Fuel Subsidy).

This announcement follows the decision of the Federal Government of Nigeria (“FGN”) to reduce the pump price of petrol from N145 to between N123.50 and N125, following the steep drop in oil prices due to the prevailing low demand for oil, owing to a global economic shutdown occasion by the coronavirus (“COVID-19”) pandemic.

Fuel Subsidy has historically been a divisive issue in Nigeria, with statistics showing that Nigeria spent at least N10trillion on Fuel subsidy between the years 2006 and 2018. In the midst of reports that Nigeria projected to spend circa N750.81billion on petrol subsidy in 2020, many have argued that Fuel Subsidy in Nigeria is a subsidy which benefits only the rich and the funds spent on petrol subsidy would be more appropriately applied to fixing Nigeria’s huge infrastructure deficit, as well as providing funding for medium, small and medium scale enterprises in Nigeria to benefit a wider spectrum of the society.

Many stakeholders consider that the crash in global oil prices, leading to the low cost of petrol make this an appropriate time to consider the removal of fuel subsidy and this no doubt played a factor in prompting Mr. Mele Kolo Kyari’s declarations.

This article will analyze  the measures currently being implemented by the FGN in relation to the subsidy regime in Nigeria and what they indicate about its long-term plans for the regulation of the price of petrol.

Petrol Subsidy prior to the Crash in Global Oil Prices

A subsidy can be defined as a discount provided by a government to ensure the availability of essential goods and services to the public at affordable prices. In essence, the fuel subsidy regime operated by the FGN was a means by which the FGN capped the price of petrol at a price determined to be affordable for the majority of the populace regardless of the prevailing market forces.

In practical terms, the petrol subsidy is calculated as the difference between the Expected Open Market Price (“EOMP”) and the approved retail price of petrol, both of which are determined by the Petroleum Products Pricing Regulatory Agency (“PPRA”) in line with set policies. The EOMP is determined as the sum of landing costs of petrol and a distribution margin. In simple terms, it is composed of the cost of production (that is the cost of purchasing refined petrol and importing same into the country) and an expected profit margin per litre of petrol. The PPRA determines the approved retail price of petrol (the “pump price”) derived from a consideration of the EOMP vis-à-vis prevailing economic conditions and the FGN pays the difference between the EOMP and the pump price as Fuel Subsidy to the petrol marketers to ensure that petrol is sold to the public at the approved retail price without incurring losses for the marketers.

Petrol Subsidy After the Crash in Global Oil Prices

The analysis above lays down the foundation for understanding the methodology behind the Fuel Subsidy regime in Nigeria. Being that Nigeria relies heavily on the importation of petroleum products into Nigeria, the global price of oil determines the landing cost of petrol and has a corollary effect on the EOMP and the cost of subsidy, as the EOMP will determine the amount, if applicable, of subsidy to be paid on the petrol to attain the pump price.

Presently, the COVID-19 pandemic has caused a significant slowdown in global economies as countries fight, through impositions of partial or total lockdowns, to stem the spread of the disease. This has, in turn, led to a reduction in the global demand for crude oil, causing a significant crash in the price of oil from circa US$60 in January 2020 to less than US$20 in April. This has, consequently caused a reduction in the landing cost of petroleum products, with reports showing that the landing cost of petrol fell to as low as N64.32 per liter at March 19, 2020 from reported landing costs of N123.88 per liter in February 27, 2020.

Accordingly, the drop in the landing cost of petrol has resulted in the EMOP falling below the pump price of petrol, thus dispensing with the need for subsidy.

As a result, the PPRA in a press statement dated March 18, 2020 announced a new regime for petrol pricing, effective from March 19, 2020 which set the pump price for petrol at N125 per liter from the previous N145. The PPRA also stated that subsequently, it would monitor trends in market fundamentals and stipulate monthly EOMP at the beginning of each month commencing from April 1, 2020. In line with its policy statements in its press release of March 18, 2020, the PPRA issued another press release on April 1, 2020 setting the price band for the pump price of petrol between a lower band of N123.50 and an upper band of N125.00.

In our view, the FGN’s actions serve as an indication of its intention to transition toward liberalization of the price of petrol, where the price of petrol is determined by prevailing market forces with limited government regulation. The FGN has taken the first step in this direction, by ensuring that the pump price of petrol, not just the EOMP, is reflective of the changes in the market factors which determine the price. The FGN’s stance however indicates that this transition to price liberalization will be a gradual one, commencing with price modulation by the PPRA, as indicated in the press releases referenced above.

The PPRA would, therefore, retain the responsibility of setting policies to determine the price of petrol through monthly guidelines on the approved price range of petrol having regard to the ongoing economic situation. It is believed that this transitionary period is to enable marketers exhaust their pre-existing stock of petrol accumulated prior to the change in the pricing regime. The eventual aim with price liberalization is to develop a free market system where oil marketing companies are entitled to set the prices of their products themselves without being subject to prices or price ranges fixed by the PPRA.

The FGN’s implementation of the new pricing regime is also aimed at ending the Nigerian National Petroleum Commission’s monopoly on the importation of petroleum products into Nigeria. In the PPRA’s press release, it stated its expectations that the new price regime would stimulate investment in the downstream sector and encourage the resumption of importation of petroleum products by oil marketing companies, with consequential positive impacts on the economy. it is believed that the transitional price modulation period is expected to provide the necessary time and stimulation for this to occur, before the implementation of full price liberalization.

It is also worthy of note that with the liberalization of price, competition law can come into place to protect the interests of consumers, in line with the Federal Competition and Consumer Protection Act. The Federal Competition and Consumer Protection Com (“FCCPC”) would therefore monitor the activities of oil marketers to prevent collusion between oil marketers to drive up the price of petrol, especially in situations such as the present situation where the global price of crude oil is low, and the FCCPC would, within its powers under the FCCPC Act, investigate complaints from consumers on any breach of the provisions of the FCCPC Act and impose sanctions on any defaulting oil marketers.

These reforms to the petroleum sector, if implemented in line with the projections herein, will have a positive impact on economic development.

It is hoped that the  when full price liberalization is implemented, oil marketers will be free to adjust the prices of petrol in inland areas to reflect the extra transportation costs, which would render the Petroleum Equalisation Fund (“PEF”) obsolete thus further reducing government expenditure. The funds saved on these adjustments can be allocated towards critical but underfunded areas including Nigeria’s healthcare system and the improving infrastructure, measures which will be of the benefit for the masses in Nigeria.

Economic development will also be boosted if the FGN follows through with plans to increase Nigeria’s refining capacity and boost domestic production of petrol. Recent reports have shown the NNPC’s plans to shut down Nigeria’s four refineries for major repairs and to subsequently enter into Operations and Maintenance contracts with private companies for the operation, management and maintenance of the country’s refineries. It is expected that the selected private companies will have the requisite capacity to operate and maintain the refineries which have historically operated well below capacity.

In conclusion, it is hoped that the FGN’s decision to review the pricing regime for petrol is an indication of its intention to finally end fuel subsidy and liberalize petroleum pricing. It is also hoped that the FGN will compliment the removal of fuel subsidy with improving Nigeria’s refining capacity and applying funds saved from the fuel subsidy to critical and underfunded areas, in order to promote economic development.

 

 


Ayodele Oni ([email protected]), a commercial lawyer, specializes in international energy (oil, gas & power) investment law.

 

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