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Petroleum Downstream Deregulation and Inevitability of Petroleum Subsidy Removal in Nigeria

Prof. Omowumi O. Iledare

Preamble:

In an environment where perfectly competitive petroleum downstream market exists, the inkling for price regulation is an anomaly.  However, if the downstream market structure or conduct is a natural monopoly, then, a significant regulatory effort is required to prevent market failures due to anti-competitive behaviours, and/or socially undesirable consumer behaviours. Market failures, in such cases, reflect the inability of the market to allocate resources efficiently, and perhaps, equitably.

Let me declare upfront that the Nigerian petroleum downstream sector is, in my opinion, an institutionally induced market with regulatory and unjustifiable high barrier to entry. Under that type market circumstances, the sector is, though operating not in a perfectly competitive or contestable market mode, it is also far from exhibiting a natural monopoly structure, making economic regulations undesirable.

However, the wholesale and retail segments of the downstream market in Nigeria consist of small number sellers that are relatively big firms characteristically operating like a pseudo oligopoly. On the other hand, the distribution market segment (retailing) appears to be pseudo monopolistic, featuring very many small sellers who are price takers with guaranteed margin plus illegal rent. This is possible because of regulatory failures, and, perhaps, ineptitude governance of the sector over the years. Thus, to a large extent, there is not an exact-economic model to appropriately define the market clearing price to ensure consumer surplus and producer surplus within the context of Pareto optimality conditions in the sector. The deviation from the Pareto efficiency frontier is exacerbated because of the low refining capacity in Nigeria and monopoly source of imported petroleum products in the more recent years, precisely, since 2015. Thus, the rationale for deregulating petroleum product price control and delegitimise petrol subsidies, using illegal fiscal process is evident from the unintended consequences of the coercive interventions espoused over the years in Nigeria (see charts I and II). 

These apparent unintended consequences reflected in the charts above, in my opinion, include, but not limited to, funding inadequacies for priority projects, crowding out investors for competition for scarce capital investments, and uncontrollable FOREX market. The paradox of petroleum subsidies, arising from price control, is evident from charts 1 and 2. Nigeria seems, over the year, to prefer burning cheap fuel on debilitated road infrastructure than spending money on education, health, and science. The charts also portray what ought not to be that has remained to be for years as evident in Chart II.

This Op-Ed attempts to proffer plausible rationale for deregulating economic regulations to ameliorate the unintended consequences of price control and, perhaps, dispel deregulatory apprehensions in the community. As I mentioned earlier, price control or regulation is a legitimate intervention when the market system fails to promote efficiency, equity, and social responsibility. In the process, however, government intervention may become an albatross. Thus, when the costs of regulation overshoot the benefits to the extent as observed in charts 1 and 2 above, something has to be done, and what ought to be done is price decontrol or to deregulate all economic regulations of petroleum downstream sector in Nigeria.

Rationale for downstream market deregulation in Nigeria:

Price regulation, through the use of coercive power of government and fear of social unrest, is like riding on the back of the tiger and the belly of the tiger may end up being the final destination of the rider. The metaphor simply implies that, if Nigeria continues to use the power of regulations to disrupt the ability of the pricing mechanism to function appropriately, then the end results could be quite catastrophic. It is plausible to argue that the prevailing high misery index, in terms of the combination effects of high inflation, high unemployment, and high exchange rate, is statically correlated with regulatory failures in the petroleum downstream market in Nigeria.

So, what is the way out of this catastrophic path, keeping in view the energy transition dynamics? Perhaps, additional historical perspectives and comparative regional lessons might help Nigeria to get out of the lacuna created by the perpetual petroleum subsidy payments at the expense of so many desirable projects with posterity implications – good road infrastructure, enhanced energy infrastructure, education and expanded economic output. As I mentioned earlier, crowding out investors from capital fund inhibits growth just as money supply continues to chase fewer goods. Countries like the United States and Venezuela, which, for many years, controlled the price of petroleum products, offer great lessons for Nigeria not to continue along this path.

Lessons from the US under President Nixon in the 1970s, when price and allocation regulations became a disaster waiting to happen, and it did happen until President Carter and President Reagan reversed the inappropriate government interventions. The opportunity costs of such regulatory interventions may be difficult to estimate, but it was huge on the US economy, according to Bradley (1996). More recently, too, Venezuela offers good lessons on what not to do with oil money – do not subsidise the consumption of an economic good for just a pleasurable lifestyle of the few.

Venezuela made the mistakes, offering petroleum product at the cheapest possible rate at the expense of priority projects, and it paid dearly for it. Nigeria seems to be following the Venezuela path unabated. An honest assessment of charts 1 and 2 tells the story of Nigeria’s preference for burning cheap fuel through tail pipes of motor vehicles, and for political survival because of the fear of social unrests than for sustainable quality education and excellent road infrastructures. Of course, there are other factors that affected Venezuela oil and gas industry, and the collapse of its economy beyond income redistribution through petroleum subsidies. But ineffective governance of the oil and gas sector was a significant factor that brought Venezuela economy to its knees.

I have spoken about governance a lot with a loud lamentation that PIGB 2018 did not become an Act. It was a good bill sacrificed on the altar of a perfect bill and political expediency. Perhaps petroleum price decontrol would have occurred before COVID-19 debacle and the ongoing drainage on the federation account because of petroleum subsidies circumvented.

That is history now, anyways. Consequently, what then is the way forward? The simple answer is to change the rules of the game with respect to the downstream petroleum sector. Unfortunately, those with the power to change the rules, to avoid chaos, benefit the most from the chaotic downstream market inefficiency and ineptitude governance of the sector. Nevertheless, the use of coercive power of the government to control price, increases barrier to entry, and in the process, promotes undesirable social behaviour must discontinue.

To change the rules of the game, it is important to have a proper perspective on failed government interventions in Nigeria in order to facilitate the reform process going forward. Theoretically speaking, there are three main categories of regulations or government ways to interfere in the market system – economics, market, and social (Bhattacharyya 2011). The first category is economic regulations put in place to address the inability of the market to attain efficiency and equity due to market failures, especially when the form of the market is a natural monopoly. The second category represents the application of the coercive power of government to protect the society from anti-competitive practices of economic agents. Of course, there are government interventions targeted at promoting socially desirable grouped in the third category of regulations. Unfortunately, in Nigeria, the people with the responsibility to regulate anticompetitive behaviours apply such power of authority to make regulating anticompetitive behaviour evasive yesterday, and today…

Regarding the inefficiency and inequity in the Nigeria downstream, economic regulations through the use of coercive power of the government to control prices continue exasperate the inefficacy in the downstream market. Thus, it is evident that price control in Nigeria has not been able to promote economic efficiency. Therefore, Nigeria cannot continue to do the same thing, and expect different results. More so when the inefficiency is as a result of government intervention failures, rather than market failures.

As to regulating social behaviours, the promotion of social behaviour effectively requires public education and a level of integrity across the board. For the most part, Nigeria seems to be averse to rules of law when it comes to promoting desirable social behaviours by regulations. In fact, those who are in the position to regulate and promote socially desirable behaviours are more prone to exhibit socially undesirable behaviour in the downstream market in Nigeria.

Let me, therefore, limit my conversation in this Op-Ed to deregulating economic regulatory interventions in the form of price control and allocation of petroleum products in Nigeria. But that does not mean that regulating anticompetitive and social behaviours is not important. In fact, economic deregulatory effectiveness is subject to effective regulations that inhibit anti-competitive behaviours and promote socially desirable consumer behaviours. Focusing on deregulating economic deregulation of the petroleum product pricing, the following discourse describes briefly the plausible arguments in support of the call for downstream deregulation in Nigeria over the years.

Nonexistence of a natural monopoly: The very first plausible economic rationale for the deregulation of the Nigeria downstream is the absence of a natural monopoly structure. Economic regulation is desirable only when the market cannot guarantee efficiency and equity with an undebatable evidence of social welfare loss. What Nigeria is experiencing is inappropriate government interventions, which have created an unnecessary barrier to entry, with respect to petroleum product import. Furthermore, price equalisation mechanism inhibits the ability of the market to put in check undesirable behaviour, which makes the price system to function properly as a resource allocation mechanism. Subsequently, the government has overburdened itself with its intervention that are somehow incapable of doing what the market can easily accomplish. It is a lesson the US learned in an expensive manner in the 1970s. No natural monopoly, no economic regulation, no price control, no subsidies, and more money ensured in the process for priority projects.

Increasing evidence of downstream regulatory failures and capture: Over the years, implementing price control is cumbersome, and to a large extent, pervasive. The ability of the regulators is hindered because of limited skillsets and capacity to understand regulatory economics. The governance structure and funding inadequacy for regulatory institutions make regulatory capture more likely than not. So, regulating anti-competitive behaviour to facilitate market efficacy is often compromised under such environment. I am sure one can recollect the NASS bribery issues some years ago. The less economic regulation of the economic agents, the less the burden of the regulators to regulate anticompetitive behaviours in the market!

Declining barrier to entry: Economic regulations of the downstream sector has created barrier to entry in ways that may be difficult to perceive by the union and regional hawks.  There are, in the system, many hit-and-run retailers, with celebrated trader mentality, thereby giving a pseudo contestable market ‘feature of free entry costless exit’ in the Nigeria petroleum downstream. I believe that with deregulation, it would be difficult to get much above normal profit, thereby, maximising consumer surplus, and keeping in the business only those who understand the complexities of the market, and know the implications of sanctions and penalties for evidence of anti-competitive in deregulated market.

Colossal national debt profile: Borrowing money to attempt to sustain an unproductive lifestyle is worrisome. And when a great proportion of the borrowed money is burnt at the tail pipe of vehicles for pleasurable ride, it portrays a disregard for optimising intergenerational equity. Just imagine having not to spend money in such a way to maximise social welfare loss, rather than maximising social welfare gain. Economic regulations of a failure, induced by government intervention, drives the former, while removal of such failed intervention promotes the latter. I think more people need public education of how deregulation is the key to social welfare maximisation in Nigeria going forward.

Diminishing perception of petroleum as a pubic good: There are some who continue to equate petroleum product as a public good, and as such, it must be given out for free.  To such, cheap or free petrol is their right, more so, because crude petroleum is produced in their country. This is a woolly thinking that must be disabused. I am more alarmed when I hear people say petroleum must be cheaper with refineries working in Nigeria.  Unfortunately, this is not the case. There is a serious rivalry in the petroleum consumption, and exclusivity is the rule of the game. Government intervention is incapable of allocating an exhaustible resources, like petroleum, efficiently and equitably. Only an inhibited price system can do that effectively. As people begin to understand the implications of the inefficiency of government interventions, deregulation of economic regulations of the price system becomes more realistic.

Deregulation apprehensions: It would be full hardy to think that deregulating petroleum downstream would just solve the problems of the sector without some shock to the economy. That is why I have offered some ways to ameliorate the inevitable price shock in the short run. Again, the US deregulatory process offers a perfect example to adopt.  The way to go is partial deregulation, but with a set full deregulation start date in mind. One thing is sure. There can be no deregulation without changing the rules of engagement.

First, the power given by PA1969 to the Minister, with respect to the power to set petroleum product prices, must be repealed, and PIB must become an Act. This is necessary because there must be evidence of political stability in terms of the legislative and regulatory process termed stability of the rule makers. Secondly, the concept of setting a price must be avoided. I remember saying that much in 2016 to the then Minister of Petroleum, when the price was set at N142 per litre. That is not the way to go, unless Nigeria wants to go with price modulation, but not at the instance of the government. I am now hearing a call to set the pump price at N385 per litre. There must not be a price ceiling or price floor, if deregulation is to deliver the ultimate goal, efficiency and equity in the downstream. Going from N162 to N385 per litre in one sweep may create a disequilibrium similar in nature to the volatile jump in exchange rate with its unintended consequences on money supply.

There is just so much to say on the unintended consequences of petroleum price regulations in Nigeria. But I would rather see a policy in place on how to ameliorate in the short run the likely impact on a deregulated market, after so many failed efforts. So, I want to think outside the box in conclusion, and I saw the recommendation worked in a similar situation, of course, with some ramifications, like product shortages in the unprotected other from anti-competitive behaviours and unregulated social dysfunctional behaviour. Nonetheless, if there is a way to have two parallel market outlets until a defined end date, NNPC (Nigerian National Petroleum Corporation) can continue with the current practice until PIB becomes an Act with NASS (National Assembly) regulations target at sanctioning anti-competitive behaviour of private outlets. Of course, undesirable behaviours of public transporters round-tripping must be sanctioned, as well.

Omowumi O. Iledare, Professor Emeritus, LSU Center of Energy Studies, USA and GNPC Petroleum Research Chair, UCC Oil and Gas Studies, Ghana, Fmr. President and Fellow, Nigerian Association for Energy Economics

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