Petroleum Products and Power Markets: Contemporary Matters Arising on the Role of Government in Nigeria
Professor Omowumi O. Iledare
1.0 Preamble
It is not imaginary that petroleum rent sharing has significantly affected the governance structure, social structure, and the value system in Nigeria. In fact, the interpretation and execution of the 1999 Constitution of the Federal Republic of Nigeria, thus far, has been rendered petroleum vulnerable to rent sharing and rent seeking. There is high marginal propensity to entitlement in Nigeria with perpetual tendency to blame government for unachievable personal wants and expectations. Government, for political expediency tends to adopt unrealistic economic populism approach, which in turn perpetuates society’s high entitlement propensity. For example, society clamors with the threat to go on strike because of petroleum subsidy removals. Yet petroleum subsidy is at odd with petroleum and energy market fundamentals and efficiency with significant impact on the aggregate economic wellbeing.
Further, it is not conjectural to contend that the less-than-optimal level of energy accessibility, affordability, and availability has delimited or bounded sustainable economic development in Nigeria. Energy consumption per capita is significantly less than the global average expectations of about 1000 MW generation capacity per million people. The aim of this Op-Ed is to instructively espouse the fundamentals of petroleum and power market systems and the role of government to ensure market efficiency, resource allocation effectiveness and economic equity in society. The primary goal is to deepen the understanding of intricacies in the petroleum and power markets and to affirm that deregulation is the absence of price control and not necessarily an absence of regulations. The Op-Ed hereby wishes to enlighten the minds of those who take for granted the role of government to ensure the existence of an efficient mechanism to enhance the market system beyond price control.
2.0 The Petroleum Market Structure in Nigeria
The petroleum value chain has three segments, upstream, midstream, and downstream. Each segment is a standalone business unit by itself but there is room for vertical integration, operationally. For example, NNPC Limited is vertically integrated, though its refineries are currently still dysfunctional. There are few other firms, which are evolving to become vertically integrated in Nigeria. Thus, the structure which describes the petroleum market in Nigeria is not the purely competitive nor the monopoly market structure, but a hybrid structure that is evolving in anticipation of a full petroleum downstream deregulation. PIA 2021 provides provisions to accelerate the petroleum market system evolution to improve the domestic value addition in petroleum value chain in Nigeria. The three anchor institutions, the Petroleum Commission and the Petroleum Authority, NNPC Limited, and Minister, are so far so good stepping on the plates to actualize these expectations regarding the crude oil market dynamics, petroleum products market system, and the competing natural gas markets- export and domestic.
Crude Oil Market in Nigeria – Applying international competitive market framework to dictate the price signal for trading crude oil for domestic refining in Nigeria is really something to understand, appropriately. There are petroleum market analysts and experts advocating a pricing mechanism majorly premised on domestic market fundamentals, without compromising the profit maximizing theory of the firm. There is no worldwide market structure for crude oil trading that fits every domestic economy; just like there is no worldwide market structure for skilled or unskilled workforce that fits every economy. Thus, pricing crude in a domestic economy at export price parity and petroleum products pricing without consideration for import price parity of products has repercussions in the domestic economy.
Petroleum Products Market in Nigeria – The petroleum products market structure in Nigeria is an amalgamation, a mixture of oligopolistic competition at the retail end for PMS and diesel with high concentration ratios for the top-four firms and top-eight firms. It is oligopolistic because the top four sellers/firms in the market exert considerable influence over the market behavior in that segment of the petroleum value chain. However, at the retail diesel product market for end-users, pricing is also oligopolistic with interdependency. Whereas in the PMS market, the dominant firms, especially NNPC Limited, tend to influence the market pricing dynamics.
The influence of NNPC Limited, as the dominant firm in the PMS market occurs because of its near absolute monopoly market power in the PMS wholesale market. It is the sole importer of PMS, even if there are rooms for disagreement, which makes it a monopoly. This explains the ongoing debate on who pays and who receives PMS subsidy, and if there is no subsidy why is the price of PMS static despite crude oil price dynamics? Statistically, when the price of crude oil goes up, product prices go up as well. The landing cost of PMS in Nigeria has increased compared to when the dominant firm in the PMS market set the price of a liter at N500 in May 2024. Additionally, the price of a dollar in Naira is more than twice now than in May.
Empirical evidence from literature review suggests there is a direct correlation between the price of petroleum products prices and crude oil. Thus, empirical evidence does not support the mantra that there is no subsidy on PMS in Nigeria, speaking contemporaneously. For example, the price of PMS in Ghana is, on average, more than a dollar per liter and in Europe the primary source of PMS to West Africa, including Nigeria. Interestingly, if I may add, in most places worldwide, the price gap between diesel and petrol is at most about 10-20%. The price gap in Nigeria between diesel and PMS is certainly uncommon.
Role of Government in Petroleum Market – PIA 2021 provides three anchor institutions to improve competitiveness in the petroleum market in terms of structure, conduct and performance. Unfortunately, the obsolete Petroleum Act 1969, the Petroleum Pricing Regulatory Agency Act of 2003, and the NNPC Act of 1977, remain imminent and loom larger than life in the feature of contemporary petroleum products market governance and regulatory dynamics. No wonder, every feature of market failures, such as illegal market, PMS shortages, subsidy, long queues at retail stations, and social welfare losses existing before PIA 2021, still characterize the petroleum products market, two years after. It looks as if the twenty-year journey to reform the industry is worthless as business as usual seems to be the order of the day with the same transactional mindsets and prebendalistic tendencies.
3.0 The Power Market Structure in Nigeria
The power market also has three segments—generation, transmission, and distribution. Each segment is a standalone business in Nigeria. The Electricity Act 2023 has the enormous potential to rekindle the electric power industry. The decentralization of the governance of the electricity supply industry with state participation is laudable, commendable, and incredible. Of course, there is an apprehension that state governments may create government owned power companies, and this is plausible. However, it is so amazing to read from media sources the willingness of NERC to surrender regulatory functions to agencies in the constituent states in the Federation to regulate the power market in the state. Indeed, the dawn of a new era in the power sector in Nigeria. Perhaps, taxation, policing, education, banking and other sectors of the economy that are currently centralized may become decentralized during this administration as well.
Power Generation Value Chain – The structure of the power generation segment of the electric power supply industry is oligopolistic with a highly concentrated generating capacity by the dominant firms. There is no empirical evidence of vertical integration, across the power value chain in Nigeria since the demise of the National Electric Power Authority. The dominance of thermal gas power plant in the total power systems capacity in Nigeria is, however, worrisome. Efforts to transit to renewable energy systems, hydroelectric power, seems desirable within a mixed energy strategic framework. Usually, gas power plants work well and best to satisfy peak demand.
Further, unlike the upstream value chain with increasing marginal cost curve, the generating power value chain decreasing marginal cost curve. Thus, the pricing mechanism is different for investment optimization and the recent settling of wellhead gas price for gas to power investment by the authority within the context of PIA 2021 deregulation expectations, ill-advised. The Act gives no authority to any institution of government in Nigeria to set the petroleum products or natural prices in Nigeria. Natural gas competes with itself and fixing its price, discriminatorily for a sectoral end user of gas, compromises market allocation efficiency. High natural gas prices for power generation automatically puts pressure on the electricity tariff. Immediately the natural gas price for power generation increased, the electricity tariff for band A customers went up from about 70 Naira per KWhr to 225 Naira per KWhr. Interestingly, there is no definitive assurance that the 20 daily hours of electricity supply to Band A customers is enforceable.
Power Distribution Value Chain – This segment of the power value chain has a direct link to end-users and a suboptimal business performance in this segment has implications on the entire value chain. The market structure in this segment of the power value chain is not a natural monopoly in the real sense but a territorial monopoly. Unfortunately, too, the territory assigned to each Disco is quite heterogeneous in terms of market features—income, social structure and culture, and status and fundamentals—access to national grid, affordability, and adaptability. The suboptimality of this segment explains the overall delimited access to power in Nigeria at an affordable price. This is clear when you compare the 4000-5000 MW electron transmission capacity to 10,000 – 15,000 MW generating capacity. It becomes obvious that the availability aspect of the energy supply security is unachievable. There is a clamor to revisit the sales agreement with Discos in Nigeria to reevaluate the sale agreements and to revoke the licenses of all nonperforming Discos. This is really a promising idea.
Power Pricing Mechanism – On April 1, 2024, a new tariff appeared after the increase in the wellhead price of natural gas for power generation. Nigeria must come to terms with the fact that 68 Naira per KWhr is a price ceiling in the power market. This is significantly below the market clearing price of electricity. In fact, 68 Naira is also not anywhere close to the fair return price of an economic good with decreasing marginal cost and average cost curve like electricity powered majorly by thermal plants. The social best price of electricity is also not 68 Naira either. So, NERC had to have done something about this discrepancy long before now and this is better late than never. Even if there are disagreements on the proper tariff, there is no disagreement on the fact that 68 Naira per KWhr is a bidding for perpetual subsidy payment in the power sector and it is not sustainable.
The new tariff system embraces price discrimination mechanism, and it is not a new phenomenon in the power sector worldwide. The precision of the band A tariff started recently is, however, conjectural because of supply uncertainty and the assumptions and facts within the context of the pricing model applied. As more facts become available and assumptions reevaluated for real, the pricing model can then be recalibrated in a self-adjusting manner. Also, there must be a way to protect the consumer surplus of customers affected because of affordability and metering issues because of this new tariff. Assuming the reports published in the print media are correct, then the ongoing price discrimination application is based on daily supply hours for selected users. Such a mechanism is not unusual in the power market, the airline industry does the same thing.
4.0 Concluding Remarks
The Federal Repulic of Nigeria has been vulnerable to petroleum rent sharing and rent seeking. Largely, governing the Federation has been quite challenging as petroleum revenue dwindles. Even as marginal propensity to entitlement in the nation increases, the perpetual tendency to blame government for unmet personal expectation grows. The government, therefore, perpetuates these unrealistic expectations with economic populism ideas including petroleum and energy subsidy payments. Economic populism and petroleum and energy market fundamentals and efficiency are antithetical to achieving high aggregate economic wellbeing. Venezuela experience of the impact of economic populism using petroleum rent to subsidize petroleum and power for political expediency, offers Nigeria perfect lessons to understand.
Empirical evidence does not support the mantra that there is no subsidy in the petroleum PMS in Nigeria, speaking contemporaneously. For example, in most places worldwide, the price gap between diesel and PMS (petrol) is at most about 10-20%. The price gap in Nigeria between diesel and PMS is certainly uncommon. PIA 2021 provides three anchor institutions to ease competitive framework for petroleum market structure, conduct and performance. Unfortunately, the obsolete Petroleum Act 1969, the Petroleum Pricing Regulatory Agency Act of 2003, and the NNPC Act of 1977, remain imminent and loom larger than life in the contemporary petroleum products market governance and regulatory institutions. Allow me again to recommend that the President of Federal Republic of Nigeria needs to rethink the hosting of the PIA Policy Institution in the Presidency.
The power generating value chain has a decreasing marginal cost curve, which makes the pricing mechanism significantly dependent on input cost and opportunity cost of capital. The recent setting of wellhead gas price for gas to power investment by the authority within the context of PIA 2021 deregulation expectations, is ill-advised. High natural gas price for power generation automatically puts pressure on the electricity tariff. Thus, as the natural gas price for power generation was se significantly above the gas price to NLNG, the electricity tariff for Band A customers went up from about 70 Naira per KWhr to 225 Naira per KWhr.
Regarding the new tariff scheme, which became effective on April 1, 2024, Nigeria must come to terms with the fact that 68 Naira per KWhr is a price ceiling that is significantly below the market clearing price of electricity. Even if there are disagreements on the proper rate, there is no disagreement on the fact that 68 Naira per KWhr is a bidding for perpetual subsidy payment in the power sector and it is not sustainable.
Finally, looking at everything done so far in an attempt to expand power availability, accessibility and affordability including, the presidential executive order of 2024, the increase in wellhead natural gas price by the Nigeria Petroleum Authority, and this discriminatory electricity tariff by NERC; the benefits seem very skewed to enhance producer surplus at the expense of consumer surplus. The biggest challenge, however, is the implementation bordering on how to properly distinguish the targeted class with ability to pay and ensure 20+ hours of power supply to them. There also seems to be no penalty attached if a DisCo does not supply 20+ hours of quality electron delivery to customers. The only change is constant, and the only constant is change.
