Managing the Modulation of Petroleum Product Prices in Nigeria

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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.

  1. The price modulation policy currently applies to PMS only. The minister’s statements have focused on PMS only and the new PPPRA templates for AGO and LPFO indicate that the prices of AGO and LPFO will not be modulated, at least not yet. There is no new template for kerosene yet, so we cannot say if kerosene price will be modulated, at least not yet. The December 24 template for HHK (kerosene) indicates that the EOMP is N90.27 while the retail (pump) price is fixed at N50 per litre while the under-recovery (subsidy) is N40.27 per litre. In the absence of a new template for HHK, we can assume that the December 24 template is the one currently in operation, although most consumers buy kerosene at filling stations at prices far higher than the N50 in the PPPRA template. NNPC/PPPRA needs to clarify if the price of kerosene will be modulated like that of PMS or whether the government will continue to pay the hefty subsidy on kerosene with the “inflated” distribution margins and “other landing costs”. It is my candid opinion that to ensure effectiveness and efficiency, the prices of all petroleum products should be modulated because the products are not independent – that is, the products are produced “jointly” (i.e. have joint costs) and have varying degree of “substitutionality”. Under such a situation, economic theory recommends an integrated pricing system such as the Ramsey’s pricing rule which is the “second-best” pricing policy[ii].   A situation where the prices of some products are “modulated” while others are highly subsidized and/or deregulated is a recipe for chaos and inefficiency.
  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
emmaaojameruaye@yahoo.com
Phoenix, Arizona State, USA
January 3, 2016
 

Appendix

 Chart 1: Composition of the Expected Open Market Price (Total Cost) of Petrol

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 Table 1: PPPRA Pricing Template for PMS, December 24 and December 31, 2015

S/N Cost Element

Dec. 24, 2015 N/Litre

Dec. 31, 2015 (NNPC)

Dec. 31, 2015 (OMC)

1

Import Price (C+F)

67.34

65.5

65.5

2

Trader’s Margin

1.47

0.00

0.00

3

Lightering Expenses (SVH)

4.07

2.02

2.02

4

NPA

0.77

0.36

0.36

5

Financing (SVH)

0.51

0.00

0.31

6

Jetty Depot Thru’Put Charge

0.80

0.60

0.60

7

Storage

3.00

2.00

2.00

8

Landing Cost

77.96

70.48

70.8

9

Distribution Margins

10

   Retailers

4.60

5.00

5.00

11

   Transporters

2.99

3.05

3.05

12

   Dealers

1.75

1.95

1.95

13

   Bridging Fund

5.85

4.00

4.00

14

   Marine Transport Average (MTA)

0.15

0.15

0.15

15

   Admin Charge

0.15

0.15

0.15

16

Subtotal Margins

15.49

14.3

14.3

17

Taxes

18

   High Maintenance

0

0

0

19

   Government Tax

0

0

0

20

   Import Tax

0

0

0

21

   Fuel Tax

0

0

0

22

Subtotal Taxes

0

0

0

23

Total Cost

93.45

84.78

85.10

24

Ex-Depot (for Collection)

77.66

76.50

77.00

25

Under/Over Recovery

6.45

-1.22

-1.40

26

Retail Price

87.00

86.00

86.5

27

Expected Open Market Price

93.45

84.78

85.1

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

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 Source: OPEC Bulletin November 2015. Original data in US$/Barrel coverted to US$ per litre by dividing by 42 (I barrel = 42 litres)

 

Endnotes


[i]  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.

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