The mother and father of fuel prices


In the wake of the petroleum downstream deregulation by President Olusegun Obasanjo in 2004, and the unfolding opposition, anxiety of Labour and the Nigerian public on the adverse impact of rising fuel prices, this column published two articles entitled, “The mother and father of fuel prices” (November 22, 2004) and “Only a stronger naira will stop rising fuel prices” (August 22, 2005) see The solutions proposed in both articles remain solidly valid today, as they were 12 years ago. For this reason, a summary of both articles is again presented, in the hope that the authorities will one day heed our counsel and successfully resolve our dilemma.  Please read on.

The economic and social benefit of deregulation is evident from the demonstrable success in several countries.  Deregulation would mean market determined prices for fuel. Thus, competitive pricing and improved customer service would prevail. Furthermore, our comatose refineries would be rejuvenated and private investors would hurry to establish new refineries, as their survival and profitability would not be dependent on market manipulations or distortions by the authorities. Petrol smuggling would also cease to be an attractive venture and the national treasury would be bolstered by the plug on such revenue leakages.

However, the oppressive inflationary impact of deregulation since inception seems to be the exact opposite of popular expectations; for example, instead of lower prices, pump prices conversely remain on a continuous rise with a debilitating impact on the Nigerian patient!

Nevertheless, with the fiery intervention of the Nigeria Labour Congress, as the Nigerian patient’s next of kin, the doctor finally agreed to sweeten the bitter pills of deregulation with a modest range of palliatives to facilitate mass transit! The NLC’s robust opposition to deregulation is buoyed by vibrant public support to insist that the promised palliatives may not cure the patient. Consequently, we have both the next of kin and an enamoured doctor killing the patient, as economic and social life becomes grounded by a nationwide industrial action.

The question is how both the Federal Government and the NLC can be so right in their aspirations, but wrong in their different diagnoses of the problem! Undeniably, the NLC and the Federal Government share the same aspirations for improved social welfare, with restrained inflation and a progressive, supportive economy which is efficiently and transparently driven by market forces and competition. Furthermore, Nigerians also expect that new refineries will come on stream with deregulation, to adequately supplement domestic supply, so that surpluses can be gainfully exported. Evidently, both parties actually expect increasing job opportunities with diversification and expansion of industrial capacity. Regrettably, the pursuit of these objectives seem to have taken to different tracks and yet neither party is anywhere nearer the goal.

In general, however, the following factors have often been popularly canvassed as primarily responsible for rising fuel prices. These are poor condition of refineries, additional cost of imported fuel, corruption and smuggling, rising crude oil price and the naira exchange rate.

However, a careful examination of these major price instigators may reveal that even if the existing refineries work at full capacity and new refineries are also built, the local price of petrol in a deregulated scenario may only be cheaper than the imported fuel, by not more than 10-15 per cent! The difference is the additional cost of transporting crude oil abroad and the cost of shipping refined petrol to Nigeria.  The potential savings in cost from relatively cheap local labour may invariably be nullified by the cost of provision of own infrastructure, particularly high cost of power, and high cost of funds.

We cannot deny that corruption and smuggling also indirectly affect petrol price, just as inefficiency and lack of accountability in public service could also lead to indiscrete resource allocations with attendant market distortions and higher prices.  The cross border smuggling of both crude and imported petrol will similarly affect prices at different levels. However, although massive smuggling of crude oil may help to stabilise or lower international crude oil prices, but cross border smuggling of imported the PMS instigates a bloated local demand and also represents a substantial open-ended subsidy to the economies of our ECOWAS neighbours. It is plausible, however, that the listed fuel price instigators by themselves do not fully explain the geometric leap in domestic fuel prices from less than N1/litre to its present (2005) oppressive level of over N50/litre.

However, the popular welfarist argument that Nigerians should enjoy lower prices for their natural resource endowment may inadvertently jeopardise the multiple advantages of a free market and the additional benefit of attracting foreign investments for refineries, with competitive product pricing and improved customer services by marketers.  Besides, the inevitable monstrous revenue allocations to fund an open-ended subsidy to stabilise lower petrol prices, in spite of steady naira depreciation, will ultimately have a catastrophic effect on the survival of existing public refineries, as they would most certainly go under. For example, the Nigerian National Petroleum Corporation continues to absorb daily subsidy values in excess of N350 million (over N150 billion annually) as reported by the Group Managing Director recently (2005).  This burden would ultimately kill any prospect of private investment in our refineries!

Nevertheless, it is not inappropriate to expect that even if international crude oil prices are rising, the expected upward push on domestic fuel prices will be restrained by a stronger valued naira vis-à-vis the dollar (the crude oil value denominator), since the additional dollar revenue which automatically accrues from rising crude oil prices would also increase our foreign exchange reserves positively, and such increase should be reflected in a stronger naira exchange rate. In this manner, domestic fuel prices will ultimately either stabilise or even fall in response to a stronger naira.  Technically, even though Nigerians will be able to buy fuel more cheaply, even when crude oil prices rise, petrol smugglers will, however, be liquidated, as a stronger naira will erode profit margins and make petrol smuggling business unprofitable! Thus the stronger the naira, the lower in fact will be the local price of fuel to keep inflation in check.

Furthermore, fuel prices can also accommodate a 10-15 per cent petrol tax per litre, while the revenue collected should be dedicated to critical areas of need such as education, health, transportation and other social infrastructure.  From the preceding, it is evident that the single most important factor in the determination of local fuel prices is actually the naira exchange rate.  Indeed, in a deregulated market, local fuel prices have no choice but to move in sympathy with international crude prices, but the appropriate and sensible management of the foreign exchange inflow from increasing dollar revenue, will determine the naira exchange rate and consequently the price also of fuel domestically.

Thus, in such an enabling marketplace with the correct infusion of our dollar revenue into the economy, the self-evident benefits of deregulating the oil industry’s downstream sector will become manifest as local fuel prices will become market determined. Thus, when crude prices rise, Nigerians will earn more dollars which will strengthen the naira rate to induce cheaper petrol prices locally, without a kobo subsidy, but with the benefit of a possible petrol sales tax.

The impact of a cheaper naira pump price will trickle down in a cascading positive impact on the economy, as transport cost collapse and food stuffs become cheaper to transport from the farms to the cities.

Conversely, however, the naira rate will inevitably continue its downward spiral so long as the Central Bank of Nigeria continues to auction the dollar to the highest naira bids, in a market, that is already suffocated with excess naira supply.