Tuesday, October 20, 2009

Market forces - a response

I received an excellent response to my Saturday post via email from Fatai Thomas. I am pasting it in full. I'm sure you'll find it as helpful as I did:

"From an economic perspective, subsidies are generally a bad thing as they create market anomalies. This is a fact globally i.e. once you subsidise something (or do the opposite, slap a windfall tax on it) it encourages people to arbitrage. However, as a policy tool, they are the most potent for encouraging behavior.

In Nigeria, the pump price is fixed by the Government at NGN 65 per litre – 26p a litre. As a benchmark, in the UK the pump price is about 100p per litre. However this price includes about 50p of fuel tax so the “real” pump price is 50p. In other words, at NGN 123 per litre, a UK based fuel retailer can pay for transport, staff, raw material (refined product) and still make a profit.

Today, the Nigerian market is dominated by the major oil marketers. Together they have about 64% of the market. They buy product for NNPC on the world market, transport it to Nigeria and sell it. To fulfill its policy aims, the Government pays them the difference between where they buy and where they are told to sell it.

There are four problems with this in the long-term:
a) The Government is not an efficient and fair organization creating a lot of room for leakage
b) The increase in oil price and population (i.e. consumption) means at some point the subsidy will become unaffordable. I don’t have the statistics to hand but I am sure you can correlate development and fuel consumption (especially in a hot country)
c) The subsidy, although it is very effective as it reaches so many, is flawed because by having a fixed price, the Government has no way of controlling demand i.e. a fixed price means you never reduce your demand handing a windfall profit to the oil marketers (this is why so many people have gone into that business – printing money would be harder!)
d) Finally, anyone who considers building a refinery would not be happy selling into a price controlled market – yes you get a subsidy but it means you don’t enjoy the benefits of the cycle in the good times

So to answer your questions:

Q1 - “how much will the price go up” – I would expect it should not exceed NGN 125 a litre

Q2 - “given the fact that it is much more profitable to sell high quality 'sweet' (low sulphur) Nigerian crude on the international market than locally in Nigeria, how would the government ensure that local crude is made available to the refineries?” – if the local price is the same as the world markets (deregulated), then there is no arbitrage i.e. as a rational seller, I have no incentive to sell abroad or in Nigeria. In actual fact, given that transportation costs would be lower for a Nigerian refined product, the local refinery can afford to pay more than an international refinery. If I am an international refiner, I would be very concerned about Nigeria building its refinery capacity

Q3 – “How can anyone ensure the refineries ramp up their capacity, given that they have never been able to do this previously?” – if it is privately owned and you offer direct incentives i.e. impose a tariff on imported refined products, refineries will get built. After all, this was what happened to allow Dangote to build a sugar plant

Q4 – “The refinery question is surely key to the fuel price eventually dropping - if refineries still do not produce close to national daily need, importing petrol will keep the price of fuel high indefinitely” – I think people should realize that it is a lie that the price will eventually drop. Why would it? Why would I sell a product to a Nigerian at a lower price than a foreigner would pay? Actually the benefit is not really about making the fuel price lower – it’s about creating jobs and energy security as well as using the subsidy money (probably the largest Government expense) to spend on better things. In Europe today, it is the other way round – Governments TAX fuel consumption rather than subsidise! Think how much money Nigeria is losing.

Q5 – “In terms of a political economy context, for how long could high prices (some suggest fuel prices will have to double) be maintained, without widespread protest and industrial action?” – Although a valid question, it is ultimately irrelevant. Nigeria needs widespread protest and industrial action! Ultimately, If you create jobs, people will cope. Trickle down economics

Q6 – Grid power point – a stable refinery market will mean grid power is more of a reality. Again, prices won’t necessarily come down but the Government can at least channel that money into investing in the infrastructure. Also your point about private sector generation is spot-on. In a free market, there is more likely to be competition

As a final point, I think deregulation in all its forms is what Nigeria needs. I doubt there would have been a viable mobile market if it had been left to NITEL. Similarly, we can’t allow large, poorly run and difficult to change state institutions to drive our economic future."


MsMak,  7:23 pm  

Thanks Jeremy for posing the questions,and Fatai Thomas for the clear cut answers. Especially #4. Like Jeremy, i'd always assumed an increase in the capacity oflocal refineries would lower prices...

yousuf siddiqui 7:52 pm  

Hello there,

I am Yousuf Siddiqui and I provide coaching to leaders and organizations.
I refer to my work as Business Performance Coaching. I increase my clients' effectiveness by thinking through their most burning issues with them and creating plans to get tangible, measurable and specific results.

I want to connect with you and follow you on your blog. I hope to learn from you and exchange thoughts with you.

Yousuf Siddiqui,

Anonymous,  8:13 pm  

Q1: 'I would expect it should not exceed NGN 125 a litre'

Even under a 'controlled' govt regulated regime, prices frequently sky-rocket and the slightest hint of shortage or strike by (say) transporters leads to prices over N200 per litre.

There is no guarrantee that a deregulated regime will keep a cap on prices. Private interests always trumph public good in Nija and this will become a problem, as the 'cost of doing business' (i.e improved infrastructure) will not drop in the near to medium term.

Qn 2: Exporting crude or refined product will again trumph local supply as it will attractforeign exchage earnings. The oil cartel (which will not go away) will do better to export than sell locally.

Q3: Yes, refineries will get built.

Q 4: Govt does not have a credible tax structur and there i no reason to believe this will magically appear any time soon. Hence there will be no meanmingful benefit to taxing refineries.

i.e. we will still not see the money/benefits.

Q 5: 'Trickle down economics'

Is a failed economic model. Enough said.

Q 6: 'Grid power point – a stable refinery market will mean grid power is more of a reality.'

Quelle optimisime!! (pardone ma French!). Since when has one plus one made two in Nija??

'As a final point, I think deregulation in all its forms is what Nigeria needs.'

The last year has just seen the most comprehensive and clear questioning of the free market model globally. How can we pretend we have the capacity to make it work in Nija, with all our short-comings?!

Is China 'deregulated'? Was Singapore? Why should we believe that market forces will work any better here than around the world.

Deregulation should be undertaken slowly, purposefully and on a sector-by-sector basis, gradually proving and building the model.

We lack the manegerial, legal and governance infrastructure to undertake this bold step.

We need institutional reform, first - banks, tax, governance - to provide us the framework for bolder reform and economic transformation.

The fuel subsidy is the one thing Nigerians can all directly benefit from government. Le it continue until they have shown themelves to be better managers of our national economy.

If not, fuel will goup, then transportation, then the cost of goods then wage demands will go up.

Yes, we will have riots, but they will not be the romantic revolution you seem to crave, Ajayi.

Jeremy, if you and Ajayi cooked up this posting as a 'flag' for policy-meddlers (sorry, makers?!) - tell them it will not work, bro!!


Anonymous,  10:07 pm  

Sorry I wrote Ajayi, what i meant was Fatai!


Myne Whitman 4:50 am  

A very well thought out response from Fatai. Thanks Jeremy.

Who is Moddibo?

Anoda Anon,  12:48 pm  

The structure of the petroleum industry is currently skewed towards encouraging corruption. I know for a fact that years ago, a certain Alhaji at PPMC collects a few kobo per litre of refined fuel pumped out of Mosimi. I wonder if the racket is still going on. The power of arbitrarily allocating a scarce commodity corrupts.
Currently, it should cost about 60K to provide electricity for a three bedroom flat for a month by the time you consider fuel, generator maintenance and depreciation. But PHCN charges 2K and offer a few hours of light. If the fuel price is deregulated, the cost of maintaining own electricity will double, but guess what, you won’t need to “bringyourown” because you could be paying 20k per month and having 95% uptime in power supply. Now who would complain about that kind of efficiency, considering where we are now?

Hassan Awodi,  2:22 pm  

@ Fatai,

Your answers seems to reflect the Washington Consensus/IMF model of economics that is seriously flawed and more than anything else favours the wealthy.

In the last decade, the "trickle down" economics has failed. To get a balanced write up on this, please read "Making Globalization work" by Joseph Stiglitz

All that is needed for an economy like ours to work, is sincerity of purpose and the will to work honestly by the government.

If we do a complete deregulation like is been suggested, majority of the populace will suffer and may lead to chaos because, the already wealthy will corner everything it will never be for the interest of the nation. Regulatory agencies here are very weak and corrupt.

This happened in Russia during Yelstin before Putin came to right a lot of those wrongs. Moldova is another example of privatization/deregulation gone bad.

Let whoever wants to compete with government agencies do so but not buy buying up government companies.

Most of the private sectors are like the ministries. There is so much mediocrity with jobs done by most private sectors here. I don't think they are much better than government parastatals.

If we must develop, we should model our economy along the successful Asian countries with the same passion and nationality that they have.

Anonymous,  10:33 am  

Hassan Awodi,

With all due respect, I am not exactly sure which Nigeria you live in (assuming you actually live in Nigeria) where the private sector is purportedly NOT "much better than government parastatals."

Unfortunately, in the Nigeria that rest of us inhabit, we have personally borne witness to the state-owned Mtel (and Nitel) unable to compete with Globacom, MTN, Zain, Etilasat, etc., who have thankfully taken us from Nitel/Mtel's 400.000 functional lines after 40 years of independence to about 66 million lines in less than 8 years.

Reality is that the private sector has completely outclassed the state-owned parastatals in every industry -- from banking, hotels, downstream petroleum, cement manufacturing, newspaper, airline/aviation, power, insurance, real estate, to even schools and hospitals/healthcare. Frankly, much of the Nigerian public sector is effectively a WELFARE SYSTEM to keep folks off the streets.

Anonymous,  6:56 pm  

@ Anon 10:33

'banking, hotels, downstream petroleum, cement manufacturing, newspaper, airline/aviation, power, insurance, real estate, to even schools and hospitals/healthcare'

The top part of your list is spot on - this is what the private sector does very well.

The last three items are not areas in which the PS has, or indeed can do very well - delivering public services.

1. 'Real estate' is better known os housing, or simply 'shelter' to the bottom of the pyramid (which in Nija accounts for 75% of the population). Real estate is doing great (Maitama, Lekki etc) - housing on the other hand is a disaster for most Nigeians.

2. School: great - if you can afford the fees. Public schooling., not so good, yet again, what the bulk of Nijas depend on. What i the 'private sector' solution for the kids of lowly market women?

3. Healthcare - again, no problemo, if you can afford N5k a night for a bed space. What about healthcare for those earning N5k a month.

You are right that we have no 'Publc Service' to speak of in Nija (Civil Service a-plenty, public service, nada).

Whilst the power sector needs a PS solution, the fuel subsidy should remain for now. It is, as I have alluded before, the one concrete public service that FGN does which touches every strata of the economy. It is proportional by cost, in that those that run gens 24/7 spend (say) N30 to 50k per month (domestically), whilst those who only use kero to light lamps and stoves get by on N3 to 5k per month.

We need a comprehensive system, which is also proportional, accessible and framed with a modicum of social justice.

Free-marketeers, dogs and economic liberals NOT welcome!!


Anonymous,  7:18 am  


And exactly how many Nigerians at "the bottom of the pyramid" were able to afford the 1004 Estates when it was developed and run (or rather rundown) by the govt? Or Eric Moore Towers or Alagbon Towers or Bar Beach Towers? Or perhaps Gwarinpa I and II estates in Abuja? Bodija in Ibadan, etcetera?

Frankly, apart from the occasional Jakande Estate (which is substantively no different from, say, the private sector Cornerstone low-income estate in Ikorodu, etc), the govt has actually spent most of its real estate/housing/shelter naira on accommodating the public sector high-and-mighty (from the Apo Legislative Village to myriad GRAs dotted all over the country).

On the other hand, most of the housing/shelter for those Nigerians situated "at the bottom of the pyramid" as found in face-me-I-face-you and room-and-parlor dwellings all across Nigeria (and not just in urban centers but also in semi-rural and rural areas) have been largely developed by PRIVATE sector single landlords.

PS: And while my line of discussion had actually been on performance, rather than access or costs, most Nigerians would rather pay a little bit more to receive relatively good treatment at private hospitals or a decent education at private schools than to die from simple ailments at purportedly "free" (after one has paid for an admission card and purchase one's own drugs and syringes) govt hospitals or be barely able to spell after graduating from another purportedly "free" (after paying all manner of uniform and developmental levies, and purchasing one's own books, laboratory and other supplies) public school. I am steadfast advocate for massive governmental investment in education and healthcare, but frankly the REAL COST that Nigerians currently pay for purportedly free or subsidized public services (from electricity that regularly non-existent to educational certificates that are hardly worth the paper) is quite staggering.

Anonymous,  7:57 am  


Just for clarification, I am NOT suggesting that govt cede housing, education or healthcare to the private sector, but merely disputing Hassan's assertion that the private sector is not much better than its public counterpart. And I do so regardless of cost (or more accurately, nominal cost), for it easy to charge lower rates when one is providing little or nothing at all. Of course, the REAL cost to Nigerians is a totally different story.

Anonymous,  9:11 am  

OK Anon, then we are in agreement that there is a distinct role for govt and PS.

I agree that the power sector is one of the areas that outright PS drive and expertise would work.

On fuel subsidy, I wold like to see the 'GSM' odel, where PS comes up with a more effective structure and COMPETES with the poor govt model. Let it be that the more expensive fuel is delivered with such regularity and quality that people voluntarily turn away from govt fuel, beset by shortages, strikes, uncontrolled price etc.

Fuel has too much impact on inflation and is frankly too 'political' to be liberalised willy-nilly.

The argument for lifting the fuel subsidy, including dealing with the consequences and impacts, has not been properly set out.


About This Blog

  © Blogger templates Psi by Ourblogtemplates.com 2008

Back to TOP