Saturday, October 17, 2009

Market forces..

Economics is most definitely not my area of strength. I'd therefore like some help from the much better economics minds out there on thinking through the downstream de-regulation process. With the proposed (but so far deferred) removal of the subsidy the Federal Government pays to downstream marketing companies, those companies will have to jack up the price to cover the costs of importing petrol - in a time of close to zero credit financing and a banking sector that needs to be brought back to life.

First question: by how much approximately would the marketers raise the price and on what basis? Could this not be calculated simply by working out the naira cost of the current subsidy per litre and tacking it onto the current price?

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? How can anyone ensure the refineries ramp up their capacity, given that they have never been able to do this previously? 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. 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?

The same issue applies to power, where the current subsidised cost of PHCN electricity is around N7 per kilowatt. Meanwhile, the cost for back-up power (which is produced and consumed in multiples of grid-electricity) is obviously conditioned by the combined factors of the cost of diesel, the generating set and maintenance. Lets say then that the cost of back-up power is around N50 per kilowatt. The reality is that the market forces determined price point for electricity may be some way between N7 and N50 - at random lets say N30 per kilowatt.

This represents the amount consumers are willing to pay (they are willing to pay much more for back-up power) balanced against the cost of production plus operating margin. This would mean that those who cannot afford to run a generator may not now be able to even afford what little grid-based power they get. However, it would have the huge advantage of creating a viable business model for private sector power generation that generates and distributes power to a far greater percentage of the populace in time.

The conundrum for policy makers is that the move towards a market forces arrangement for both the oil sector and for power is essential and close to unavoidable in terms of long-term government financial management. However, both moves are fraught with risks and requires careful modelling and scenario planning. They both involve a spike in prices for a yet-to-be estimated (as far as I know) amount of time. I have yet to read of much better-informed big picture thinking on either topic, although I'm sure Pat Utomi, Bode Agusto and others have tackled it. Can anyone provide links or more/better thoughts on all the above?


Hassan Awodi,  7:22 pm  

Nice article J.

The problem with the whole deregulation thing is that basic infrastructure are not functioning so if you deregulate now, prices will keep going up ad infinitum.

Let the government invest money to maintain and build new refineries so that local consumption can be taken care off.

Once that is done, the government can then deregulate the downstream oil sector. Is it so so so difficult?

One argument will be that government can not build and maintain refineries. And the response to that will be that we are doomed!

Myne Whitman 11:09 pm  

I would like to know the answer to this too. The fuel issue is a vexatious problem in Nigeria especially now.

Anonymous,  12:23 pm  

Good talk J.

Speaking of models, the best parallel I can see is the telecoms sector, where GSM introducd a 'de-regulated' alternative to a failed government povider.

In this model the private sector brought in a wholesale alternative (which the state provider initially made a feeble attempt to compete against - MTEL/NITEL, but eventually gave up), complete with infrastructure, staff, financing and evn alternative power supply.

Telecoms cosrt remains high in Nija (relative to other African nations), yet the market also continues to grow and is slowly becoming more compoetitive/consumer-driven.

Could this be a model for power/fuel too?

Could, for example, power-sector investors be invited in to compete with NEPA (sorry, PHCN!), whilst sharing/taking over infrastructure. i.e grant private providers licenses to generate, distribute and generate income independently and in a way that consumers choose who they buy leccy from?

I recognize that the GSM model is different because they were able to set up an independent/parallel infrastructure that did not depend on NITEL, in a way that power suppliers may not be able to profitably (arguably NEPA's most important asset is the network of powerlines/transformers nationwide).

Deregulated monopolies (? did I just make that up) are fatally flawed 'models', and that seems to be the conundrum facing us in Nija.


Anonymous,  3:33 am  

Removing fuel subsidies will undoubtedly have an inflationary impact in the short-term but frankly is the BEST long-term route for Nigeria.

Expending increasingly more amounts every year on fuel subsidies (reportedly more in 2008 than the federal govt's entire capital expenditure budgetary provision), not only makes little economic sense but will ultimately prove unsustainable. Furthermore, these subsidies are effectively being a Nigerian subsidization of employment abroad, when more economic pricing of products would render domestic refining financially viable and accordingly encourage private investment in domestic refining, which is not only the most meaningful long-term solution to our supply problems, but would also create thousands of direct and indirect local jobs (as well as hopefully create enough competition to moderate prices).

And of course, paying a more economic price for products should have the consequential effect of encouraging a more efficient consumption pattern.

Anonymous,  9:46 am  

The real problem is that, (to paraphrase IBB) Nigeria defies economic theory.

In principle removing the fuel subsidy SHOULD work itself down thru the economy to a more sustainable market - but WILL it?

Show me one single area of the economy where competition has produced favourable pricing for Nijas.

We travel more than any other African nation - yet our ticket prices remin high, we are Africa's biggest GSM market, yet we pay more that other countries, the Hilton Abuja is poorer quality yet higher room-price than Hilton SA....the list goes on.

We live in a country with poor (and deteriorating) security, unstable electricity, bad public services (health, education), erratic democracy...etc, etc.

The one thing government tangibly does for its citizens is to subsidize petrol, which allows us to get on with our lives at a slightly cheaper cost, in our 'you-are-on-your-own' nation.

And now we are to lose this one 'public service' (i.e. subsidized fuel)? Government is divesting interest in all economic sectors, privatizing anything that can be privatized, yet budgetting more annually in an economy in which govt is responsible for less and less -

WTF is going on??!!

Anonymous,  11:51 pm  

Actually, the Nigerian economy does not defy theory or logic. Rather, the REAL problem is that Nigeria has been saddled with rulers (not necessarily leaders) such as IBB who obviously does not understand basic economic concepts.

The reason that the things that you listed are more expensive in Nigeria is NIGERIA HAS POROUS (TO NON-EXISTENT) INFRASTRUCTURE! There's no rocket science to the fact that when businesses have to provide their own infrastructure, it translates into higher pricing. Nevertheless, when folks complained about stuff like the pricing of GSM services in Nigeria (disregarding the need for 2 generators and security guards for everyone of the thousands of cell sites, in a country with virtually no national backbone infrastructure), they tend to forget the REAL cost of not having those things at all.

Accordingly, rather than continue to subsidize employment ABROAD by continuing to subsidize fuel imports, I personally would rather pay a little more to incentivize the building of (private) domestic refineries, that would not only better ensure the security of supplies but would also provide thousands of domestic direct and indirect jobs for Nigerian professionals, engineers, managers, technicians, suppliers, contractors, artisans and even unskilled labor, as well as a multiplier effect on the domestic economy.

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