Nigeria’s Fuel Subsidy: The Balancing Act

  • Nigerian fuel subsidy has cost $3bn over previous year

  • Exchange rate fluctuations are seriously impacting the cost of subsidy

  • Increased domestic fuel demand puts ever greater strain on Nigerian State

  • The removal of the fuel subsidy could lead to reduced profits for importers who may decide to sell refined product elsewhere, grinding Nigeria to a halt and creating social turmoil

President Buhari recently stated that Nigeria’s costly fuel subsidy programme will continue whilst his new Administration balances priorities in the midst of depleting Government coffers. An expensive decision as the administration struggles with cash shortages resulting from a record-low oil prices that are predicted to continue. According to our independent analysis based on average domestic fuel consumption, subsidies claimed by fuel marketers cost Nigeria $2.9bn over the last year. This is a 400% increase since 2007 and a sum equivalent to 13% of the Federal Budget, passed in April 2015. However, official Government data estimates the cost of the subsidy at $5bn. It’s interesting to note that the Berne Declaration calculated no less than $6.8 billion of unjustifiable subsidies were paid out between 2009 and 2011, that’s $2.3bn a year, strangely close to the difference between our independent analysis and official Government estimates.

So what has happened to the more than $2bn that the government says it has spent on subsidies but has never been received by the fuel marketers? We will address all these issues in this month’s articles.

Subsidy costs

Calculating the subsidy

The fuel subsidy is calculated as the difference between the Expected Open Market Price (EOMP) and the retail price at the pump, currently fixed at N87 ($0.44), all provided in the relevant pricing templates. The EOMP is calculated as the sum of allowable landing costs (primarily cost of imported product & freight costs) plus distributor margins. Landing costs represent around 85% of total allowable costs in the calculation and therefore factors that affect landing costs will also affect the eventual subsidy paid.

The two main drivers of these costs are global oil prices, as changes in imported product and freight costs often reflect underlying crude prices, and the $:N exchange rate, as the pricing template is denominated in Naira, with actual costs of product and freight often financed in $.

A long (and expensive) year

The relatively stable period of high oil prices since 2011 resulted in enormous profits for the Nigerian Government, contributing to a relatively stable exchange rate as the status quo prevailed and Federal reserves were easily replenished once spent. However, in the last year as the world moved quickly to a decade low oil price, vast dollar sums were converted and spent on Nigeria’s recent election, some say the most expensive to date, as the two major opposition parties campaigned furiously across the first quarter of 2015. The situation was made worse by an extreme vulnerability and dependency of the Nigerian economy on oil revenues (the country literally needs to import almost everything): even with its decimated revenue, the government had to continue to spend billions of dollars to pay for most basic commodities, including food, further depleting country’s reserves. The combination of these factors caused the Naira to devalue by 25%, despite Central Bank intervention.

Missed the barge?

The falling price of oil initially caused a reduction in subsidy payments as the imported cost of product and freight costs fell proportionally; the subsidy available to marketers in January 2015 was N2.94 ($0.02) per litre down from N22.29 ($0.1) per litre in October 2014. However, as the oil price stabilised, the exchange rate began to depreciate and the subsidy began to increase again to N38.76 ($0.19) per litre in April 2015 and N44.86 ($0.23) per litre in July 2015 as exchange rate movements affected the claim calculation.

Quarterly subsidy costs

With derivative markets expecting a further devaluation of up to 15%, the short-term stability of the Naira is uncertain, problematic when trying to come up with a strategy to address the spiralling costs of the programme.

Allowable subsidy costs

The removal of the subsidy at today’s prices would likely result in pump prices floating around N125 per litre (as opposed to the subsidised price of N87). Profit margins for marketers would disappear, threatening petrol supplies which in turn could grind Nigeria and the new Administrations reform efforts to a halt. You can understand why the President is in no hurry to pull the plug. In 2012 the Nigerian government attempted to abolish the subsidy which led to unprecedented nationwide strikes, causing the administration to back down.

A fine balance

Any plan to remove the subsidy will be a balancing act; artificially low petrol prices are seen by many as the only benefit Nigerian citizens have gained from the discovery of oil in 1958. The subsidy programme cannot continue indefinitely, but with rising fuel consumption, how can Nigeria address increasing subsidy costs whilst maintaining fuel supplies and without sending shockwaves through Nigeria’s delicate socio-economic fabric?

The subsidy may not be President Buhari’s immediate priority, but one thing is clear: demonstrating that the new Administration is seriously tackling corruption around the subsidy will go a long way to garner public support should the subsidy be removed in the future.

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