PETROLEUM PRODUCTS DEREGULATION

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Sustainable Solution to Nigeria Petroleum Product Supply PETROLEUM PRODUCTS DEREGULATION SUBSIDY - WHAT IS IT & WHY DOES IT MATTER? Dr Ekpen Omonbude Economic Adviser (Natural Resources), Commonwealth Secretariat, London Dr. Adeoye Adefulu BARRISTERS, SOLICITORS & NOTARIES PUBLIC ODUJINRIN ADEFULU & ESTD. 1972 Infographics by:

Transcript of PETROLEUM PRODUCTS DEREGULATION

Sustainable Solution to Nigeria Petroleum Product Supply

PETROLEUM PRODUCTS DEREGULATION

SUBSIDY - WHAT IS IT & WHY DOES IT MATTER?

Dr Ekpen Omonbude Economic Adviser (Natural Resources), Commonwealth Secretariat, London

Dr. Adeoye Adefulu

BARRISTERS, SOLICITORS & NOTARIES PUBLIC

ODUJINRIN ADEFULU &ESTD. 1972

Infographics by:

HOW NIGERIA’S PETROLEUM PRODUCT NEEDS ARE MET TODAY

Petroleum Exchange &

Offshore Processing

Agreements

- SWAPS

- OPAs

Indigenous Refinery Capacity

- NDEP 1000bpd Refining Topping Plant in Ogbelle

producing 88,000 litres of diesel daily

The SUBSIDY

Arrangement

Importation thru’

Indigenous

Companies (300+)

Four inefficient Nigerian refineries with a 445,000b/d

name plate processing capacity (NNPC)

Nigeria’s Daily Petroleum (“White’)

Product Requirements

PMS (Petrol) – 32 million litres

DPK (Kerosene) – 8 miliion litres

AGO (Diesel) – 12 million litres

x

Private Enterprise with 99% availability and efficiency

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Source: adapted from NNPC data

KEY ISSUES3

This Paper Seeks To Examine 3 Key Issues Around

The Petroleum Products Subsidy Question

Does the Petroleum Products

Subsidy Exist?

What Distortions Occur Where

Subsidy is Retained?

What is the best strategy for deregulating

the sector?

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An important way to understand the subsidy is to understand what

goes into the formation of a price for petrol at the pump in terms of

fundamental questions

What is the cost of the feedstock?

There is a price associated to

the barrel of oil that will be fed

into the refining process.

What is the cost of refining this

feedstock?

What are the storage and

transportation costs? What are the distribution costs?

What are the margins? There is a price to pay for such things as cost

of debt and cost of equity and other costs linked to

the reward for the risk taken for this venture

What are the taxes involved? There is

a price to pay for the impact of the use

of these refined petroleum products

(PMS in this case), ranging from

negative impacts on the highways,

environmental pollution, import duties,

VAT and other excise duties etc.

DOES THE PETROLEUM PRODUCTS SUBSIDY EXIST?

ISSUE 1

It is on this basis that pump prices the world over are determined.

Every price template across the globe applies a variation of the above

fundamentals or the other.

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DOES THE PETROLEUM PRODUCTS SUBSIDY EXIST?

ISSUE 1

• What determines petroleum product cost

under importation model?

Cost of product, cost of shipping to

Nigeria are determined by market forces

Cost of storage, transportation

and distribution must be

determined by market forces

(and are)

Margins must be recovered to

stay profitable

•Therefore, Nigerian PMS current model (under importation model is):

Cost and freight

Trader’s Margin Lightering Expenses

NPAFinancing

FX differential & interest costsJetty Costs

Storage Charge

Distribution Margins

Taxes

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1

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Source: based on PPPRA pricing template

DOES THE PETROLEUM PRODUCTS SUBSIDY EXIST?

ISSUE 1

Based on what

we import:

• Nigeria must compensate importers

/marketers for:

• Landing costs + distribution

margins + elevated cost of

financing due to irregular

payments + FX charges

• If these costs and margins exceed

the Government’s (regulated) “target”

end user

price, then the difference is a subsidy

• Expected open market price (as of Dec

2014): NGN 97.90

• Expected open market price (as of 22

May 2015): NGN 132.97

If we did not

import:

• Nigeria must compensate for:

• Expected open market price

• Feedstock cost (there is a price to

pay for the barrel of crude oil. IT IS

NOT FREE, CONTRARY TO CURRENT

MISGUIDED ASSERTIONS)

• Pipeline & other transportation cost

• Storage costs

• Refining margins

• Distribution margins

• Based on $50/barrel oil: NGN 91.99

• Based on $64.90: NGN 110.65

• Based on $100: NGN 154.59

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DOES THE PETROLEUM PRODUCTS SUBSIDY EXIST?

ISSUE 1

The key argument of the existence

of subsidies is that product prices should be determined by

the cost of production of crude oil in the country

those who do not believe in

In view of the fact that Nigerian refinery

capacity is well below the level required

to fully supply the market, this argument

cannot stand as the price of imported

products are determined internationally

Even where local refinery capacity exists,

by pegging petroleum products pricing to

the cost of crude oil production, the nation

loses out on the value that may be gained

from the sale of the product at the higher

international price. The cost of this loss is

the inability to use the lost funds to meet

other needs– schools, hospitals, roads.

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0

20

40

60

80

100

120

140

160

2006 2007 2008 2009 2010 2011May

0

5

10

15

20

25

30

35

40

45

50

Co

nsu

mp

tio

n(M

illi

on

litr

es

/ d

ay

)

Pri

ce (

Na

ira

/lit

re)

Consumption PMS Landing Cost + margins Regulated PMS Pump Price PMS Platts Prices $/bbl

Subsidy Levels

PMS PRICE vs CONSUMPTION ANALYSIS

WHAT HAS LED TO SPIKED CONSUMPTION GROWTH?

PMS PRICE/CONSUMPTION ANALYSIS

Annual Outstanding HHK Subsidy Annual Approved Subsidy PMS Cumulative Subsidy

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

0

200

400

600

800

1,000

1,200

1,400

2006 2007 2008 2009 2010 2011 Est

Cu

mu

lati

ve

Su

bsi

dy

(N

’M)

An

nu

al S

ub

sid

y (

N’M

)

261 279

648

422

622

1,057

243

228

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Reasons: Illegal Cross-border

supply, Massive Fraud

(60% not supplied)

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ISSUE 1

Source: Ministry of Petroleum Resources, "Information on Subsidy", November 2011

PPPRA “PMS” SUBSIDY CALCULATION

High crude price increases subsidy.

For oil producing Nigeria, this

simply erodes our revenue

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20

40

60

80

100

120

140

Feb. ’09 Dec. ’10 Apr. ’11 Dec. ’14 Jan. ’15

0

20

40

60

80

100

120

140

160

Feb. ’09 Dec. ’10 Apr. ’11 Dec. ’14 Jan. ’15

High landing cost in Nigeria due to:

- Inadequate port facilities for large

number of marketers

- Systemic inefficiencies,

- Overt rent-seeking & gaming

- Collusion between fraudulent marketers

and some regulatory entities

- No sanction for non-performance,

Opaque pricing & inherently costly

2-months Crude Price Average ($/bbl)

Landing Cost (=N=/Litre)

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Almost zero subsidyThe window of opportunity for Government to remove subsidy

Lower Oil Price = Lower Revenue to Nigeria = Reduce income for budget =

Further devaluation of Naira.Increase Landing Cost & Financing

Cost

Exchange Rate

ISSUE 1Issue 1: Does the Petroleum Products Subsidy Exist?

The Factors Impacting Subsidy Claims & The Inherent Problems

Adapted from a variety of sources

DOES THE PETROLEUM PRODUCTS SUBSIDY EXIST?

ISSUE 1

• One of the systems designed to adjust for the lack of refinery capacity is the

crude oil swaps arrangement which exchanges crude oil for petroleum

products

• The swaps system requires an accurate calculation of the refining yields

which may be obtained from each barrel of crude as well as ensuring that all

the yields are returned to Nigeria

This can be very complex. Depending on the complexity of the refining

process, the refining yields could produce product from naptha through

gasoline and LPG to petrochemicals

The true value of the yields is only known after a thorough assay of the

crude and the refining process has taken place

Therefore any arrangement that involves the exchange of crude oil for

petroleum products that do not correspond exactly with the product

yields based on an assay or based on a refining process is inaccurate. It

could result in an under-valuation or over-valuation of the crude oil

• Serious concerns on both fronts, with NEITI suggesting Nigeria may be

losing billions of dollars annually

• The system :

is opaque and discretionary in determining the relevant yields

requires strong contract administration

provides corruption gateways

The Problem with SWAPS

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DOES THE PETROLEUM PRODUCTS SUBSIDY EXIST?

ISSUE 1

Cost Element N82.41Distributions Margin N15.49Taxes 0

Based on what we imported in December 2014

Avg brent price at $62.34/bbl

N97.90

Retail price

N97

Fuel Subsidy

Expected Open

Market Price

N0.90

Scenario:

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DOES THE PETROLEUM PRODUCTS SUBSIDY EXIST?

ISSUE 1

Cost Element N117.48Distributions Margin N15.49Taxes 0

Based on what we import in May 2015

Avg brent price at $64.90/bbl

N132.97

Retail price

N87

Fuel Subsidy

Expected Open

Market Price

N45.97

Scenario:

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DOES THE PETROLEUM PRODUCTS SUBSIDY EXIST?

ISSUE 1

Cost Element N142.04Distributions Margin N15.49Taxes 0

Based on imported fuel at

Avg brent price at $80/bbl

N157.53

Retail price

N87

Fuel Subsidy

Expected Open

Market Price

N70.53

Scenario:

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DOES THE PETROLEUM PRODUCTS SUBSIDY EXIST?

ISSUE 1

Cost Element N174.57Distributions Margin N15.49Taxes 0

Based on imported fuel at

Avg brent price at $100/bbl

N190.06

Retail price

N87

Fuel Subsidy

Expected Open

Market Price

N103.06

Scenario:

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DOES THE PETROLEUM PRODUCTS SUBSIDY EXIST?

ISSUE 1

Cost Element N91.55Distributions Margin N15.49Taxes 0

If we didn’t import based on

Avg brent price at as at Dec. 2014$62.34/bbl

N107.44

Retail price

N87

Fuel Subsidy

Expected Open

Market Price

N20.44

Scenario:

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DOES THE PETROLEUM PRODUCTS SUBSIDY EXIST?

ISSUE 1

Cost Element N95.16Distributions Margin N15.49Taxes 0

If we didn’t import based on

Avg brent price at as at May. 2015$64.09/bbl

N110.65

Retail price

N87

Fuel Subsidy

Expected Open

Market Price

N23.65

Scenario:

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DOES THE PETROLEUM PRODUCTS SUBSIDY EXIST?

ISSUE 1

Cost Element N139.10Distributions Margin N15.49Taxes 0

If we didn’t import based on

Avg brent price at $100/bbl

N154.59

Retail price

N87

Fuel Subsidy

Expected Open

Market Price

N67.59

Scenario:

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Petroleum products subsidy is an inefficient way of targeting

benefits for the poor

- Propensity to seek rent from

government inefficiency at play

- Created incentive for smuggling

- Diminishes competitiveness

- Discourages investment in

all sectors (especially the

midstream & downstream)

- It has not worked in Nigeria

ISSUE 2DISTORTIONS CAUSED BY FUEL SUBSIDY

Resource costs

Cost of time it takes to verify claims

Creation of corruption gateways

In order to reduce leakages, government would need to spend significant amounts in

building the resource base to properly monitor and verify subsidy claims. The time it

takes to undergo such processes also imposes additional costs on both Government,

importers and financial institutions. Finally, the process of monitoring and

verification provides avenues for corruption of government officials and value

leakages.

Every Naira spent on subsidizing petroleum products is not invested in necessary

infrastructure

Subsidy funds may be better utilized in building schools, hospitals and a world class

road network

Subsidies disproportionately cater to the lifestyles of the rich

Top richest 20% receive 20 times more subsidy than bottom poorest 20% for PMS

The cost of transferring subsidies to the bottom poorest is US$33 for every dollar

actually transferred

Incentivises waste

The presence of subsidies encourages inefficient use of energy – use of multiple cars

and use of vehicles as opposed to other means of transportation

With the significant difference in petroleum prices in neighbouring countries, there is a

strong incentive to smuggle petroleum products thereby transferring benefits meant for

Nigerians to foreigners, smugglers and corrupt officials

Opportunity Costs

Costs associated with verification of subsidy claims

Subsidy for the rich & the middle class?

Smuggling

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ISSUE 2DISTORTIONS CAUSED BY FUEL SUBSIDYSmuggling is an inevitable consequence of petroleum subsidies because it has an economic incentive. The

prices for gasoline in Benin, Togo, Ghana, Cameroon, Ivory Coast, Sierra Leone, Liberia and Burkina Faso

make Nigerian PMS an attractive prospect for smuggling across the border.

Gasoline Prices US$/litre (May 2015), Selected Countries

$0.00 $0.50 $1.00 $1.50 $2.00

Norway

UK

Burkina Faso

Ivory Coast

Cameroon

Sierra Leone

Benin

Liberia

Togo

Niger

USA

Chad

Ghana

Azerbaijan

Russia

Indonesia

Malaysia

UAE

Nigeria

Qatar

Venezuela

$2.50

$0.29/litre smuggling incentive

$0.45/litre smuggling incentive

$0.51/litre smuggling incentive

$0.76/litre smuggling incentive

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Source: http://www.globalpetrolprices.com

Factors to Consider

SUBSIDY

Arrangement

SWAPS &

OPAs

Existing

Govt

Refineries

Nigeria IndependentProcessing Plafform /

Refinery

Exposure to Govt

In-Efficiency

Cost Plus to Govt

Value Add (Tax Revenue)

Loss/Abuse/Corruption

Enabler to Economic Diversification & Growth in Value Chain

Employment Generation

Fiscal & Budget Sustainability

Transparent & Accountable

Is this a Sustainable Option NONot in med -

long termNo- If NNPC Operated.

Yes, Should be replicated

Cancel

(now or Phased)

Subsidy

Improve

& Audit for short term use

Transparency

NIGERIA’S PETROLEUM PRODUCT SUPPLY OPTIONS - ASSESSMENT

SUGGESTED ACTION TO TAKE

Privatise /Sell off

Use this to place product processing capacity across the country

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ISSUE 3Issue 3: What is the best strategy for deregulating the sector?

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PROPOSITION

STOP PMS, DPK & AGO subsidy

De-regulate but introduce a transparent and credible Automatic Pricing

Mechanism

Re-structure current supply/demand framework with a combination of:

(i) Large international product suppliers with refinery & logistic

platforms

(ii) A select group of credible indigenous marketers (based on clear

transparent criteria)

This would guarantee Nigeria a more cost effective and transparent

system

Re-structure the SWAPs and OPAs to remove opaqueness

Pass competition regulations under the Petroleum Act to combat opportunistic

pricing and anti-competitive practices post de-regulation

Privatise the existing Nigerian refineries

Enable the planned Nigeria refinery projects (e.g. the Dangote Refinery

projects)

Encourage small indigenous operators to adopt the development of topping

plants to aid product processing across the company (adopt the NDEP Topping

plant model)

Significantly improve the Infrastructure to improve the supply, transport and

storage platforms to ensure it is adequate for needs and removes bottlenecks

Primary proposal is based on a

de-regulated pricing framework

In the Short Term:

In the Medium Term:

ISSUE 3Issue 3: What is the best strategy for deregulating the sector?

ISSUE 3HOW BEST TO CUSHION THE EFFECT

OF CRUDE OIL PRICE RISES

Given that there is currently in the price calculation

(which is in itself a subsidy), the other feasible approach to take would

be to

or

no tax element

adjust the bridging fund component of the price template during

price fluctuations to either reduce the end user price when oil prices are

high increase the end user price to achieve international parity when

oil prices drop aggressively redirect the funds earmarked for

maintaining petroleum subsidies towards real social inclusion

(healthcare, education, infrastructure).

Tax

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Issue 3: What is the best strategy for deregulating the sector?