Tuesday, December 15, 2015

Fuel Subsidy – Who Is Subsidizing Who?

By Izielen Agbon
“Who is subsidizing who? The Nigerian oil industry was developed with Nigerian capital. Most of the experts are Nigerians, if you go to the fields. It is Nigerian capital; it is Nigerian oil. What I understand that Nigeria should charge Nigerians is the cost of 1 barrel at the wellhead and then the cost of transportation to the refinery, the cost of refining it and its cost at the pump. If anybody says he is subsidizing anything, he is a fraud. So all these people talking about subsidy, who is subsidizing who?”









*Buhari 
A first year student of refinery economics knows that the “crack spread” is a simple way to determine the profitability of a refinery at the margin. The crack spread is the difference between the sales prices of the refined products (PMS, AGO, HHK) and the price of crude oil. A 3:2:1 crack spread means that at the margin, 3 barrels (bbls) of crude oil will produce 2 bbls of Premium Motor Spirit (PMS) and 1 bbl of Automotive Gas Oil (AGO) or Household Kerosine (HHK). A barrel of Nigerian oil now cost about $40. One bbl of PMS at N87/litre cost N14159 or $71.87 at a CBN exchange rate of N197/$1. The PPPRA product pricing template of December 3, 2015 put the cost of AGO at N96.91/litre or N15772 ($80.06) per bbl. 
Thus, the gross cracking margin for an average refinery in Nigeria is [(2*71.87) + 80.06 – (3*40)] or $103.8 per bbl. The 3:2:1 crack spread is $103.8/3 or $34.6 per bbl. We can substitute HHK for AGO. At N50/litre, one bbl of HHK cost N8137.5 or $41.31. Therefore, the gross cracking margin using PMS and HHK is [(2*71.87) + 41.31– (3*40)] or $65.05 per bbl. The 3:2:1 crack spread is $65.05/3 or $21.68 per bbl. It is empirically impossible to convince anyone that Nigerian refineries cannot operate profitably under an incorruptible efficient management or that a fuel subsidy exists. What exist is the looting of public resources by a cabal aided by a corrupt bureaucracy and gross mismanagement.
Today, you can buy a gallon of PMS from a Valero gas station in Houston, Texas for as low as $1.55 or N78.8 /litre. Prices range from $1.55 to $1.99 per gallon throughout the state. The $1.55/gallon price consists of USA Federal/State taxes (19%), Distribution and Marketing (11%), Refining Cost/Profits (13%) and Crude oil cost/profit (56%). Therefore, without any taxes, the PMS in Houston would cost 19% less or N63.83/litre. Unconvectional (shale) oil production has replaced all oil imports in Texas. They produce all their oil like Nigeria

Texas has 26 refineries with a capacity of 4.72 million bbls per day. Most refineries operate at a minimum of 85% efficiency. The market operates on a production-pricing model. West Texas Intermediate (WTI) crude cost $36.45/bbl, refining cost/profit cost $8.46, Distribution/Marketing cost $7.16/ bbl and Federal/State tax cost $12.37/bbl. Therefore, a bbl of PMS is about $64.44 or N78/litre. It is therefore clear that if we build more refineries to meet all our domestic demand ( plus export) and eliminate corruption, we will not have a corruption subsidy.
In Nigeria, the PPPRA pricing template of December 3, 2015 declared that a litre of PMS in Nigeria cost N96.18 without any taxes. Distribution margins made up 16.1% (N15.49/litre) of this amount. The rest (N80.69) is the landed cost of the imported PMS. Platt Oil, a foreign institution, determines the C+F price of imported PMS and therefore the landed cost. The landed cost, in turn, determines the PMS OMP price by PPPRA. The PMS price in Nigeria is therefore determined by a foreign body. It is obvious that this World Bank/IMF inspired import-parity-pricing model is wrong, anti-development and generates a fertile environment for massive corruption. Petroleum products prices should be determine by a production cost-pricing model as explained by President Buhari above. 
This was the case before the World Bank/IMF convinced the President Obasanjo to impose an import parity-pricing model on NNPC and the Nigerian economy as a whole. The World Bank is currently putting pressure on President Buhari to raise fuel prices using the import parity-pricing model. However, President Buhari was the Executive Chairman of the Petroleum Trust Fund from 1997-2000 and he knows that fuel prices should be determined using the production cost-pricing model.
In 1995, under the Petroleum (Special) Trust Fund (Amendment) Decree No.1 1995, the cost PMS was set at N11/litre. The real cost of PMS using a production cost-pricing model was N5.68/litre.  Crude oil cost/profit made up 43.37% (N2.35) of this amount. The Marketers’ Allowance made up 22.88% (N1.30), Excise Duty & VAT was 5.81% (N0.33) and NNPC Cost/Margin was 29.93% (N1.70). The excess (N11-N5.68) or N5.32/litre was used to fund the PTF. The prevailing exchange rate was N133/$1 and oil prices were $17.3/bbl. There was no fuel subsidy or a corrupt cabal. 
Therefore, before the discussions on fuel subsidy begins during the upcoming FEC meeting, President Buhari should ask his ministers a few simple questions: How much does a litre of PMS actually cost? How much PMS do we produce, import and consume daily? What is “fuel subsidy”? How much “fuel subsidy” actually exist? What is the impact of the removal of this fuel subsidy on the Nigerian masses/economy? Who is subsidizing who?
In December 2011, prior to the opening salvo of the fuel subsidy struggles, I wrote; “At the refinery gate in Port Harcourt, the cost of a barrel of Qua Iboe crude oil is made up of the finding /development cost ($3.5/bbl) and a production/storage /transportation cost of $1.50 per barrel. Thus, at $5 per barrel, we can get Nigerian Qua Iboe crude to the refining gates at Port Harcourt and Warri. One barrel is 42 gallons or 159 litres
The price of 1 barrel of petrol at the Depot gate is the sum of the cost of crude oil, the refining cost and the pipeline transportation cost. Refining costs are at $12.6 per barrel and pipeline distribution costs are $1.50 per barrel. The Distribution Margins (Retailers, Transporters, Dealers, Bridging Funds, Administrative charges etc) are N15.49/litre or $16.58 per barrel. The true cost of 1 barrel of petrol at the Mobil filling station in Port Harcourt or anywhere else in Nigeria is therefore ($5 +$12.6+$1.5+$16.6) or $35.7 per barrel . This is equal to N33.36 per litre compared to the official price of N65 per litre. “ . 
This PMS price was determined using a production cost-pricing model. Therefore, it is not dependent on the uncertainties of PMS market prices as determined by Platts Oil. We will proceed to update this analysis in light of December 2015 conditions. The funding/development cost has not changed from $3.50 as the 445000 bbls of domestic crude oil is still been produced from more or less the same wells. The Distribution margin is still N15.49/litre or $12.80/bbl. A 10% increase due to recent FGN investment in the repair and turn around maintenance of our refineries raises refining cost to $13.86/bbl. 
The major change has occurred in pipeline transportation.  The NNPC claims that pipeline sabotage and theft of petroleum products are responsible for the poor domestic refinery output and disrupted pipeline supply. The NNPC declared that it lost 531 million litres of PMS (51.07 billion Naira) in the first 9 months of 2015 due to sabotage of our petroleum product pipeline and theft of products. Most of this loss occurred in the 30 miles Atlas Cove/Moisimi pipeline. The same problem exists in the Bonny-Port Harcourt (34 miles) and the Escarvos-Warri crude oil pipelines which supply domestic crude to the Port Harcourt and Warri refineries respectively. 
Protecting these pipelines is a security issue. Nevertheless, the NNPC chose marine route alternatives to pipeline transportation at a cost of $5.37/bbl. NNPC hired PPP Fluid Mechanics and Ocean Marine Securities to provide the marine services. These 2 companies supplied 11.6% of the total requirements of the Port Harcourt/Warri refineries from 2010 to 2015. Refinery capacity utilization/efficiency was less than 10%. NNPC imported petroleum products rather than solve the pipeline security problems. 
In 2014, the Executive Secretary of the PPPRA stated; “For example, Port Harcourt refinery has a short distance of Bonny and Port Harcourt. We lose about 30 to 40% of crude that is transported through the pipeline. When the costs of the losses are calculated, it is even better for Nigeria to import than refine locally”. He said nothing about corruption and national losses from the importation of petroleum products.
Pipe protection is a security issue. We can solve it with an added pipeline transportation cost of $2.5/bbl. We get 2 men to protect 1 miles of pipeline for 8 hours. We will need 6 men/mile/day. There are 875 miles of petroleum product pipelines and about 1325 miles of crude oil pipeline in Nigeria. So, we need about 13200 men for a 24 hr daily protection. We add 20% for support/auxiliary services, 10% for management/supervision and the rest for backup. 
Thus, 20000 men made up of 6000 soldiers from the Armed Forces and 14000 citizens from communities along the pipeline routes can protect our pipelines. At a monthly salary of N100000/month, we will spend N24 billion a year. An additional 50% will cover equipment, offices, overhead etc. thereby raising annual cost to N36 billion. An added pipeline transportation cost of $2.5/bbl yields $0.614 million/day or N44.18 billion/year. Pipeline transportation cost will increase from $1.5/bbl to $4/bbl. The cost of PMS in Nigeria will therefore be ($3.5+$4.0+$13.8+$4.0+$12.8) or $38.1 per barrel. This is N46.1/litre. There will still be no subsidy. 
We need to stop the corruption and looting of public funds in the downstream sector. In 2012, N996.8 billion was paid as subsidy to NNPC and 49 marketers for importing 17451.45 million litres or 47.68 million litres of PMS per day. But, daily national PMS consumption was 38.4 million litres. The remaining 9.28 million/day litres of PMS was never delivered. We need better meter measurement/monitoring.  More Coriolis meters can be installed on the inlet/outlet of every nodal point (process control, storage, truck loading, transfer to tanks, jetty, depots etc) in the downstream system. 
These meters will provide direct accurate real time measurement of petroleum products flows. They can detect pipe blockage and leaks as well as send data wirelessly to a centralized control station using SCADA (supervisory control and data acquisition system). We will then know how much petroleum products we produce, import and consume per day  in Nigeria
In 2014, N1.69 trillion was spent as subsidy at 47.67 million litres/day. The FGN paid N500 billion as subsidy from January to May 2015. The marketers demanded N200 billion more and went on a PMS hoarding strike. In November 2015, the FGN approved N413 billion as subsidy for June-September. The marketers went on a PMS hoarding strike to support their demand for N470 billion. The FGN is asking for an additional N108 billion for the 4th quarter of 2015.  Even with low prices and a PPPRA N10/litre corruption subsidy, we will spend N1.021 trillion on ‘fuel subsidy’ in 2015.  
The impact of this corruption subsidy is destroying the Nigerian economy and imposing unbearable burdens on the Nigerian masses. We can now answer President Buhari’s question. The FGN is subsidizing a corrupt fuel cabal with public funds.
The proponent of fuel price increase or ‘fuel subsidy’ removal want to transfer the cost of this corruption subsidy from the FGN to the Nigerian masses. They have not published the findings of any rigorous study of the impact of fuel price increase on the Nigerian masses and the economy. There are few multi-sectorial general equilibrium models of the Nigerian economy with dynamic input-output framework. 
We have a weak database. We have poor mluti-sectorial disaggregation of the petroleum sector, the agricultural sector and the informal unwaged sector where the majority of Nigerians carry out their daily activities. Our input-output tables and social account matrices are outdated. The impact of fuel price change on other sectors is mere academic/policy guesswork. Nevertheless, we can use our common sense to predict the likely impact of an increase in fuel prices. 
President Buhari explained. “When people ask you to remove subsidy ask them to define it. Who is subsidizing who? Let me make it clear. These people are gleefully saying ‘remove subsidy’…They want petrol to cost N500 per litre. If you are working and subsidy is removed, you can’t control transport, you can’t control market women, the cost of food, the cost of transport. ..If you are earning N20,000 per day and you are living in Lagos or Ibadan, the cost of transport to work and back, the cost of food. 
You cannot control the market women they have to pay what transporters charge them. But I’m thinking more than half the population of Nigeria virtually cannot afford to live…Where will they get the money to go work? How can they feed their families? How can they pay rent”. The consequences of such policy decision are the differences between life and death.
I was in Nigeria in August 2015. The poor masses on the street corners were anger and tense. The general opinion was that if the fuel cabal forces President Buhari to capitulate and raise fuel prices, then the resistance will be fierce and protracted. The 2012 subsidy struggles will be child play. If corruption pushes the Nigerian masses to the wall, the Nigerian masses will push back. The message from the streets is very clear. A wise man does not start a Savannah fire without knowing which way the wind is blowing. The FEC should listen.
Izielen Agbon, izielenagbon@yahoo.com, Twitter: @izielenagbon


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