Friday, March 16, 2018 /8:35 AM /FDC 

Global oil prices have surged in thecurrent year to $70 per barrel (pb), largely due to the combination of risingdemand and the output-cut led by the Organization of the Petroleum ExportingCountries (OPEC) and its allies. Given Nigeria’s endowment in oil, this bullishtrend in oil prices should translate to a stronger macroeconomic performance. 

However, it presents a conundrum topolicy makers in Nigeria, largely due to the fact that the country imports amajority of its refined petroleum products. This has placed the nation’seconomy in a precarious position whereby it oscillates between periods of acutefuel shortage and steady supply. 

Changes in Prevailing Macroeconomic Fundamentals
In December 2017, the Nigerian economy saw areemergence of fuel queues after 18 months of steady supply. Petroleumauthorities have accused petroleum marketers of hoarding to create artificialscarcity and incentives to divert products to the black market. Fuel marketerssay that scarcity is a result of a reduction in the importation of refinedpetroleum products due to declining profit margins. 

Clearly, macroeconomic variables have changed, sincethe pump price cap was set at N145 per liter in April 2016. For example, theaverage price of oil (Brent) has risen by 59.77% to an average of $68.99pb inJanuary 2018, from an average of $43.18pb in April 2016. Similarly, theaver-age official exchange rate has depreciated by 53.9% to N305.78/$ from anaverage of N198.69/$ in April 2016. 

These changes in macroeconomic fundamentals haveultimately led to higher costs of importation (landing costs). Given theexisting cap in pump price, this has greatly reduced profitability. Hence,independent oil marketers are reluctant to import. In an effort to ease thelingering fuel scarcity, the federal government has directed the NigeriaNational Petroleum Corporation (NNPC) to increase its fuel import. The NNPCclaims to have spent $5.8bn on fuel importation in Q4’17. 

However, fuel scarcity persisted partly due to theexistence of arbitrage opportunities. For example, the naira equivalent ofpetrol pump price in the neighboring Benin Republic and Ghana is N225 per litreand N350 per litre respectively. The disparity in price has encouraged crossborder smuggling of petroleum products and highlights the fundamental problemin the existing pricing mechanism in Nigeria. 

Means to an end
To address this recurring problem, the federalgovernment could either employ a short term or a long term approach. Forexample, the federal government could grant a temporary tax holiday as anincentive for independent fuel marketers. This could potentially lower theweighted average cost (landing cost) of petroleum imports and thus raise profitmargins in the near term. 

Similarly, the subsidy system could also be employedin light of the political risk associated with increasing pump price at thisperiod. The proposed subsidy could be in terms of lower exchange rates for fuelmarketers or a direct subsidy payment system. The downside of a direct paymentis the effect on government revenue, ultimately widening the fiscal deficit. 

A long-term approach is to constructnew refineries, pass the petroleum industry bill and effectively deregulate thedownstream oil and gas sector by removing the price cap. The soleresponsibility of the government is to create an enabling environment formarket forces to thrive. The government can attain this by establishing apricing framework that factor in the effects of changes in the exchange rateand global price of oil and increasing domestic refining capacity byconstructing new refineries. 

A typical example of such a pricing mechanism is the one used in theUnited Kingdom. In the UK, four major variables determine the pump price offuel: government duty and tax; cost of product (crude) in the internationalmarket; retail spread; and, to a lesser extent, the ex-change rate. Theexchange rate has a subtle weighting due to the adequacy of the UK’s domesticrefining capacity; the country does not have to import refined petroleumproducts. Nigeria can draw inference from this, in order to establish a dynamicpump pricing sys-tem. Given Nigerian’s current dependence on the importation ofre-fined product, the Nigerian mechanism needs to put a higher weighting onexchange rate and crude cost. With this system in place, market factors willcome into play in pump price. For example, a depreciating exchange rate willresult in a relatively higher pump price, to help mitigate the foreign exchangeloss, while a stronger currency will translate to lower pump prices. 

However, it isunlikely that the current government will institute such a major reform in thebuild up to the 2019 general election as it will be considered politicallyrisky. Similarly, reverting to the subsidy system could mean a return to theabuses that marred the system before its abolition -another risky proposition. 

In the meantime, theNNPC will continue to bear the burden of higher landing costs which will weighon its finances. This remains a questionable use of scarce resources for thecash-strapped government and is likely to continue to lead to disruptions infuel supplies in the country 



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