PPPRA and the Nigerian Gas Market: Avoiding a Robinhood

Wednesday,March 03,2021 /08:00 PM/ By Proshare Research/ Header Image Credit: EcoGraphics

Always expect the unexpected.The oil and gas industry is terrible at predicting anything. Always have aback-up plan. - David Dixon

David Dixon's quotation may be true, but the fact thatthe oil and gas (O&G) industry will undergo a major transition over thenext decade, is not a bullet from nowhere, as crude oil demand dips and gas demandrises. The change in the composition of global energy demand would require acritical review of pricing templates to ensure that the pricing of thedifferent energy sources is fit-for-investment. For example, gas pricing inNigeria until recently has been determined by will buyers and willing sellers,allowing for a price discovery process that is market-led rather thanadministratively determined.

The global march towards a less carbon-toxicenvironment has meant that companies and governments have started the greatmarch towards friendlier power and energy sources such as gas, thereby raisingthe profile of this source of energy in the global economy and productionmatrix.

So far gas has not been trapped in the steely fingersof a cartel and pricing appears to be efficient in a conventional market sense.However, the economics of the gas market could become badly distorted ifgovernments decide to interfere in the market price determination byintroducing a battery of taxes, levies, and charges. The signs of thesepossibilities have started to appear in countries like Nigeria where thePetroleum Product Pricing Regulatory Agency (PPPRA) has introduced anadministrative charge of N1.23k per litre of liquified petroleum gas (LPG).

Analysts have noted that the introduction of anadministrative charge on local gas supply in Nigeria is an unfortunateimposition of fiscal drunkenness on economic sobriety. The major challenge withthe charge is that it creates deadweight economic loss as well as discouragesthe demand and supply of gas, which is an outcome at variance with the federalgovernments proposed decade of gas policy set to increase gas use forcommercial and private automobiles and domestic cooking (see illustrationbelow).

Illustration 1 LPG; AvertingDeadweight Economic Losses

Proshare Nigeria Pvt. Ltd.

The imposition of charges on gas at a time when gas isbeing encouraged as a friendlier alternative energy source is counterintuitiveand does not internalize the economic benefits from using gas rather than dual purposekerosene (DPK) or local firewood, both of which emit environment damagingcarbon. Economists have noted that charges on gas for obscure administrativereasons shift the marginal cost curve of the product upwards and lead to higherprices and lower consumer demand which combine to reduce the net present value(NPV) of gas use. The added effect would be to discourage investment in anindustry that could grow employment along several value chains. Increasingproduct cost in an inflationary environment (domestic inflation for January2021 was 15.57%) is ill-advised say oil and gas (O&G) economists (seeillustration 2 below).

Illustration 2 LPG: Counting theCost

Proshare Nigeria Pvt. Ltd.

Letting the Market Speak-the Cobra Effect

The best approach to market development would be onethat openly internalizes all costs associated with the sale of gas (LPG andLNG) and taxes chargeable are clear sales taxes rather than levies and chargesthat do not have clear paths of value addition by oversight authorities. Thesecharges typically reflect what economists call the cobraeffect or a situation where a solution breeds worse problemsthan it was meant to solve.

The charging of administrative levies on gas suppliersincreases the burden on consumers and cuts back demand for cooking gas, forexample. This results in consuming alternative sources of energy for cookingwhich could prove to be hazardous to health and a blight on the government'sefforts at containing carbon emission and gradually achieving carbonneutrality. The adverse effect of carbon emission on health would play up inhigher expenditure on public-sponsored healthcare and health infrastructure inaddition to lost manhours resulting from the vulnerability of workers exposedto carbon-tainted workspaces.

The obvious option to dealing with these possible externalities would be for thegovernment to remove administrative charges and create a friendliermarket-determined price for domestic gas.

Moving forward, Cautiously

The gas age is inevitable as global demand for fossilfuel for public cars, factories, public transportation, and domestic cookingbegin to decline and gas becomes the new oil. Nevertheless, fossil fuel willnot disappear down a rabbit hole, the demand for fossil fuel (PMS, DPK, andAGO) will be with us for a while, but growth in demand will be constrained bythe global pivot towards gas. For instance, Britain's carbon emissions are downby 44% while Germany's emissions are down by 29%. A trend showing that majorwestern economies are winding down carbon-emitting fossil fuel as an energysource (see illustration 3 below).

Illustration 3 Oil and Gas in ATime of Transition

Proshare Nigeria Pvt. Ltd.

The gas market will expand rapidly over the nextdecade as oil gradually winds down, to integrate the gas future into itsdevelopment plans for industry and domestic users, the pricing of the productmust principally be market-determined, otherwise, price distortion emergingfrom official price intervention would disrupt investment, use, and supply,combined outcomes that would be unsavoury.

Section 1 of this reportintroduces readers to the oil and gas market and explains the dynamics of howthe market works. Pointing the way forward in a gas-dominated world and how theleaning towards gas would shape the emerging global economy and its energyrequirements.

Section 2 of the reportvisits the Petroleum Industry Bill (PIB) and examines in many strong points butdraws attention to a few gaps that could prove knotty in the future, forexample, a large part of the bill fails to make a distinction between thedifferent types of gas: liquified petroleum gas (LPG), liquified natural gas(LNG) and condensed petroleum gas (CNG).While section 167 and 168 of the billrelates to LNG, the wordings are not explicit enough within the sections toclarify the meaning of the generic term 'gas'.

In section 3 the report dissects the import ofderegulation and its impact on the gas market, insisting that for the market toevolve to its full potential the government must avoid the temptation of priceregulation as has been the case with premium motor spirit (PMS). Themarket-distorting impact of price regulation could have severe consequences forinvestment, consumption, and business development.

Consideration of the regulatory mandate of oil and gas(O&G) oversight agencies was made in section 4 where it was arguedthat it was an anomaly to charge an administrative fee for a commodity that hadbeen price-deregulated and no service could arguably be attributed to theadministrative charge of N1.23 per litre by the Petroleum Product PricingRegulatory Agency (PPPRA), a cost which passes on to consumers and results in a 'deadweight' economic/market loss (see illustration 1 above).

Section 5 of the reporttackles issues of pricing of LPG and the need to keep the market both consumerand investor-friendly to enable the country lean successfully into the new gasage without the problems associated with the oil market. Keeping the gasbusiness catholic by avoiding avoidable costs and unfriendly regulatorypractices is critical to sustaining industry efficiency and competitiveness. Thissignificance is underlined in section 6 that makes the case for aninvestor friendly market.

The concluding section of the report, section 7reviews the impact of the global health pandemic on global supply and demand ofgas, both LPG and LNG and looks at the future of the market in a more stableand less fragile global marketplace. The wrap-up section emphasizes that themarket was the best arbiter of price and supply/demand and the less thepotential distortions that could arise from public sector bureaucracy thehealthier the market.