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Deregulation: Solution to constant petroleum supply shortages

By Yemie Adeoye
Current situation in  the downstream petroleum sector The dependence on imports, inadequate supply and distribution infrastructure and poor state of the refineries, as well as the huge subsidy being incurred by the government cannot be separated from the government’s involvement in this very critical sector.

Rilwanu Lukman

It is no wonder that the downstream sector is beset by myriad problems created by structural, systematic and institutional weaknesses as well as policy deficiencies.

These include:  Lack of investment in refinerie, excessive dependence on imports,  Supply and demand imbalances leading to shortages,  Smuggling/Leakages, Inadequate Port and Reception Capacity High Distribution and storage costs Uncompetitive market structure,  Inefficient Pricing structure,  Rent seeking, Budgetary pressure from unsustainable subsidy payment, Inefficiencies in the Downstream Sector

Malfunctioning Refineries Current National refining capacity is 445,000 bpd, Significant gap between local availability and demand due to lack of adequate investment and mismanagement in the sectorAt full capacity, domestic refineries can only meet about 60% of PMS demand.

However, over the past two decades, local refineries have functioned at 40% of capacity at the best of times due to poor management, long decision-making process, limited authority to incur expenditure, inadequate investment, lack of mandatory Turn Around Maintenance, exacerbated by corruption and sabotage

As such, well over 90% of PMS consumed is imported, while the refineries are largely idle and operate at a substantial loss to the nation even as resources are used to maintain a non-performing work force

Huge Supply Gap
Capacity utilization of refineries is on the average, 10% of  local demand, leaving huge supply gap. This has led to near total dependence on imported petroleum products.

Massive import requirement to meet consumption needs include:   35 million barrels of PMS 18 million barrels of DPK, 22 million barrels of AGO.
There is, however, no supporting import structure
Inadequate Port Facilities
The ports and existing import reception facilities are not designed to handle current levels of product import volumes.

Supply infrastructure is planned to be mostly inland-focused Inadequate Port  facilities lead to attendant (but significant) distribution costs like demurrage and lightering expenses

Government has been unable to make investments to upgrade the existing port facilities and  the results are expensive distribution costs and occasional disruption in product supply.

Oligopolistic Market Structure
Near Oligopolistic Market structure for fuel importation and distribution. Few players dominate market (NNPC and about 12 independent importers)

NNPC imports large volumes of products (about 60%) through oil traders by tendering process.
This is neither cost-effective nor efficient and fraught with funding challenges.  The oligopolistic market structure requires the Petroleum Product Pricing Regulatory Agency (PPPRA) to perform effective oversight function and protect customers.

High Storage Costs
NNPC currently maintains a PMS storage capacity of 1.2 billion litres (about 40 days’ supply) made up of, Inland Storage depots (178.52 million litres)

Marine floating vessels (1.02 billion litres),Current price is costly and inefficient (Demurrage from floating storage was N113 billion in 2008 alone).

In a deregulated framework, private operators will ensure that product stocks are maintained at the most cost effective levels, and devise to secure supply channels.
Inefficient Pricing structure

PMS prices and until recently kerosene and fuel oil are fixed by government, but diesel prices are deregulated.
A fixed pricing regime is employed by PPPRA based on a pricing template (import parity prices plus mark ups for transportation, distribution, marketing and guaranteed margin).

The current pricing structure allows transfer of inefficiencies fully to consumers.The pricing structure does not encourage marketers to focus on reducing inefficiencies since:Importers are guaranteed a fixed return on investment
High interest charges are transferred to consumers

All risks are transferred to government and consumers The fact that importers are guaranteed a 19% profit margin based on the PPPRA template reflects an uncompetitive and inefficient downstream sector, especially since opportunities exist for cost reduction.

Unsustainable Subsidy Payments Current pricing strategy has led to huge unsustainable subsidy burden.Over N1.2 trillion spent on subsidy payments between 2006 – 2008.Subsidy claims for 2009 estimated to reach 600 billion, at current prices.

The 2009 projected subsidy payments represents    117% of the amount devoted to critical infrastructure (Aviation, power, transport, FCT infrastructural projects),  186% of the budgeted capital expenditure for human capital, Development (Health, Education, MDG quick win projects).

The Burden of Subsidy Subsidy payments have impacted on the revenue situation of government at all tiers.
Subsidy has resulted in the diversion of scarce public resources away from spending in critical infrastructure and human development (Education, health, etc) while putting further pressure on government resources.

Fuel subsidy is not reaching intended beneficiaries – subsidy level favours generally richer households who consume larger quantities of petroleum products. Subsidy administration is beset by inefficiencies, leakages and corruption.

PMS is not obtainable at N65 per litre in many parts of the country, except in few major cities like Lagos, Abuja, Kaduna and environs.

Subsidy has discouraged competition and stifled private investment in refineries. Huge price disparity has encouraged smuggling of petroleum products across neighbouring countries where prices are high.

Disparity in prices of refined petroleum products encourages smuggling to neighbouring countries
Government is implicitly subsidizing smuggling and making it more lucrative

Downstream sector reforms will help ensure that prices find their natural levels, and that any exporting of refined products is done through legal channels (ensuring revenue for industry participants and the government).
Other Costs to the NationThe avoidable foreign exchange demand for oil importation puts additional pressure on the exchange rate and forex supplies.

According to the CBN, as much as 29% of its foreign exchange sales was used in January 2009 to finance the importation of refined petroleum products

The overbearing presence of government in the sector and inappropriate pricing of products has made the sector unattractive to private sector investors. Private investors are reluctant to set up refineries as they cannot guarantee fair returns on their investment.

Addressing Inefficiencies in the Downstream Petroleum Sector
Holistic and comprehensive approach is needed to address inefficiencies and remove supply bottlenecks. Deregulation and price liberalization of the downstream sector constitutes the basis and bedrock of any medium to long-term reform within the downstream petroleum sector.

Overall objective of deregulation is to introduce competition, enhance efficiency and improve supply. Liberalized pricing environment will help reduce inefficiencies in pricing and deregulation/liberalization must be accomplished by infrastructural development, institutional and regulatory reforms. Unfortunately, the Federal Government policy on the deregulation of the downstream petroleum sub-sector has continued to meet with stiff opposition from various pressure groups, media, political parties, companies/corporate organisations


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