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Deregulation: Solution to constant petroleum supply shortages

By Yemie Adeoye
THE 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.

Dr luckman

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

and the general public at large despite its merits. This situation is observed to be unconnected with the non-committal stance of the government in ensuring effective stakeholder engagement and education of the facts on the issue of deregulation.

This situation has resulted in the policy being reduced only to the issue of pricing whilst other issues such as landing cost, sustainability of supply, competition in the sector, improved funding for the critical infrastructure (Power, Aviation, Petroleum Resources, Works, Transport and infrastructural projects) has been relegated.

The general reaction of the public in the face of current hardship in the purchase of petroleum products is: “What we want is constant supply either by subsidy or deregulation as we are tired of all these problems.” Unfortunately, the current Federal Government policy on subsidy has put the country in huge fiscal and financial burden. The cost of subsidy payments on petroleum products in the period 2006 – 2008 is over N1.2 trillion and the 2009 subsidy payments projected to be about N600bn. These could have financed 45,000 km of roads, 15,000 megawatts of power and 615,000 classroom blocks.

The unfairness of subsidy is also a major consideration in support of the deregulation policy. It is common knowledge that the pump price of N65 per litre is not constantly available in many parts of the country especially the hinterland subsidy deduction at source from the federation account. Majority of consumers at Markurdi, Sokoto, Borno, Plateau, Enugu, Owerri and Bayelsa pay between N90 to N120 per litre. The only way to address this inequity is deregulation, ensuring prices find their natural levels.

Subsidy provides an incentive for smuggling petroleum products to neighbouring countries where prices are higher in view of the huge disparity in the prices of refined petroleum products between Nigeria and neighbouring nations. This means that government resources are being used to subsidise smuggling rather than the consumers thus making it lucrative for them as well as resulting in petroleum products scarcity in the country.

Aside this, the act of subsidy deduction from source is unconstitutional as no local, state or federal government budgets for subsidy, therefore, there is no appropriation.

It is obvious that subsidy has left most of the infrastructures in the downstream petroleum sector with problems, dilapidated and in a state of decay and deregulation is the cure as it means marketers can source (import) and distribute petroleum products freely according to relevant government laws while allowing market forces to determine prices of such products. Like in other sectors, the economic forces of demand and supply will come to play, thereby giving rise to healthy competition.

The key benefits of deregulation are;
Product Availability:
Guaranteed constant supply of petroleum products to Nigerians, especially in remote locations that have perhaps never enjoyed adequate products supply.
Improved Service Delivery:

The competition arising from deregulation will ginger marketers to strive to satisfy customers in order to retain their patronage.

Efficient Utilisation of Resources:

Marketers will operate effectively and efficiently, all resources will be allotted to derive maximum benefits, wastages will be eliminated.
National Economic Growth:

There will be increased production due to availability of products and elimination of lost Man-hours due to long queues – consequently there will be increase in other activities that nourish the economy.

5.   Removal of Irregular Price Disparities
There will be significant reduction sharp differences between locations. A situation where PMS is N65 per litre in Lagos and Abuja and between N100 to N150 in other locations will be eliminated.

Increase in Government Revenue:
Government will have enough money to fund laudable projects (like in the education and health sectors) and social amenities.
6.   Increased Investments:

Deregulation will attract foreign and local investments in the number of refineries licenced years back. Investments in other ancillary services will follow as well.

7.   Increased Employment:
This will follow enhanced capacities by marketer, governmental financial empowerment, the new investments following and the general increase in economic activities that follows deregulation.

This policy is not strange as other sectors such as Aviation, Telecommunications, Petrochemicals, Textile etc has worked and greatly benefitted Nigerians in terms of better services, more options to choose from and hundreds of new job opportunities created. The petroleum downstream sub sector would not be an exception.

Marketers have already demonstrated state of readiness to support this initiative with necessary logistics in place such as storage facilities, vast retail outlets, standard trucks and depots constructed. Apart from this, the Apapa facility has been handed over to the major marketers by NNPC. Major Marketers will maximally utilize the Apapa jetty’s capacity of 7 cargoes per month. Expectations are that there would be a double shift daily; better jetty operations and better coordination. All this will lead to increase efficiency significantly.

Why the Petroleum Downstream Sector Reform
The objective of the reform is simple: to end once and for all the many problems that are preventing Nigeria from getting petrol, Kerosene and other fuels regularly and at affordable prices in every part of the country.

Currently, the Government (through NNPC) is the major operator in Nigeria’s downstream petroleum sector, owning all refineries and most of the major infrastructure (depots and pipelines) except petrol stations. This reform will reduce government’s undue participation in the industry so that the public sector can step back from being an active participant in the industry and the private sector can come forward to participate at all levels to make the whole system more efficient and deliver concrete benefits to Nigerians.

The private sector’s involvement will be in the following areas:
* Local refining
* Importation of refined products
* Pipelines for product supply distribution
How it will Guarantee Constant Supply of Fuel at Affordable Price
Specifically, the downstream petroleum sector reform will lead to removing inefficiencies arising from malfunctioning refineries, huge supply gap leading to near total dependence on imported petroleum products, inadequate port facilities, leading to high distribution costs, high storage costs, and inefficient pricing system which allows consumers to bear the cost arising from inefficiencies, and huge subsidy payments that benefit the privileged groups, few citizens and smugglers.

The reforms will remove all these inefficiencies that increase the pump price of fuel by opening up the market to many private investors to build refineries, import fuel, and ultimately ensure that prices find their natural level.

Reforms will also encourage private investors to build and maintain pipelines to supply products quickly and efficiently. This will reduce the incidence of tankers on the attendant problems of high cost of distribution and damage of our roads. However, the reform will not mean that government will abandon its role in the industry.

The government (though the restructured Petroleum Products Regulatory Authority) will still have a regulatory role in maintaining standards and control in the industry.

Necessity of the Reform
To appreciate why reform is necessary consider the current situation with the telecommunications industry. Before the sector was deregulated, less than 500,000 phone lines were available to about 120million Nigerians. Only the very rich could afford phones and middlemen had a field day extorting money from desperate Nigerians.

But today, phone ownership has been freed up and millions of Nigerians can reach their business partners, friends and relatives anywhere in the world virtually anytime they want and at relatively low cost.

This reform will ultimately have the same effect on the downstream sector. It will also lead to improved service. It will also lead to improved service delivery, reduce inefficiencies and waste of government money on malfunctioning refineries.

Given the large potential market in Nigeria and the West African Sub-region, establishment of additional refineries, construction of open access Pipeline Networks, jetties, Depots and other downstream logistic infrastructure remain promising investment opportunities.
Any Difference from Past Deregulation Efforts?

It is true that reform is not really new to Nigerians. Some previous governments canvassed the idea and even made some effort to implement various aspects of deregulation such as increased private sector participation through granting refinery licenses.

But they did not go the whole hog. And as a result, the measures implemented in the past did not lead to significant or sustainable improvement because they did not go far enough. The major issue, government’s dominance and the attendant problems remained.

President Yar’dua’s government has now taken a bold decision to frontally address the problems facing the sector and resolve them

It will also resolve the many problems currently facing the downstream sector, leading to a reduction in the costs of product delivery and a much more vibrant downstream sector that supplies the nation’s refined product needs, provide jobs and earns exports income and foreign exchange for the nation.
Government Commitment to Budget Management

In the first half of 2009, the government faced a challenging revenue situation due to declining oil prices, crude oil supply disruptions and the global economic crisis. Despite these challenges, the government has remained steadfast and committed to the nation’s economic development by embarking on key strategic projects.

The government recently commenced the dredging of the lower Niger, a project which had been ignored for decades by successive governments but one that will greatly facilitate the movement of goods and services, and make inland ports possible in cities like Onitsha and Lokoja. This will spread development to other parts of the country and reduce the pressure on roads.

The government has also restarted the process of revitalizing the railway lines and services to foster the movement of goods and people across the country.
The government also remains committed to the provision of key backbone infrastructure, especially in the Power Sector and is exploring all options (including facilitating various Independent Power Projects) to ensure the improvement of services in this key sector.

To ensure continuity and a holistic approach to development, the government has adopted a medium term (at least 3 years) framework to budgeting, to reduce the incidence of abandoned and uncompleted projects. The government has also made massive investments in agriculture (through a $2bn intervention fund) to help jumpstart the development mechanized farming and guarantee food security in the country.

This is part of the president’s 7 point agenda, and is already yielding results as the Central Bank recently reported a reduction in the inflation rate (from 15% to 11%) due to declining food prices.

The government continues to invest in Human Capital, and has a presidency level Millennium Development Goals Office, and remains committed to long term economic development through its vision 20: 2020 program.

We have tried the alternative without success. Let’s give deregulation a chance for at least six months, then we can judge the difference and call for change if not satisfied. After all this is a democracy.
Deregulation is good for Nigerians and it is good for our country. We have to join hands to make it work.


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