Monday, October 11, 2004

Petrol:No longer the fuel of love

Petrol:No longer the fuel of love

By Dele Sobowale
Thursday, January 01, 2004

Nigeria is the only country among the top ten oil producers classified as poor. The question is: why?


The history of crude oil in Nigeria began in the now almost forgotten setting of Oloibiri in the 1950s with the discovery of crude deposits by the Shell Petroleum Development Corporation at a time when the country with three regions; East, West and North, practiced true Federalism even under a colonial government. At the time, the discovery was seen as a blessing adding to the list of exportable products which included: cocoa, palm oil produce, rubber, hides and skin, coal, tin, columbite and groundnuts. Crude oil was a marginal contributor to the economy which was characterized by even development based on fiscal federalism based on the principle of derivation, now called resource control. The decline of the country from a multi-product economy to a mono-product economy is ominously reflected in Oloibiri which for all its contribution to national development is now in the grips of the most abject poverty, its oil wealth has been exploited to benefit others and the former agricultural setting cannot even return to its past on account of environmental degradation which constitutes an unavoidable part of oil exploration. The whole of Nigeria mirrors Oloibiri in many respects; the nation has gone from a productive economy where healthy rivalry among the three regions has been replaced by a predatory country where the political rivalry centers around sharing the proceeds of crude oil. From the first military intervention till today, unitarism has replaced federalism and allocation of crude proceeds has supplanted productivity. Agriculture which constituted the back-bone of our economy in 1957 has now been forsaken and is in relative decline perhaps irretrievably. Only five or six states out of the 36 created out of the four regions the military met in 1966 are economically self-sufficient. That explains why our politics has become so murderous; the rest of the nation has become a parasite on the oil producing states.
Oil which came into our lives with the promise of improved economic and social welfare leading to unity is now threatening to tear us apart. The recent fuel price increases and the added N1.50 per litre tax which is scheduled, if the President has his way, to take effect from January 1, 2004 might be the last measure that will ignite a national conflict whose end nobody can predict. Already, the battle lines are being drawn.


In the Report of the Special Committee on the Review of Petroleum Products, Supply And Distribution released on October 2000 by the Federal government, it was reported that " industry sources estimates (sic) that the daily domestic demand for Premium Motor Spirit (PMS) is 18 million litres" ( p 28). Today’s consumption can reasonably be estimated at 20 million litre per day. The implications are quite clear; government is imposing on Nigerians taxes as follows: N30 million per day, N900 million per month and N10.8 billion per annum.

The tax which is really a sales tax, which is a constitutional issue in itself, will be used for the maintenance of Federal roads as a substitute for the collections from toll gates which have not been applied for the purpose for which they were intended. Secondly, the price structure before the so-called deregulation of fuel prices in October last year already included a tax of N5.20 per litre which had not been removed. Fuel as a result of the new surcharge against it, will now be taxed three times.

And that is not the only objection against this measure.
Lagos State alone accounts for 40-45% of all the fuel used in the country and its inhabitants irrespective of religion, ethnic group, sex, age, or state of origin will contribute between N4.32 and N4.86 billion of this amount. Businesses, which can, will pass their own share of the tax burden to consumers and here again Lagos accounts for about 48% of Nigerian commercial activity. Yet, the percentage of Federal roads in Lagos is less than 0.5%. Lagos State government is already protesting the inequity in what promises to be a long drawn out battle which other states will eventually join. Lagos in particular has a reason to lead the charge; it has been short-changed in the allocation of Value Added Tax (VAT) allocations from which it receives less than 3% while contributing close to 52%. Other relatively highly industrialized states with few Federal roads will be in the same predicament as Lagos making the fight over the formula for sharing the revenue one of the most bitter the country will face in the new year.

Quite apart from the additional revenue which the government hopes to derive from the surcharge. The surcharge will in effect increase the pump price of fuel from N22.00 per litre in 2000 to between N46.00 and N47.00 per litre in 2004; more than 100% increase.

Given the primacy of fuel as an input into all aspects of the economic and social lives of the people, the inflationary spiral that will surely follow will in the short term worsen the Human Development Index (HDI), a universal measure of economic welfare of the people, on which the country is ranked the 13th lowest in the world; Nigeria ranks 187th out of 191 countries on the health component of the HDI. Higher inflation. Rising unemployment, lower capacity utilization, and increased insecurity of lives and properties are unlikely to improve our standing in the short run. Instead, the Misery Index (MI) which includes: illiteracy, poor health and diets, housing and crime are certain to increase; at least in the short term.

The government has announced a package of reforms centred around deregulation of the Nigerian economy which will henceforth be private sector led. In reality, this is a continuation of the Structural Adjustment Programme (SAP) introduced by President Babangida in 1986 and which includes privatization of those activities which are better and more efficiently handled by the private sector. Deregulation and privatization have come to be accepted by a broad spectrum of the public as appropriate.

The government of Obasanjo has unfortunately made deregulation synonymous in the minds of the general public with fuel price increases because it has applied it there first on the basis of a contentious argument that there is a subsidy on fuel consumed in the nation. The question most people ask is: what is wrong with subsidy; after all it is an economic safety net which many countries apply to cushion the negative impacts of adjustment? But even those in support of subsidy removal have their own quarrels with the government.

To start with it is not clear that there is a subsidy on fuel for the simple reason that the true cost of production of fuel is not known and the accounts of the NNPC have remained unaudited for years. The Report of the Committee was explicit in this regard; according to that report : "The lack of isolated accounting system for the refineries called Strategic Business Units (SBU) by the NNPC, made it difficult to ascertain the cost of operations", that is on page 9. Question is: with such self-damning admission how is it possible for the government to state unequivocally that there was a subsidy which deregulation is designed to remove?

Even on purely economic and cost accounting basis the case for subsidy is weak, if not fraudulent. Every economist and accountant knows that the unit cost of a product increases inversely with the capacity utilization. Thus a plant operating at 80-90% capacity enjoys the economy of scale lowering unit cost. By deliberately operating the refineries at less than 20% of capacity for the last five years, including four years of the present administration, government was inducing the high cost which formed the basis of its pricing policies. Had the refineries been operated at 75-80% of installed capacity, the cost structure would have been significantly different and the pump price would accordingly have been reduced even with all the unnecessary additions to the cost.

In addition, government has adopted a questionable method of accounting for NNPC’s cost of operations. The crude allocated to NNPC, which were not refined locally, were sold at the going global price of crude which had averaged $28.00 per barrel yielding about N360 billion per annum before expenses were deducted. But even in the worst case scenario, NNPC’s costs should not have exceeded one-third if the gross leaving a net surplus of N240 billion which should have been sufficient to finance the import of finished products without a subsidy. Till today despite the spirited attempts by the National Assembly to find out what happened to the revenue derived from sale of crude by NNPC, the nation has met a brick-wall with the President leading the cover-up as the de facto Minister of Petroleum.

Altogether it quite clear that the case for the presence of a real subsidy remains unsubstantiated while the argument that government through neglect, inappropriate accounting, corruption and bad management has made spiraling fuel price increases inevitable is almost impossible to dispute. Even the current prices ranging from N44-47.00 per litre will not end the spiral as long as exchange rate continues to weaken; the nation might be paying as much as N60.00 per litre by December 2004 and N100.00 per litre by 2005 because there is a built-in escalator factor hinging on exchange rates which guarantees automatic price increases once the nation becomes hooked on imported fuel. The incentive for the major oil marketers with excess refining capacity abroad does not exist either. Deregulation has given them the freedom to act at will and to put additional pressure on the exchange rate.

Basing its policy on shaky premises was not the only fault with government’s approach to deregulation however. The government which announced that it would no longer fix fuel prices had made an about turn to impose a band of prices nationwide mandating that fuel should not sell above N41.00 per litre in Lagos and N45.00 per litre in the North and the East. Contrary to the pronouncements of government when fixing new prices, the price of fuel has been deregulated for years by the market itself. Nobody can remember buying fuel at the control prices in the East and most of the far north since the 1990s. By the time government belated announced its deregulation of fuel prices petrol was selling for over N60.00 per litre in most of the Northeast and Northwest and over N40.00 in the Southeast.

"For a period of almost 70 years, the petroleum marketing companies sourced products themselves, transported and distributed them using their own distribution and retail outlets", according to the report. Nigerians would want to know how we got into the business of providing every infrastructure for the oil private sector and why despite that we are in the mess in which we find ourselves; a mess which the government appears incapable of erasing despite all the promises. The reasons were supplied by the government itself.

There are four refineries in the country owned by Government through the Nigerian National Petroleum Corporation(NNPC) commissioned between 1965 and 1989 with the under listed installed capacities" See charts.

The following can be deduced from the charts and they are pertinent to the debate on what to do about the refineries.
Only one refinery was built by a civilian government and it was also the smallest.
Only one refinery, the Kaduna refinery was sited far from the crude oil base raising the cost of production accordingly.

The oldest refinery is 38 years old, the second 32 years old; the third 24 years old while the fourth is 23 years and the last 14 years old.

Given advancing technology, only one refinery can be considered world class; the rest are technological antiques. Repairing them amounts largely to a waste of funds as anybody with an old car knows very well.
lThe older an equipment or a production unit is the more repairs it requires and break-down increases. Thus the Turn Around Maintenance for the four oldest refineries must be carried out as and when due for them to function properly.
But what has been happening to the refineries. Again the Committee provided us with the answers.

lThe Turn Around Maintenance ( TAM ) was last carried out in 1994 before the current TAM which began in May 2000 and is yet to be completed".
WARRI REFINERYlThe last TAM was carried out in 1994 . The refinery operated from January to February 2000 at about 10.3% of the installed capacity and was shut down because the Main Heater blew up".

lIt was shut down in August 2000 partly to allow rehabilitation of the heaters and because the TAM which started in 1998 was yet to be completed. The last TAM carried out before then was in 1992 which means that two consecutive TAM ( 1994 and 1996) were not carried out".

What emerges from this report is a pattern of deliberate neglect of the refineries which has provided the excuse for government officials from the 1990s till today to import fuel at higher prices and to use that as reason for claiming subsidies which might not exist if the refineries were made to function as they should. That pattern of deliberate neglect bordering on economic sabotage continues till today. The TAMs that were ordered by the present administration have either not been carried out as and when due, the contracts according to a knowledgeable insider have been awarded to party men without previous experience in TAMs. Refineries have been treated in the same manner as road contracts and we know the result on those.


Pricing of petroleum products has followed the usual formula of cost plus margin but with a uniquely Nigerian government variation to the honest and equitable formula. Right from the start the cost structure has included extraneous elements such as the Petroleum Equalisation Fund (PEF) which was established by Decree 9 of 1975 and later amended by Decree 32 of 1989 to ensure uniform pricing of petroleum products throughout the country. The Fund received its money from an in-built cost of N1.50 per litre. ( Does that figure appear familiar?). According to the law the Fund was used to reimburse marketing companies for loses sustained as result of marketing petroleum products nationwide.

Two things are noticeable about this Fund which was capable of being abused and was widely abused. First the loss was reimbursed even if the companies’ inefficiencies were responsible for the loss. Second and equally vital was the fact that the government lacked the resources to verify the claims of the marketing and distribution companies.

Those two facts combined led to an open raid on the Fund that is still going on till today because the Decree has not been repealed. Lastly, the Fund has failed woefully to make fuel available at control price throughout the nation yet it is still retained. The reason is simple: it serves the interest of the petroleum companies and government officials even as it works against the interest of consumers.

Furthermore, cost-plus-margin as a method of arriving at product price is flawed in a fundamental way. It takes the cost as given, thereby discouraging efficiency and encouraging corruption.

Only a corporation operating on cost-plus-margin basis could pay N240 million for the hotel accommodation of its Chief Executive and consider it a bargain when a befitting building could have been built or purchased for the same amount and it will remain an asset on the book of accounts instead of constituting a charge against current operations each and every year. And housing was not the only unnecessary cost for which consumers have to pay.

Inflated contracts, unexecuted contracts and most of all the deliberate neglect of the refineries which necessitated imports did not eliminate fixed costs which were charged even if all the refineries failed to work.

Even when they were in operation, the cost of production per litre increases given lower capacity utilization. Thus with the four refineries operating at about 20% of capacity for the last four years the cost of production per litre was bound to be high. Why government expects the consumer to pay for its own negligence and incompetence is a mystery Obasanjo only can unravel.

Given the ease with which costs were passed on to the consumer by NNPC and the devaluation of the naira, it requires no high degree of imagination to understand why the pump price has been jumping since the last four and a half years.( See table).

The fear most people now entertain and with justification rests on two issues: the sustainability of the present prices and the assurance of availability.

Already there is the widespread suspicion based on recent experience that the present prices might just be the beginning of an upward spiral that will terminate in N60-100 per litre of fuel; perhaps as early as next year. People whose businesses have been devastated by the present levels are apprehensive about the future as they should be because the future based on the analysis of the present is bleak. There is no light at the end of the tunnel into which government has driven us.

The question about availability , at least in the short term, was answered partly by the debacle of scarcity hitting the nation at Christmas. All of a sudden the smug smiles on the faces of the deregulators was wiped out when the private sector failed its first crucial test of making fuel widely available for travelers at Christmas.

Many who traveled home are at risk of being stranded; they certainly will have to pay more than they bargained for.

Is this a shadow of coming events and will all the arguments in favour of deregulation have been in vain? Time will tell.

Obasanjo may gain the respect of the citizenry in the long run; but in the short term and the foreseeable future, he stands a leader without followers. That unfortunately will not be just a personal tragedy; it will be national. As President Kennedy has said: " The worst thing that can happen to a leader is to look back and see that there is no one following". If the President looks over his shoulder today, he will discover that the followership has dwindled to a handful.


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