Part 2: Deregulation of The Downstream Sector of the Nigerian Oil Industry

Inefficiency and Welfare loss

Nigeria: The welfare of the people needs attention

Building on the first post, it cannot be overemphasized that the demand for PMS and other related product (kerosene, diesel, etc) is very high (inelastic) and the supply of these relatively scarce commodities are low. So we are right to call these few (but foreign based) suppliers monopolists since we assume them to be collectively categorized under the same industry. The monopolist import fuel into Nigeria and sells at the price it fixes by itself. If we look at Diagram A, it becomes clear that the monopolist charging prices at Po results in allocative inefficiency since consumer welfare is loss of the range QoQ1. Another issue is that these foreign based producers will not ensure lowest cost in their production (i.e. it will not produce at its lowest average cost. See Diagram A). It is therefore productively (or technically) inefficient. A monopolistic market mechanism is an imperfect one especially in the Nigerian situation. The affordability range of the common man is improved when prices of petrol come down. And this is where government needs to come in, but should it be through subsidy?

If the data available at PPPRA is correct (sincerely), then there is truly regulation and government involvement; the Diagram B shows the obvious disparity in what is supposed to be the price of petrol to what is obtainable at retail or filling station. What we are supposed to pay is N139.69 but we are currently paying N65 because government has subsidized the actual cost. If the billions of naira subsidy is truly paid as we are being told, the masses are being helped and removal (diversion as some stakeholders claim) of these subsidy will lead to unprecedented hardship for the masses. But applying subsidy itself is not an efficient solution, it comes with problems.

Governmentization Problems

while it is still very difficult for us to verify data,  if governmentization (a word I coined for government + subsidization) is actually applied as we have in other parts of the world (in order to regulate the industry), then it will surely come with certain problems. The first problem is that government lack enough information about the industry and particularly about the production outlay of foreign firms. Paying for subsidy on very poor information of the industry is tantamount to waste of resources and money. Additionally, it may be difficult for government to also quantify these products since they government may not be directly involved in quantity estimation. It may be useful to note also that the time to apply subsidy may have been wrong from the beginning. Subsidy implementation administrative cost may result in overall higher cost. The final and most important problem with subsidy is that most of government involvement in issues like these is politically motivated and the economic rationality may not be fully considered. Although it may look like it benefits the people, maybe an arrangement is been made between the government and a particular foreign oil firm (?)

More Key Issues

If we must always use petrol and related product, we need to demand for lower prices. There must be a way for us to get these products at a cheaper price. If prices must then fall from what we have now, we need to look more into the supply side economics. Governmentization may be a feasible option but it does not look like a sustainable one. Subsidy comes with its own problems as explained above and so may not result in a pareto optimal solution. Since what will result in a continuous price reduction will emanate from reducing production cost and increasing efficiency (allocative and technical), it will be logical for us to think first of revamping Nigeria’s refineries. We can then ensure that those firms that import or sell to Nigeria from abroad establish local refinery in Nigeria. This will not only reduce their overhead costs, it will lead to increasing FDI flows into Nigeria. I have mentioned earlier on this blog that, although it may come with risks, companies that invest in new, unfamiliar or difficult terrain like Nigeria will be quick to reap the revenue because they will build economies of scale, increase in their experience curve and enjoy the ever buoyant domestic demand potentials that Nigeria possess. The result of this is increased infrastructure and competition. We will tie everything together in the economic theory of contestability which I will discuss briefly later.

Seun Oyeniran


References

Beesley, M. E., and Littlechild, S. C., (1989), ‘The regulation of privatised monopolies in the United Kingdom’, Rand Journal of Economics, Vol. 20 No. 3, pp. 454-72.

Borcherding, T. E., Pommerehne, W. W., and Schneider, F., (1982),‘Comparing the Efficiency of Private and Public Production: A Survey of the Evidence from Five Federal States.’, Journal of Economic Theory, Public Production, Suppl. 2 pp. 127-56.

Ehrlich, I., Gallais-Hamonno, G., Liu, Z., and LutterSource, R., (1994), ‘Productivity Growth and Firm Ownership: An Analytical and Empirical Investigation’, The Journal of Political Economy, Vol. 102, No. 5, pp. 1006-1038.

Quiggin, J., (2002), ‘Privatisation and nationalisation in the 21st century’, Growth 50, 66–73.

http://www.pppra-nigeria.org/

Grossman, G.M., and Helpman, E. (1994), Endogenous Innovation in the Theory of Growth, Journal of Economic Perspectives 8, No. 1, pp. 23-24.

Ehrlich, I., Gallais-Hamonno, G., Liu, Z., and LutterSource, R., (1994), ‘Productivity Growth and Firm Ownership: An Analytical and Empirical Investigation’, The Journal of Political Economy, Vol. 102, No. 5, pp. 1006-1038.

Lewis, W.W., (2004), The Power of Productivity, Chicago: University of Chicago Press

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The Economist (2010), Businesses will learn to look beyond the BRICs, Nov 22nd 2010 | from The World In 2011 print edition (http://www.economist.com/node/17493411?story_id=17493411)

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CORRUPTION PERCEPTIONS INDEX 2010 , accessed 3/3/2011

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Deregulation of The Downstream Sector of the Nigerian Oil Industry

The Struggle for Optimality

Petrol is an essential commodity. As one of my friends always asserts, after water, another product the common man cannot do without is petrol. It is therefore not a surprise that any policy adjustments that concerns this essential commodity raises the attention of not only the masses, but also key stakeholders like the Nigerian Labour Congress (NLC). While the issue of deregulation is an extensively broad one (I must confess), we will better understand the concept when we furnish ourselves with some level of information. The first idea we need to carry on is the fundamental idea of Optimality (Pareto Optimality) put forward by Vilfredo Pareto. Pareto Optimality is a situation where social efficiency is attained. And social efficiency is only attained when changes in production or consumption can make at least one person better off without making anyone else worse off. We are all rational in our economic behaviour, we tend to maximise our tendencies towards increasing activities that produces higher marginal benefit than marginal cost and do less of activities whose marginal cost exceeds marginal benefit. Inevitably our businesses (including those in the downstream oil sector) are handled in this economically rational way. We will apply this basic understanding of optimality vis-a-vis price theory and simple demand and supply analysis, to explain the struggle towards deregulation of the oil industry in Nigeria.  

Petrol Demand, Regulatory Framework and Black Market

Markets (firms, businesses) are always aiming for private (business) efficiency so their model is predominantly tilted towards profit maximization. It is always the role of government (and other regulatory machineries such as the PPPRA) to bring the private sector to social efficiency where their operating cost covers also for the externality they produce.  It is the involvement of government, this struggle to attain Pareto Optimality or Social Efficiency, that brings about price controls which comes in form of taxes or subsidy. But because petrol is an essential commodity (where demand-price ratio is inelastic), many firms operating within the downstream oil sector are natural monopolists that set prices by themselves. The pump price that gets to the consumer is usually a function of the landing cost of imported refined crude oil. While the four refinaries in Nigeria (two in Port-Harcout, one in Warri and one Kaduna) remain at non-functional state, many regulatory attempts to change the pump price has led to sudden shortage in supply due to excess demand as shown in the diagram above. Since demand remains very high, many of the traders will sell at the ‘Market Price’ Pe, rather than the 'Official Price' P1.  Even so, many of the masses are still willing to pay for the high price at Pe. Keeping the prices mandatorily at P1 leads to persistent product supply shortages (Q2) while demand remains high at Q1. The fact that people want to still buy at Pe, despite regulatory frameworks, is actually cause of ‘Black Market’. Until there is a way that the ‘Official Prices’ Balances with the ‘Market Prices’, Nigeria will continue to have shortages which are in reality ‘disguised shortages’(since the traders are monopolists). To ensure that shortages are not witnessed nationwide and to support the masses, government apply subsidy so as to 'disguisedly' maintain the prices at less than Pe or probably at P1. BusinessDay newspaper recorded the amount of this subsidy to averages N400 billion per year between 2006 and 2008 increasing to about N600 billion in 2009.

Critical Questions

Moving forward, the first question to ask is that are we really not buying Premium Motor Spirit popularly called petrol or gasoline and other related products at the market importation landing cost even though we say there is subsidy? With our level of corruption, have we really witnessed subsidy in the first case?  The second issue is that if truly subsidies need to be provided, how can these prices balance? Will government continue to pay subsidies as other regulatory machineries struggle for consistent fall in prices of petrol? Or do we leave the market forces of demand and supply to control the price of petrol by itself by introducing contestability? We may want to ask finally that how do we really achieve Pareto Optimality or Social Efficiency that will lead to higher welfare gains for the common people? 


As I look through the lines again, preparing for the next post on this blog which will be a sequel to this very post (where I explore the implication of the removal of subsidy and the advent of privatization in the downstream), it is imperative we call ourselves to earnest prayers for the country. This blog remains firm on a positive note that Nigeria will be great, albeit only through divine visitation. What seemed like 'resource curse' in the time of Elisha was reversed by divine intervention (2Kings 2: 19-22), it can happen in Nigeria. We need God's instrumentality.  


Seun Oyeniran


Reference
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Beesley, M. E., and Littlechild, S. C., (1989), ‘The regulation of privatised monopolies in the United Kingdom’, Rand Journal of Economics, Vol. 20 No. 3, pp. 454-72.
Borcherding, T. E., Pommerehne, W. W., and Schneider, F., (1982),‘Comparing the Efficiency of Private and Public Production: A Survey of the Evidence from Five Federal States.’, Journal of Economic Theory, Public Production, Suppl. 2 pp. 127-56.

Ehrlich, I., Gallais-Hamonno, G., Liu, Z., and LutterSource, R., (1994), ‘Productivity Growth and Firm Ownership: An Analytical and Empirical Investigation’, The Journal of Political Economy, Vol. 102, No. 5, pp. 1006-1038.
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