Monday, November 07, 2011

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

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