Monday, December 12, 2011

Deregulation of The Downstream Sector of the Nigerian Oil Industry (Part 3)


Feasibility | Contestability | Sustainability

Revenues from Nigeria's Oil resources has not
translated into substantial economic gains
Although the recent Occupy WallStreet is a major advocacy against corporate greed, the free market upon which this corporate organizations are built hold key values underpinning the modern economy. But we also need the government to play its own role in strengthening the operating environment thereby allowing a level playing ground for businesses. When some foreign firms make supernormal profits at the detriment of the common man, the common man is bound to revolt. Obviously, perfect market scenario create the efficient and welfare maximizing structure and behaviour for the common man particularly because allocative and technical cost considerations as well as pricing mechanisms are always favourable. Monopolists are not necessarily inefficient but our major concern is in terms of their pricing mechanism, their absolute freedom to set prices and the resultant supernormal profit is what raises concern. What we need to think about then is how do we ‘contest’ the monopoly powers in the downstream oil sector in Nigeria?

Contestability will ultimately result to Sustainability
A market is feasible (a usual condition for markets) when it clears (i.e. Total output=Total demand at price P) and firms that operate within the industry are not making negative profit.  More importantly a market is sustainable if above all it is feasible, no new entrant into the market can make profit (given incumbent price). If this is the case, it implies that marketers must set prices sufficiently low so much so that any further price reduction will lead to negative profit. But monopolist (especially the ones that operate in Nigerian oil market) will hardly ever bring their price that low. We can only attain an economically sustainable point in premium motor spirit (PMS/Petrol) and related product pricing when government encourages contestability rather than regulate (control-which brings about more corruption as will be discussed later) or renationalise (total government ownership- which is characterized by greater inefficiency, waste more corruption) is introduced. So let me stop making the term “contestability” a cliché, this is what it means in principle:
“A con-testable market is one into which entry is absolutely free, and exit is absolutely costless” Baumol (1982) [1] “The market price is independent of the number of firms currently serving a market because the mere possibility of entry suffices to discipline the actions of the supplier” (Browing and Zupan, 2009)
“The threat of entry is enough to cause the incumbent monopolist to price at the competitive level”
Let me demonstrate the idea with this diagram:
Click to enlarge
While the idea of contestability is very rare in real market scenario, it is a broader ideal which has a wider applicability based on the perfect market model and it is obviously an extension of Adam’s smith theory of the invisible hand.
This is what we advocate for in summary that government can promote sustainably low prices by encouraging contestability. As much as possible, government must ensure that barriers to new entrant into the oil market be removed. When the monopolist is contested, we can witness powerful optimal results: Prices will fall from Pm to Pc (see Diagram A), firms operate in a unique environment where zero profit is made; prices are equivalent to the average costs of the firm and best (second-best) pricing can be achieved. We also don’t need to regulate the industry as there will be a level playing ground for firms. No need for government to be involved. But we need to keep an eye on the fact that incumbent monopolists still have their way of erecting entry barrier upon which they still make their supernormal profit.

The Downside: Corruption
Just as I have always anticipated in previous posts that most of the figures available to us may be subject to inaccuracies, I am not at all surprised as a recent Sahara Report of the Ministry-of-Finance-aidedKPMG forensic report of the NNPC shows various levels of anomaly. We know that if government has truly been subsidizing as it claims our people should be better off; the hardship would not be this pronounced. it seem clear now that both the recent importers/marketers have questions to answer and the NNPC responsible for of paying the huge billions of subsidy money as well as handle all Nigeria’s oil transaction have develop mastery in diverting a portion of these money for personal benefit, leaving the masses struggling to meet their daily need. It’s a low blow for someone like me who claim Nigerian in overseas country when faced with such report of corruption.

The upside: Corruption will be dealt with
But we will not give up. As the global disparity become more pronounced - emerging economies becoming brighter (especially those in Africa) while the western world witness shortfalls (climaxed in the EU crisis and poverty spikes in the US) - we will continue to advocate for efficient optimal solutions for our dear country. We are optimistic that our nation is at a cross-road, where God fearing people have to take their stand in corporate and governmental arena. Not just Christians (many have failed us), we need sons and daughters of God who will not compromise God’s standard in their daily dealing. I believe you and I can bring that so much desired, long awaited change. But first, we must change ourselves. Now is the time for change.


Seun Oyeniran


[1] [‘freedom of entry’ is used carefully here. It does not mean that it is costless or easy, but that a new entrant suffers no disadvantage in terms of production technique or perceived product quality relative to the incumbent monopolist, and that potential entrants find it appropriate to evaluate the profitability of en-try in terms of the incumbent firms' pre-entry prices]
References
Smith, Adam (1977) [1776]. An Inquiry into the Nature and Causes of the Wealth of Nations. University Of Chicago Press
Baumol, W. J., (1982), Contestable Markets: An Uprising in the Theory of Industry Structure, American Economic Review, Vol. 72 No. 1, pp. 1-15
Baumol, W. J., Bailey, E. E., and Wil-lig, R. D., (1977), ‘Weak Invisible Hand Theorems on the Sustainability of Multiproduct Natural Monopoly’, American Economic Review, 67, 350-65.
Browning, E. K.,  and  M. A. Zupan, (2009), Microeconomics: Theory and Applications, John Wiley & Sons Inc.


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