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Fuel Subsidy –When will Price Modulation Fail?



“Always bear in mind that the people are not fighting for ideas, for the things in anyone’s head. They are fighting to win material benefits, to live better and in peace, to see their lives go forward, to guarantee the future of their children..”  – Amilcar Carbal, Unity and Struggle. PAIGC

Part 1

What is Price Modulation.? When will price modulation fail?. What will the FGN do after price modulation fails? How do we solve the major problems facing our refining sector?. We will answer these questions. Speaking to the press after a visit to the Kaduna refinery, Dr. Ibe Kachikwu, the Minister of State for Petroleum Resources is reported to have said, “There is energy around the removal of subsidy. Most Nigerians we talk to today will say that’s where to go. I have since left the dictionary of subsidy by going to price modulation, which is a bit more technical. …The price of refined petrol today is N87. It was N97 before it was reduced and we really have to go back to that because we don’t really have the finance to fund it. There are lots of safety barometers between the N87 and N97per litre regime. The government does not have to fund subsidy and yet the prices would have been fairly close to what it is today…..That is the first mechanism we are going to work with. It is when that mechanism fails that we will begin to look at a total subsidy exit. We believe we can achieve that.” On January 1, 2016, the PPPRA modulated the PMS retail price and fixed it at N86.50. Dr. Kachikwu has answered the last question. We know what the FGN will try to do when price modulation fails. The FGN will look at a total subsidy exit. We will cross that bridge when we get to it. Therefore, let us proceed to answer the first two questions. Then, we will examine possible solutions to some of our refining problems.

What is Price Modulation.? The new Fuel Subsidy Removal or Fuel Price Increase by Price Modulation is an updated IMF strategy aimed at imposing fuel price deregulation on the Nigerian masses. The updated IMF strategy called for using the present low price regime to remove fuel subsidy and deregulate fuel prices. Price modulation fixes the commodity price in a market by tweaking price components. PPPRA will fix the retail PMS price while the Expected Open Market Price will vary daily depending on the Platts daily Northwest Europe PMS spot prices and freight costs. The modulated prices will be reviewed quarterly. The modulated PMS price for the first quarter of 2016 is N86.50 per litre. In reality, the fuel cabal/marketers can sell at whatever price the customer will pay given the vast number of private petrol stations and the few DPR inspectors available to monitor pump PMS prices nationally. The Nigerian fuel market is a corrupt oligopoly. The increase in fuel prices will have oligopolistic limits. The retail fuel price that PPPRA fixes would therefore acts, in practice, as a minimum fuel price for the domestic market. Price modulation ignores corrupt practices and allows the fuel cabal to pass the cost of corruption and mismanagement directly to the masses. The FGN did not border to discuss the price modulation strategy with stakeholders, like labor unions and civil society organization, who oppose the corruption subsidy and fuel price increase. Rather, the FGN set the modulated PMS price at N86.50 so that these stakeholders would not be able to mobilize. The FGN starts by breaking the lower boundary of its own modulated PMS price range of N87 to N97. Therefore, it will be able to claim precedent when it breaks the upper boundary of N97. 

When the Expected open market price rises above N86.50/litre, the PPPRA Retail price will also increase. Beyond N86.50, there will be no subsidy payment by the FGN as the cost of corruption and mismanagement by the fuel cabal will pass on directly to the Nigerian masses. The FGN wants the Nigerian masses to pay for the corruption subsidy directly. There is actually no fuel subsidy. What we have is a corruption subsidy for the fuel cabal, which the FGN has no more money to pay. Therefore, rather than fight the corruption of the fuel cabal, the FGN wants the Nigerian masses to pay directly for it with price modulation. The PPPRA will attempt to keep the PMS Retail price below N97/litre as oil prices rebound and C+F increases by modulating the price components. Beyond a certain crude oil price, price modulation will fail and the PMS price will rise above N97/litre. The FGN plans to look at a total subsidy exit when this occurs. There will be no corruption subsidy payment.

When will price modulation fail?. The PPPRA template of January 21, 2016 put the C+F at N59.9/litre and the landed cost at N65.01/litre. Therefore, the Trader margin + Lightering SVH + NPA + Finance SVH +Jetty Depot + Storage = N5.11 (reduced from N12.1). Distribution Margins (Retailers + Transporters + Dealers + Bridging + MTA + Adm) = N14.3 (reduced from N15.49). The expected open market price (OMP) was N79.31/litre.  What is the crude oil price at which the PMS Expected OMP (with the maximum price components modulation) will rise above the N97/litre barrier? The most efficient price modulation can only reduce the difference between the landed cost and C+F to N3 (reduced from N12.1) and the Distribution Margins to N10 (from N15.49). Any further reduction will lead to hoarding strikes and resistance from transporters, Dealers and Marketers.  Therefore, beyond a C+F of (N97-N13) or N84/litre, Expected OMP will be greater than N97/litre. At a crude oil price of $45.46/bbl, the C+F price would be approximately $572/MT or N84/litre. Therefore, when oil prices rise beyond $46/bbl, the retail PMS will be greater than N97/litre. Let us assume the most theoretical possible limits in which the FGN has magically modulated the entire price differential to zero. Under this idealist scenario, the C+F = landed cost = expected OMP= Retail Price = N97/litre. At a crude oil price of $54/bbl, the C+F price would be approximately $661/MT or N97/litre.

When will future crude oil price/bbl rise beyond $46.00/bbl? Let us examine some World Bank and IMF crude oil price forecasts. The World Bank average spot price (Brent, Dubai, WTI) data for 2013, 2014 and 2015 was $104.1/bbl, $96.2/bbl and $52.5/bbl respectively.  The World Bank predicts that the average spot price per barrel (Brent, Dubai,WTI) will be $51.4 in 2016, $54.6 (2017), $57.9 (2018), $61.5 (2019) and $65.3 (2020) [World Bank Commodity Forecast Price data, October 2015]. The IMF average spot price (Brent, Dubai, WTI) data for 2013, 2014 and 2015 was $104.1/bbl, $96.2/bbl and $51.6/bbl respectively.  The IMF predicts that the average spot price per barrel (Brent, Dubai, WTI) will be $50.4 in 2016, $55.4 (2017), $59.8 (2018), $62.2 (2019) and $63.0 (2020)[  IMF Commodity Price Forecasts, October 2015 ]. All forecasts show that by 2017, crude oil prices would have recovered to about $55/bbl. Therefore, by 2017, the price modulation will fail and the FGN will begin looking at a total subsidy exit. 

We must organize and prepare for this time of reckoning. More importantly, we must join the Nigerian masses and refuse to pay for the corruption and mismanagement of the fuel cabal during the price modulation period of PMS prices between N87/litre and N97/litre. We must demand that the FGN fight corruption to a standstill and jail all the corrupt members of the fuel cabal. By 2019, when the next election comes around we will have about $62/bbl. A crude oil price of $62/bbl will give a C+F of about $752/MT for PMS ( C+F = N110/litre) leading to Expected OMP/Retail PMS price  of N127/litre or higher.  A ruling political party cannot win the 2019 election with a Retail PMS Price of N127/litre. It is either back to subsidy or the opposition takes over. Therefore, price modulation is a ticking political time bomb for the party in power in 2019. The likely political ramification of successful price modulation is more instability. The economic ramifications are far reaching for the Nigerian masses.

Part II

The NNPC is faced with many contradictions within the economic constraint of import priced input (domestic crude oil), fixed price output (PMS, HHK) and its refusal to fight corruption (and thereby eliminate the so-called subsidy). The 2002 IMF inspired decision to impose import parity prices on domestic crude oil was not correct. Furthermore, the FGN does not want to fight corruption in the oil and gas sector or implement the PIB. We lose our absolute advantage as an oil producer when we import petroleum products.  Import parity pricing for domestic crude oil eliminates the distinction between export and domestic crude oil, discourages domestic refining and encourages imported petroleum products. We need production cost pricing for our brown field refineries in order to update them and make them operate profitably under a financially independent, commercial, efficient and honest management. 

We can avoid the problems of price modulation by using a production cost-pricing model (recommended by OPEC) to determine the PMS price. Such a pricing model would not be dependent on the uncertainties of PMS market prices as determined by Platts Oil.  The cost for new onshore infill wells in West Africa is about $10/bbl.  However, the funding/development cost of our crude oil has not changed from $3.50 as the 445000 bbls of domestic crude oil is still been produced from more or less the same old wells. The Distribution margin is  N14.3/litre or $11.81/bbl. A 10% increase due to recent FGN investment in the repair and turn around maintenance of our refineries raises refining cost to $13.86/bbl.  The major change has occurred in pipeline transportation. Pipe protection is a security issue. We can solve it with an added pipeline transportation cost of $2.5/bbl.  Pipeline transportation cost will increase from $1.5/bbl to $4/bbl. The cost of PMS in Nigeria will therefore be ($3.5+$4.0+$13.86+$4.0+$11.81) or $37.17 per barrel. This is N45/litre. If we impose a 20% profit margin, we will get N55/litre. There is no fuel subsidy. Any price above N87/litre introduces a corruption subsidy that is paid to the fuel cabal from the public purse. At a domestic PMS price of N87/litre, there is an excess of N32/litre that is going to the FGN. This is how we were able to fund the PTF during Abacha’s regime.

The Abacha regime promulgated the Petroleum (Special) Trust Fund Decree No.25 of 1995, which was amended by the Petroleum (Special) Trust Fund (Amendment) Decree No.1, 1995. This decree was very important because it broke down the different cost component of PMS Price for the first time. The decree established a Petroleum (Special) Trust Fund “into which shall be paid all the monies received from the sale of petroleum products less the approved production cost per litre which, for the time being, is as follows – (a) cost of crude oil – 2.35k; (b) excise duty and VAT – .33k; (c) marketer’s allowance – 1.30k; (d) NNPC cost and margin – 1.70k;”. Thus, after a detailed study by the FGN, the production cost of one litre of PMS was N5.68. The profit margin (N5.32 per litre) funded a Petroleum (Special) Trust Fund. The fund was used for development projects that directly benefitted the masses. There was no fuel subsidy. Rather, the FGN used the PMS price increases to generate additional revenue by transferring wealth from the Nigerian masses to the State. We know what works. We could do the same today at a PMS price of N87/litre and use the extra fund thus accumulated to repair our refineries and solve the major problems facing our refining sector. We should reject the IMF inspired neo-classical theory of import parity pricing of our domestic crude oil and refined products. This presupposes that we must refine enough petroleum products to meet our domestic needs.

We will examine some of the major obstacles to achieving refining self-sufficiency in Nigeria. These obstacles include pipeline security, metering, turn around maintenance (TAM), upgrading our old (Brownfield) refineries, eliminating corruption and mismanagement, appropriate pricing of refined products and building new (Greenfield) refineries. One of the major issues facing the FGN is pipeline security.  The NNPC claims that pipeline sabotage and theft of petroleum products are responsible for the poor domestic refinery output and disrupted pipeline supply. The NNPC declared that it lost 531 million litres of PMS (51.07 billion Naira) in the first 9 months of 2015 due to sabotage of our petroleum product pipeline and theft of products. Most of this loss occurred in the 30 miles Atlas Cove/Moisimi pipeline. The same problem exists in the Bonny-Port Harcourt (34 miles) and the Escarvos-Warri crude oil pipelines, which supply domestic crude to the Port Harcourt and Warri refineries respectively. The NNPC chose marine route alternatives to pipeline transportation at a cost of $5.37/bbl. NNPC hired PPP Fluid Mechanics and Ocean Marine Securities to provide the marine services. These two companies supplied 11.6% of the total requirements of the Port Harcourt/Warri refineries from 2010 to 2015. Refinery capacity utilization/efficiency was less than 10%. NNPC imported petroleum products rather than solve the pipeline security problems. 

We can solve the pipeline security problem with an added pipeline transportation cost of $2.5/bbl. There are 875 miles of petroleum product pipelines and about 1,325 miles of crude oil pipeline in Nigeria. Therefore, 20,000 men made up of 6,000 soldiers from the Armed Forces and 14,000 citizens from communities along the pipeline routes can protect our pipelines. An added pipeline transportation cost of $2.5/bbl yields $0.614 million/day or N44.18 billion/year, which can pay the 20000 men and run the whole security operation. It might be cheaper to use more modern technology instruments like drones, but given the low technological capacity of Nigeria, we might not be able to maintain the drones or use them effectively. Furthermore, mobile patrols along the pipelines allow us to absolved about 14000 ex-militants and graduates of higher institutions. We could start by focusing and securing the crude oil pipeline supplying the current refineries (the Bonny-Port Harcourt (34 miles) and the Escarvos-Warri crude oil pipelines).

We need to know how much petroleum products we produce, import and consume per day in Nigeria. In 2012, N996.8 billion was paid as subsidy to NNPC and 49 marketers for importing 17,451.45 million litres or 47.68 million litres of PMS per day. But, daily national PMS consumption was 38.4 million litres. The remaining 9.28 million/day litres of PMS were never delivered. We need better meter measurement and monitoring. More Coriolis meters can be installed on the inlet/outlet of every nodal point (process control, storage, truck loading, transfer to tanks, jetty, depots etc) in the downstream system. These meters will provide direct accurate real time measurement of petroleum products flows. They can detect pipe blockage and leaks as well as send data wirelessly to a centralized control station using SCADA (Supervisory Control and Data Acquisition System). We will then know how much petroleum products we produce, import and consume per day in Nigeria and help stop the corruption and looting of public funds in the downstream sector.

Refinery turnaround maintenance (TAM) is a planned partial or full shutdown of one or more units of a refinery in order to perform inspection, repair, and maintenance of equipment to ensure safe and efficient operations. Material and obsolete equipment are replaced. A refinery TAM takes place every 3-5 years and requires about 1-2 years of advance planning. The actual TAM operations take about 6-12 weeks.  A well-implemented TAM program reduces unplanned disruption of production activities in a refinery and helps maintain operations at more than 85% capacity utilization. 

We have a poor maintenance corporate culture in Nigeria.  The refineries were built in the 1980’s and have a poor TAM history. TAM operations were carried out in the 150000 bpd Port Harcourt refinery in 1991, 1994, 2000 and 2007.  The second 60000 bpd Port Harcourt refinery has similar poor maintenance problems. The last major TAM was in 2000. It will have to be modernized and upgraded. The last TAM in the 110000 bpd Kaduna refinery was in 2008. The one before that was in 1998 after a major fire. TAM operations were carried out in the 125000 bpd Warri refinery in 1994, 2000 and 2008. According to NNPC information, $32 million was spent in 2013 with 75% of the parts needed for the Port Harcourt TAM already on ground. $147 million was approved for repairs and $406 million for modernization. We have run our refineries without maintenance. It is like running a car without tune-ups, oil change or repairs. 

A TAM requires about 18-24 months advance planning covering its 4 phases (planning & preparation, shutdown, maintenance and startup). The planning & preparation stage is essential for a successful TAM. Pre-planning starts about 2 years before the TAM. Pre-planning requires an inspection of the refinery with testing and critical analyses of the units. The integrity of each unit is evaluated. We need to ensure TAMs are done by proven competent companies with a history to turning brownfield refineries around.  The TAM needs to be scheduled well ahead of time and the funds accumulated from a TAM tax on petroleum products whose prices were determined by the production cost-pricing model.

Technical options available for the update of brownfield refineries (like the Port Harcourt, Warri and Kaduna refineries) include Splitter, Naphtha Stabilizer, Continuous Catalytic Reformer Unit, Kerosene Hydrotreater Unit and Fluid Catalytic Cracking Unit (FCCU).  In 2013, a continuous catalytic reformer unit with a capacity of 50000 bbls per stream day and construction time of 24 months cost $140 million (2013). A splitter with a capacity of 50000 bbls per stream day and construction time of 18 months cost $100 million (2013). A Naphtha stabilizer (no stripper) with 20000 bbls per stream day and a construction period of 18 months cost $30 million. Turnkey projects with these technical options in the Port Harcourt refinery will cost $270 million. The same amount will update the Warri Refinery giving a total of $540 million. 

A kerosene hydrotreater unit with a capacity of 50000 bbls per stream day and construction time of 18 months cost $140 million (2013). This can be added to the Port Harcourt refinery. A Fluid Catalytic Cracking Unit (FCCU) with a capacity of 60000 bbls per stream day and construction time of 30 months cost $150 million (2013). (‘Technical Options for Processing Additional Light Tight Oil Volumes within the United States’, US EIA, Apr.2015). We can therefore invest a grand total of $830 million (N163.51 billion). This amount can be generated in 30 months with a N4.47/litre tax on profit obtained from using the production cost pricing method. The refineries can pay for themselves if well managed (more revenue from the sale of products other than PMS have not be included here). A Greenfield (new ) refinery with a capacity of 250000 bbls per stream day and construction time of 36 months cost $3.39 billion (2013) or $4.12 billion with accrued interests during construction. This is a lot of capital that is best left to a time when the brownfield refineries are functioning at 85% efficiency and crude oil prices are high.  Furthermore, a greenfield refinery might find it hard to compete with the larger planned Dangote refinery (more economy of scale).

Only companies with refineries should be allowed to lift domestic crude oil for offshore processing purposes.  Currently, NNPC is responsible for importing 75% of refined products into Nigeria. In future, NNPC should be the sole importer of petroleum products. The NNPC storage tanks need to be repaired and more need to be built. The dependence on private storage tanks should be discouraged. The practice of marine storage of petroleum product inventories (I billion litres) should be stopped. The demurrages incurred by these floating ships while they are being used for permanent storage is very high. All permanent inventory storage facilities should be onshore. 

Most forecasts are that Bonny Light crude oil prices will increase from its $29.47/bbl on January 21,2016 to about $62/bbl by 2019. At $46/bbl and an exchange rate above N197/$1, PMS prices will break the N87-N97 barrier with the present price modulation strategy. This might happen by mid-2017. The price modulation strategy is not a permanent solution. By 2019, the PMS Expected OMP prices will be well over N127/litre (crude oil price of $62/bbl).The FGN will be faced with returning to an explicit subsidy or fighting the Nigerian masses politically in the streets. The other alternative is to eliminate corruption from the refining sector and introduce production cost pricing.

All the past recommendations of NEITI and all the recommendations from the numerous probes and investigations of the fuel subsidy regime/refineries in Nigeria should be implemented. All those found quality of corrupt practices should be put on trial and sent to jail. It is unacceptable that nobody from the list of suspected corrupt firms identified by the 2012 Farouk Lawan fuel subsidy investigation has been found guilty and sent to jail.

The update of our brownfield refineries calls for the proper pricing of refined products in the domestic market. The economic limits imposed by the balance of power between the masses and the Nigerian ruling class today is N87/litre. This is the political reality. We recommend that the FGN should reject the IMF inspired import-parity model of imposing spot market prices on NNPC domestic crude oil. This policy does not encourage the growth of domestic refining. The price modulation cannot keep PMS prices in the N87-N97 range as crude oil prices begin to rebound. 

The FGN should go back to a production cost-pricing model. Using the production cost-pricing model, the FGN can maintain PMS prices at N87/litre by imposing varying crude oil production taxes and petroleum products sales taxes across the production-petroleum product sales chain. This will encourage NNPC to operate efficiently and raise some FGN revenue. Private participation in petroleum products imports should be discouraged in favor of private participation in refining with proper incentives until FGN participation in the refining business is reduced to a non-operational minimum level. The FGN should pass the PIB and create the enabling environment for the success of this new policy. 

We will not pay for corruption. We must organize, mobilize and join the Nigerian masses for the upcoming struggles “to win material benefits, to live better and in peace, to see our lives go forward, to guarantee the future of our children”. 

Paper presented at the Nigerian Labour Congress Organised Stakeholders Meeting on Fuel Subsidy and Petrol Pricing, Lagos, January 28, 2016.

 Izielen Agbon


Twitter: @izielenagbon

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