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The rising cost of Nigeria’s petroleum subsidy

By Ruth Olurounbi, in Lagos
Posted on Tuesday, 15 January 2019 09:32, updated on Friday, 8 March 2019 11:23

The Azura-Edo gas-fired power plant. Industrial insurance remains under-used in Nigeria.

The government spends a huge amount of money subsiding the electricity and petrol sectors, but in the end is it worth the cost?

Rising oil prices float all boats in Nigeria – or so one might think. But while government revenue from oil production rises, so too does Nigeria’s subsidies on petrol prices for consumers. The Nigerian government subsidises things like electricity and petrol – paying the difference between the cost to produce and the cost charged to customers – in order to make them more affordable. If the rise in the cost of petrol subsidies was not enough, subsidies to the power sector are rising fast too. Can the national budget take the strain – and how will things play out in upcoming elections?

Africa’s second-biggest economy could spend as much as $5bn in subsidy payments by the end of the year, according to Lagos-based economic research and analysis firm Financial Derivatives Company (FDC). That is far beyond an earlier projection of $3.5bn by the minister of state for petroleum resources, Emmanuel Ibe Kachikwu. The cost overrun comes as other spending priorities attract attention on the campaign trail, such as the 11 million Nigerians who are not in the school system.

After the government of Muhammadu Buhari stopped a costly and corrupt subsidy programme managed by his predecessor, Goodluck Jonathan, it has been keen to suggest that it is out of the subsidy game.

What the government calls its spending may have changed, but it still pays the bill to insulate Nigerians from the full cost of petrol prices. Instead of paying subsidies to importers, as was done under Jonathan, the Buhari government has made the national oil company responsible for fuel imports and swallowing the difference between its costs and the price at the pump.

With global oil prices rising from $49.49 per barrel since Buhari took office in 2015 to as much as $70.28 this year, Nigeria’s subsidy costs have grown sharply. They soared 210% over a two-month period, from a daily average cost of N774m in March 2018 to N2.4bn per day in May, as the country grapples with fiscal deficits and rising debt levels.

Ahead of elections planned for February 2019, People’s Democratic Party presidential candidate Atiku Abubakar and others have been criticising the Buhari team for the rising cost of subsidy spending and the opacity in their management, which could be used to carry out corruption.

Calls for change

Subsidies are also a hot topic because it is politically unpopular to reduce them and force consumers to pay more. When the Jonathan government announced that it would abolish the fuel subsidy in 2012, he faced massive street protests and relented on how much to cut them.

As the price of oil rises, there is more pressure for the government to cut the subsidies or raise fuel prices, either of which would be harmful to the government party’s chances of re-election. But a growing number of voices are calling for change.

“If the forecast of FDC proves accurate,” says Ekpen Omonbude, chief executive of UK-based energy and mining consultancy firm Bargate Advisory Limited, “you would be talking about 70% of government earnings for 2017.” Total government revenue for 2017 stood at about $7.2bn.

International financial instit­utions like the World Bank and the International Monetary Fund are ­urging governments to cut costly ­national subsidies and to provide them in a targeted fashion to poor communities. The World Bank says that subsidies “impose a heavy fiscal burden and are likely not sustainable.” It continues its criticism, saying: “Since these subsidies disproportionately benefit high-income households, they are a costly way to protect the poor.”

Since these subsidies disproportionately benefit high-income households, they are a costly way to protect the poor

That is borne out on the ground. “Vast parts of Nigeria actually pay a bit more than the fixed pump price of N145 per litre. This negates the oft-argued concern that Nigerians would struggle to pay for deregulated fuel”, says Bargate’s Omonbude. Using July 2018 data from the National Bureau of Statistics, residents of 26 states paid, on average, nearly N3 per litre more than the national pump price. It was up to N10 more in one state, and between N5 and N6 more in at least three other states.

“What is interesting is that the areas with arguably better living standards, such as Lagos and Abuja, pay the exact price, while the states with arguably lower standards of living pay higher. The subsidy system can be argued in essence to subsidise Nigeria’s better off at the expense of the worse off,” Omonbude adds.

“The petroleum subsidy payment is simply unsustainable,” argues Victor Eromosele, a former general manager of finance of Nigeria LNG and now chairman of the Centre for Petroleum Information.

Pressing priorities

“Another way to paint the picture is that the [initial] N1.4trn estimate for subsidy payments is nearly five times the annual capital budget appropriation for agriculture, education, healthcare and trade and investment combined,” Eromosele says. “I stress these sectors because they are more important to Nigeria’s development than sustaining petrol subsidies. There are other more pressing priorities to worry about.”

The Nigerian government also subsidises the ailing power sector. The country’s electricity supply is erratic because of problems with gas supplies, poor infrastructure and late payments. The government has spent a significant amount of money on power sector reforms over the years – amounts that include an estimated $16bn for the Power Fund between 1999 and 2007 to another N155 bn on an intervention fund for the Multi-Year Tariff Order to subsidise shortfalls in expenditure for the power sector between 2009 and 2013.

That spending has not done much to break the country’s reliance on costly and polluting diesel generators.

The government completed a power sector reform and privatisation process in 2013, and due to continued problems in the sector it paid an estimated N420bn in tariff shortfall payments between February 2015 and December 2016. These are deficits caused by tariffs lower than cost of service delivery – leading to a payment from the government to private sector operators.

By 2017, Abuja released another N701bn through the Power Intervention Fund. Although the government is not classifying these payments as subsidies, government officials as well as distribution company chiefs see it as such.

Source: IMF

“The government is subsidising the value chain,” says an official from an electricity distribution company (Disco). “After the privatisation of the sector, electricity prices were supposed to be determined by the rules of demand and supply per the agreement we signed with the government, but that is not the case here because the government is now setting the price.” The privatisation contracts said that the tariff would be cost reflective, but in the first quarter of 2015 the government changed tack.

‘Centralised monopoly’

“So for instance, if the generating companies are selling power at $30 per kilowatt, the Discos are mandated by the government to sell to Nigerians at $15 per kilowatts,” the Disco official explains. “The government then bears the shortfalls of the other half. The price differential shortfall is what is now known as the Intervention Fund because the government is not coming out to say it is subsidising the power sector. But however you slice it, it is still a subsidy.”

The power sector reform and privatisation was done so private investors could deliver sustainable, adequate, qualitative, reliable and affordable power in a deregulated market, but post-reforms, the government still holds 40% stakes in Discos. It also owns and operates the transmission network, which remains the weakest link in the power supply chain.

The government should move away from “centralised monopoly”, argues Sunday Oduntan, the executive director for research and advocacy at the Association of Nigerian Electricity Distributors. Power minister Babatunde Fashola said last year that the government is considering divesting its shares in the country’s 11 Discos.

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