Deregulation or Subsidy Removal?

The twin issues of appropriate pricing of Petroleum products and the (non) functioning of the downstream infrastructure (Refining and Petroleum Products distribution) have dogged the path of every Nigerian minister of Petroleum since 1992.
The then very influential Petroleum Minister, Prof. Jibril Aminu lost his job in June 1992 in response to public agitations over Petroleum products scarcity. That was the first real sign of crises in the downstream sector. Over the nearly twenty year period, no lasting solution has been implemented.

At the core of the crisis is the state of the downstream infrastructure. Our four refineries as well as the distribution network (consisting of 19 storage depots and interconnecting pipelines) were all built between 1978 and 1988. They ran efficiently in their first five to ten years, largely because they were new facilities. The first signs of decay arising from a poor maintenance culture were noticed in 1992. Since then, these facilities have steadily degenerated to the point of near-zero performance today.

The consequences are two-fold:
• The country has resorted to massive importation of petroleum products to bridge the gap created by the non-functioning of our refineries. The complicated logistics associated with this exercise (freight, insurance, demurrage, port charges, etc) probably adds some 30% to the landed cost of these products.
• Because the distribution infrastructure, which are largely tied to the four refineries no longer function, some 80% of the entire volume of products imported into the country is available to retailers along the Lagos – Mosimi Axis only. The implication is that haulage trucks have to travel for days (or even weeks) and mass up along this axis to pick up products for distribution. In some cases, the cost to the Petroleum Equalization Fund (PEF) for a truck load of PMS is higher than the value of Cargo itself! Add to this, the share nuisance created by these trucks along this axis.

Clearly, therefore, our entire strategy for taking petroleum products to consumers is hinged on functional refineries tied to a distribution network of pipelines and depots which ensure that no truck travels more than five hours to pick up products for distribution to retail outlets.

Due to political pressure and a very strong advocacy from the Unions, Petroleum Products prices have remained regulated. The result is that at high crude oil prices, the associated subsidy which is borne by government becomes prohibitive. At nearly $7 billion per annum, with arrears of payments running over $5 billion, this subsidy is simply unsustainable. Besides, all well run economies around the World have since moved away from communist-style subsidies that neither enhance productivity nor even truly reach the intended audience. Infact, diesel which is the fuel for mass transit vehicles and electricity generators in Nigeria has been deregulated for over five years. No sensible case can be made for the huge subsidy on PMS and Kerosene, which effect does not even get down to the entire populace.

Deregulation vs Subsidy Removal
My real worry, however, is that what is being discussed today as deregulation is actually subsidy removal as an end in itself and not a means to the solution.

Government’s broad plans are to withdraw the subsidy, move to market prices for Petroleum products and hope that this singular action will open up the downstream to fresh investments in refining and distribution. In the process, Government would save some $7 billion per year which can then be applied to fund some palliatives and win over the populace.

This will be catastrophic!

As the subsidy is withdrawn (for this must happen first to catalyse other actions) the Honourable Minister must announce a clear time-table of twenty four to thirty six months during which the refining and distribution bottlenecks would be fully addressed. The promise, therefore, would not be the palliatives but a commitment to providing a final solution to the downstream problems such that the initial pains that the populace would have to bear would last only 24 months.

How will the Honorable Minister deliver on these strong promises?

The refining business is tough business (high capital outlay and relatively low margins) which is why very few new refineries are being built around the world. Therefore, the mere removal of subsidies will not bring Refiners scampering to Nigerian to invest in new facilities. The Minister has to induce the process, particularly with the short time frame available to deliver. My prescriptions are outlined below:

• Spin off two of the four refineries to Private Operators, leaving two with NNPC to test their ability in a competitive environment. In order to take full control of the process and avoid the pitfalls of our privatization bureacracy, I suggest that the minister invites four of Nigeria’s multinational Joint Venture/ PSC Partners(namely ExxonMobil, TOTAL, Chevron, Shell or Eni) for negotiations along the following lines:

– A technical audit and valuation of the refineries to determine the value of each of them as is today. It will determine what it would cost to completely revamp each refinery and bring it up to world – class operating standards. The current value of the refinery (including land, buildings etc) will be the Equity contribution of NNPC, the Nigerian state hydrocarbon company, which represents the government in this transaction, while the JV Partner funds the revamp as their equity Contribution. Thus the new refinery would be owned by NNPC and the new technical partner in the equity ratios so derived while the technical partner operates the facility. Both parties will agree a firm time-table for achieving this, bearing in mind the promise made to the Nigerian public. I believe that between Shell, Chevron, ExxonMobil, TOTAL, Eni, Phillips, Statoil and BP the minister can pick two willing partners that can genuinely commit to delivering the rehabilitation programme. The Nigerian petroleum ministry has the tools to get them to work with these companies as there are always negotiations regarding one project or the other for which these companies want some concession, a waiver or the other from the ministry. It’s a time honored rule: “you give me this, I give you that”.

This approach will deliver some 250,000bbls of efficient refining capacity in a very short time frame and create the market confidence necessary to spur further private investments in the sector.

• Simultaneously as the above steps are being implemented, spin off the distribution Network as a private sector run enterprise with the following ownership structure:

NNPC – 25%
Major Marketers – 20%
Independent Marketers – 20%
Refinery Owners – 20%
Other Investors – 15%

A technical Partner/Operator would be appointed to run the facilities on a commercial basis in a manner similar to the NLNG arrangement-which is a profitable Incorporated Joint Venture. NNPC will capitalize the existing facilities as their equity contribution while all other shareholders will contribute cash equity which will be utilized to completely revamp the existing nineteen depots and pipeline network as well as receiving facilities in Lagos, Port Harcourt and Calabar.

Once this is done, the Petroleum Equalisation Fund and PPPRA would be collapsed into one downstream regulatory agency that will license and supervise all downstream operators, ensure equitable open access to the distribution network and ensure a fair market-driven pricing mechanism.

These steps, though fairly easy to implement, would require a lot of courage, drive and political will. You are likely to be advised that NNPC can, and should be allowed to revamp the refineries and the distribution facilities. Their failure to do so for twenty years now is not because they had no access to the original manufacturers of the facilities or because there are no knowledgeable individuals in NNPC. Government institutions with their inherent beaurocracy and political controls simply do not have the structure, culture and discipline to run commercial enterprises. It would not be the first time NNPC would embark on fruitless turn-around maintenance nor a dreamy promise of turning PPMC into an efficient, commercial entity. Like other enterprises before them (Nigeria Airways, PHCN, NITEL) they will fail and be eventually reduced to scrap value. The time to revamp them and retrieve optimal value from them is now.

Thank you.

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