A Commentary on the Modulation of the Prices of Petroleum Products in Nigeria - Dr. Emmanuel Ojameruaye

The purpose of this article is to examine the concept of “modulation of the prices of petroleum products” as recently espoused by the Minister of State for Petroleum Resources, and to offer some suggestions on how the process can be managed to ensure adequate supply of petroleum products at reasonable prices and on a sustainable basis while avoiding the pitfalls of the subsidy regime.  In this first part, I discuss the concept of price modulation as I see it. In the second part, I will compare price modulation with the pricing under the subsidy regime and removal of subsidies, and then suggest how the price modulation process can be managed effectively and efficiently. Read more at:

 

After over 30 years of subsidizing petroleum products by the federal government, most economists and many other professionals now agree that the policy has been a dismal failure. The subsidy regime or policy has been ineffective and inefficient, and has been characterized by frequent shortages and hoarding of petroleum products, selling of products at prices that are far higher than the official pump prices, corruption and sharp practices such as smuggling, round-tripping and adulteration of products. It has also significantly reduced revenue allocation to all tiers of government due to mounting subsidy payment which is first-line charge on the federation account. This has in turn reduced investment in critical social infrastructure. Furthermore, the subsidy regime has been responsible for the dismal functioning of the existing local refineries and has discouraged new public and private investment in local refining.  In fact, the costs of the policy have far outweighed its benefits (see my Chapters 2 and 5 in The Politics of Subsidizing Petroleum Products in Nigeria, Edited by Jideofor Adibe, Adonis & Abbey Publishers Ltd, 2013). 

 

In view of the above, many economists and observers expected that the Buhari administration would use its political capital to eliminate the existing fuel subsidies within the first six months of the administration as part of its Change Agenda, even though President Buhari did not promise to do so during his electioneering campaign. In fact, while some members of the administration and some leaders of the ruling APC have been advocating for the removal of the subsidies, the President and some other members of his administration have been very reticent on the issue because of the likely inflationary impact and the backlash from labour unions and the “subsidy cabal” that has been benefiting massively from the subsidy payments. The fact, however, is that for most part of past six months, consumers of petroleum products have been experiencing severe scarcity of the products and have been paying prices far higher than the regulated prices and “expected open market” prices.   It is against this background that one must commend the recent statements by the Minister of State for Petroleum Resources and Group Managing Director of the NNPC, Dr. Emmmauel Ibe Kachikwu, that effective January, 2016, the prices of petroleum products in Nigeria will be “modulated” to ensure efficiency and availability of the products.  However, the minister appears to have been vague and incoherent as to the true meaning of “price modulation” and how it relates to the vexed issue of removal of subsidies. It is also not clear how the “price modulation” will stop the ills that have plagued the Nigerian petroleum products market over the past 30 years.

 

From the statements credited to the minister, it is clear that he does not equate price modulation with the deregulation of petroleum prices or removal of subsidy. What then is price modulation? Before answering this question, let us look at the evolution of the concept by the minister. The minister first came up with concept of price modulation when he addressed newsmen on Thursday, December 17, 2015 in Abuja. He stated that the Federal Government would focus on price modulation of petroleum products to ensure efficiency and provision of the products and he noted that the price modulation has nothing to do with the removal or existence of subsidy. According to him, “There is too much emotion around subsidy issue, but our focus is that the Federal Government should not spend as much as it spends every year on subsidy”. He further said that the NNPC would review the template of the Petroleum Products Pricing Regulatory Agency (PPPRA) and achieve reduction in the cost for clearing petroleum products. He stated that “If we take this analysis, we can deliver products today with the price of oil where it is…It is not that we have removed subsidy but the application of market forces will enable you to sell products as close to the prices we have today”. He also said for the purpose of the modulation a band had been approved between N87 and N97 per litre but the price would no longer be fixed and that the price of crude would continue to determine what the price of product would be.

 

Later during his tour of the Port Harcourt Refinery on December 26, the minister told journalists that the Federal Government would soon release the new price template of the Petroleum Product Pricing Regulation Agency (PPPRA) and that he had approved a new price template for the agency. He stated that “we have done a modulation calculation and it is showing us below N87…I signed off on it (a new pricing template) yesterday (Thursday). I imagined that in the next couple of days the marketers would get advice on that”. He then stated that from the application market realities for the pricing modulation, government has discovered that petrol would sell for either N85 or N86 per litre. He also indicated that the federal government has decided to scrap the Petroleum Support Fund (oil subsidy) because government can no longer afford to subsidize the product following the fraud that has attended its operation.

 

Then on December 27, 2015 during an inspection tour of the Kaduna Refinery and Petrochemical Company (KRPC) he made what seemed like a “clarification” of his earlier statement. Contrary to the perception created on in Port Harcourt that the price of petrol would be reduced to N85 per litre effective January 1, the minister stated a new official price of petrol “will be adjusted within the modulating band of N87 per litre to N97 per litre in accordance with the international price of crude oil”.  He further stated that the price of petrol could go either way noting that “it may be increased above the current selling price or may be reduced below the current selling price all things being equal…If there is an increase or decrease in the price of crude oil, we will make the necessary adjustment, so in January 2016, we will announce the new price of petrol in accordance with trends in the market.” He further stated that “Today, there is no subsidy, we are selling products at N87. In January, we will look at what the trend is and we will announce prices, if that is less than N87, we will announce it and if it is more than that, we will have to announce it…But we are not going to be adjusting prices on a day-to-day basis, we are going to take like an average price and I think that today when you look at prices, we have no subsidy.”

 

It is evident from the above that the minister has not given a precise definition of the concept of price modulation and how the process will work. Neither has the concept and process been explained on NNPC or PPPRA website. Therefore, in what follows, I will attempt to propound my own theory of price modulation on the basis of my inferences from the minister’s statements.

 

The term price modulation is rarely used in economics. In fact, it appears to be new in Nigerian economics lexicon and some analyst have referred to it as a “petrolese” term. I am not aware of any precise definition of the term or the process, but one can infer what it means by examining the meaning of “modulation” which is a term used mainly in music, electronics and telecommunication.  In music, modulation is “the act or process of changing from one key to another”. In electronics and telecommunication, modulation is “the addition of information to an electronic or optical carrier signal” or “the process of varying one or more properties of a periodic waveform, called the carrier signal, with a modulating signal that typically contains information to be transmitted”.  On the other hand, modulation is generally defined as “regulating according to measure or proportion”. (Online Merriam Webster dictionary). Therefore, modulation is synonymous with “regulation” and “control” and it is safe to state that “price modulation” is a form of price control or price regulation. It is therefore different from price deregulation which is the outcome of the removal of subsidies.

 

Under subsidy regime, the pump price of each petroleum product is fixed for a long period of time irrespective of the “expected open market price” (EOMP) of the product which changes with changes in the import (spot market) price of the product or the “real” cost of producing the product locally. For instance, based on the PPPRA pricing template, the EOMP of petrol has been N87 per litre since 2012 while that of kerosene has been N50 per litre. This is in spite of the daily/weekly/monthly fluctuations (changes) in the import price of the products.  Under price modulation, the pump price of each product will not be fixed for a long period of time; it will “modulated” or changed based on changes in the import price of the products and other determinants of the EOMP. However, the change in the pump prices will not necessarily be equal to the changes in the import price, and the pump price will not necessarily be equal to the EOMP. So under price modulation, there could still be subsidy if government decides that the modulated pump price should be less than the EOMP. If the EOMP is low due to low import prices, the government can also decide to add a tax (such as highway tax) to the pump price, in which case the pump price will be greater than the EOMP. The idea behind price modulation is to ensure that the pump price of each product reflects market conditions to a large extent, but not completely. In order words, the pump price will be a “stochastic” function of the import price (and/or real cost of producing the products locally), but not necessarily equal to the import price plus industry margin plus tax which will be the case when subsidies are removed. I will return to this later after examining an alternative definition that was recently posted by Dr. Izielen Agbon (see http://www.chidoonumah.com/fuel-subsidy-removal-and-fuel-price-increase-by-imf-price-modulation )

 

In the above referenced article Dr. Agbon posited that:

“The New 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. The strategy recommended an automatic price change mechanism that changes price slowly. Price modulation means that government will ensure initial slow price increases by regulating the components of fuel price such as taxes, freight, margins, transport, storage and bridging. The slow fuel price increase will reduce immediate mobilization and opposition. There will be no direct government regulation of fuel prices. Rather, the marketers and traders will fix the final fuel price. Price modulation fixes the bottom commodity price in a market by tweaking price components. PPPRA will fix the minimum fuel price and the fuel cabal/marketers can sell at whatever price the customer will pay... Price modulation ignores corrupt practices and allows the fuel cabal to pass the cost of corruption to the masses”.

 

Dr. Agbon went further to state that “the new subsidy removal or fuel price increase by price modulation” is the outcome of the meetings held in Abuja and Lagos in December 2014 by IMF staff and officials of the Nigerian government (Jonathan’s administration). The report of the meeting stated among other things, that “Lower oil prices provide an opportunity to phase out fuel subsidies. The recent drop in crude oil prices (and lower petrol and kerosene prices) could facilitate the completion of the subsidy reform, which started in 2012. (IMF) Staff recommends introducing an independent price-setting mechanism to smoothly pass through international price changes to domestic prices and gradually eliminate fuel subsidies….”, The report further states that the officials of Nigerian government (Jonathan administration) “expressed their commitment to subsidy reform, and indicated they were considering options, timing, and modalities of implementing these reforms in light of the decline in oil prices.”  (See IMF Country Report No. 15/84, Nigeria 2014 Article IV Consultation – Staff Report, Press Release and Statement by the Executive Director of Nigeria, March). In other words, if Dr. Jonathan had been re-elected, he would have removed the subsidies sooner or later.  It is however important to note that that the IMF report referenced above did not contain the words “price modulation” or “new subsidy removal or fuel price increase by price modulation”, as inferred by Dr. Agbon. Furthermore, there is no indication that the Buhari administration has accepted the IMF report referenced above or if the minister’s statements on price modulation are based on the IMF report or recommendations.  Although the minister has not yet elucidated the proposed price modulation, reading in between the lines of his statements, I think it is different from the definition and description offered by Dr. Agbon above.

In my opinion, the proposed price modulation will or should work as follows. Using the PPPRA pricing template, we can state that:

 

1.            EOMP = LC + DM = MP + TM + LE + NP + FN + JD + ST + RM + TM + LM + BF + MT + AM

2.            LC = MP + TM + LE + NP + FN + JD + ST        

3.            DM = RM + TM + LM + BF + MT + AM

4.            PP = EOMP – S + T     

                  

where EOMP = expected open market price), PP = retail (pump) price,  MP = cost plus freight (i.e. import price of product offshore Nigeria), TM = trader’s margin, LE = lithering expenses, NP = Nigerian Ports Authority charges, FN = financing charge, JD – jetty depot thru’put charge, ST = storage charge, RM = retailers’ margin, TM = transporters’ margin, LM = dealers’ margin, BF = bridging fund charge, MT = marine transport average, AM = administrative charge. S = under recovery (subsidy), T= Taxes, LC = landing cost, DM = distribution margin Equations 1, 2 and 3 show the composition of the expected open market price (EOMP), landing cost (LC) and distribution margin (DM) of each product.  Equation 4 states that the pump (retail) price is EOMP less subsidy plus taxes. If there is no tax (i.e. T = 0, as is currently the case), PP = EOMP – S or S = EOMP – PP.  If subsidy is removed, PP =EOMP. If government decides to remove subsidy (S=0) and impose tax (per litre), PP = EOMP +T.

 

The major component of EOMP is import price MP (cost and freight). In the latest PPPRA pricing template for gasoline (PMS) published on December 24, 2015, MP was N67.34 which was 73% of the EOMP (N93.45). The other components of landing cost N10.62 or 11% of the EOMP, while distribution margin was N15 or 16% of the EOMP. Apart from the import price (MP) which fluctuates daily/weekly/monthly depending on the forces of demand and supply in the global petroleum products market, all the other components of the EOMP are administratively determined, and can therefore be “modulated” within certain ranges. For instance, government can reduce the lithering expenses, storage charge, the retailers’ margin, the transporters margin, the dealers’ margin and the bridging fund charge. As I have argued in the past (see Ojameruaye, E.O., 2013. A Second-Best Framework for Petroleum Products Pricing in Nigeria. Nigerian Journal of Social and Economic Studies. Vol. 55 No. 1, 2013: 191- 195), most of these charges are “overpriced” at levels that are exceptionally favorable to the “service providers”, thus resulting in predatory pricing and excessive subsidy payment. For instance, assuming that the other components of landing cost can be reduced from N10.62 per litre to N7.66 per litre and the distribution margin from N15 per litre to N11 per litre, then EOMP of PMS will be N86 per litre. Perhaps, this is close to what the minister and his team have done under the so-called price modulation process which has not only effectively eliminated subsidy for the month of January if import prices remain at the December level but has in fact imposed a tax of N1 per litre if the PP is fixed at N86 per litre in January. However, if the import price changes, the pump price can be modulated accordingly, say on a monthly basis using the average monthly import price or the median monthly price (i.e. price on the 15^th of the month) in the previous month. For instance, if the average import price in January (or the price on the 15^th of the month) is N60 per litre (down from N67.34 in December), then the EOMP in February will be N60 + N7.66 + N10 = N77.66 per litre, and the government may decide to fix or modulate PP at N80 per litre thus retaining a tax of N2.34 per litre. On the other hand, if the average price is January is N80 per litre (up from N67.34), then the EOMP will be N80 + N7.66 + N10 = N97.66, and the government may decide to fix or modulate PP at N95 per litre, thus making a subsidy of N2.66 per litre or the government may decide to fix PP at N97.66 and avoid subsidizing. Of course, the modulation can be done on a daily or weekly to avoid sharp changes in PP, but for a start, a monthly modulation may be preferred.  The government may choose to do the modulation on a quarterly basis. However, the longer the period in between two modulations, the larger will be the difference between pump price and the expected open market price, and hence, the greater the market distortion.

In view of the above, we can conclude that price modulation of petroleum is not synonymous with removal of subsidy. It is not a “new subsidy removal”. Prices can be modulated by government in a way that retains small amount or subsidy or taxes or removes subsidy. It depends on the import prices of petroleum products (or the cost of producing the products by local refineries). If import price is low (or below a certain threshold), the government may decide to reduce or retain the pump price while imposing a small tax so that the pump price will be greater than the EOMP. On the other hand if the import price is high (or higher than a threshold), the government may decide to increase or retain the pump price (at level below the EOMP) and provide a small subsidy. The bottom line of price modulation is to ensure that the pump price of each product moves in the direction of the import price (or cost of production by local refineries), although not necessarily proportionately.   

 

Having described what I think price modulation means, we must address three questions. The first is whether price modulation is better than the removal of subsidy or the current subsidy regime. Secondly, can price modulation cure the ills of the subsidy regime? Thirdly, how can the price modulation process be managed to ensure availability of petroleum products on a sustainable basis at reasonable prices throughout the country? We will answer these questions in part 2 of this paper. Stay tuned.

 

Dr. Emmanuel Ojameruaye, lives is in Phoenix, Arizona, USA,

emmaojameruaye@yahoo.com

December 29, 2015

 

Postscript: As I was about to post this article, I read the breaking news that the Petroleum Products Pricing Regulatory Agency (PPPRA) has announced that a new “modulated” price of N86 per litre for petrol in NNPC retail outlets (filling stations) and N86.5 in non-NNPC retail outlets through the country from January 1 till March 31, under a revised pricing template. Curiously the announcement is silent on other petroleum products. I will also discuss the implications of this announcement in part 2 of this article.