The Petroleum Subsidy Trap and The Way Forward

Ahmed Adamu, PhD

Lack of refining capacities and Petroleum subsidies have caused Nigeria to lose significant foreign exchange and its ability to fund infrastructural development.

The Nigerian government’s share of crude oil averaged around 900k barrels per day in 2021, and at least 70% of that was exchanged for petroleum products, which means only 30% of our crude oil exports brought back dollars.

Going by the above, Nigeria received an average of only $20 million per day from oil exports in 2021. On the other hand, Nigeria loses a minimum of $45 million cash to crude oil swaps every day.

Instead of receiving dollars after selling our crude oil, we receive refined petroleum to fill the local refining capacity deficiencies and meet the outrageous local petrol demand.

That has caused the flow of foreign exchange into Nigeria to reduce drastically, which caused the deterioration of our foreign exchange reserve, dollar scarcity, Naira devaluation, and hence inflation. That is the cost of not having sufficient local refineries.

On top of that, the Nigerian government is spending more than N150 billion monthly on petroleum subsidies. These funds would have been for infrastructural development and job creation programs. Nigerian government loses a significant amount of revenue due to petroleum regulation.

The subsidy also leads to serious supply leakages, where more than 40% of subsidized petroleum is being arbitraged in neighboring countries. Nigeria is creating a business opportunity for rent-seekers to buy the Nigerian subsidized petrol and then sell it at an expensive market to make a profit. This is a big revenue leakage that petroleum subsidy causes.

Petroleum Subsidy is an “evil necessity” at the moment; Despite the above challenges, the government must continue with petroleum subsidy. There is no doubt that the petroleum subsidy is not sustainable for now, but the question is when and how to remove it?

In the meantime, Nigerians cannot afford the unsubsidized price of petrol. Without petroleum subsidies, petrol prices will be more susceptible to fluctuations in crude oil prices and exchange rates. Prices at filling stations will fluctuate to any change in the exchange rate and crude oil price. These fluctuations could happen on daily basis.

The deregulated petrol price will be anything above N300 per liter at the moment; this will cause further inflation because everything links to the petrol price. The resultant inflation will harm the economy more than the subsidy harms the economy at the moment. Now, this is the trap.

Now, to answer when to remove subsidy. The best time to remove petroleum subsidy is when there is a minimum of 500k barrels per day of local refining capacities, when the exchange rate is stable, and when inflation is at a single digit.

Dangote refinery is still at a “maybe” state; there is no specific time when it is likely to start operating, but if it does, it will help satisfy the first and most important condition.

Achieving the first condition will enable us to achieve the second condition of exchange rate stability, but that has to be complemented with import substitution strategies. Fulfilling the first and second conditions will automatically make the third condition achievable.

But the how-to remove the subsidy is the main question. We have options of targetted subsidy or quota subsidy as phasing out strategies. Let us look at the targeted subsidy strategy first.

Under this regime; any Nigerian that wants to benefit from the petroleum subsidy will have to enroll in the subsidy program, where his biometric data will be collected and linked to his vehicle details. A person will receive an electronic sticker that will be scanned to verify his national identity, biometric data, and vehicle specifications at the point of purchasing the subsidized petrol.

Petrol stations will have to enroll in this subsidy regime, and it is only the affiliated filling stations that will be selling the subsidized petrol. The government should incentivize filling stations to sign up for the subsidy regime.

Other filling stations that did not join the program will be selling the petrol at the market price. So, you will have two sets of filling stations: the ones that sell at a subsidized price and the others that do not.

Nigerians that can afford the unsubsidized petrol will conveniently buy from the unaffiliated filling stations. While others will have to consume at the filling stations that signed up for the subsidy program. That is why the government should ensure many filling stations, especially in the rural areas signed up for the program.

By doing that, the consumption of subsidized petroleum will be limited to only Nigerians and the subsidy spending will reduce drastically. The government may target a certain subsidy payment threshold every month. Every beneficiary should have a maximum number of allocated liters per month to avoid round-tripping.

By implementing this, only less than 30 million liters per day will be subsidized, as against the reported 70 million liters, which automatically makes the Nigerian government save up to N90 billion every month and still provide the subsidy to the poor people.

Another alternative phasing out strategy is the quota subsidy, where a certain number of liters are allocated proportionately to categories of consumers monthly. The consumer categories will include commercial vehicle users, industrial vehicle users, and private vehicle users.

This will narrow down the subsidy more to the poor and consumer goods production processes. The need for the government to fund palliatives may not arise, as the masses will continue to enjoy the subsidy.

Finally, the savings from the reduction in subsidy spending may be used for railway construction to interlink the country for easier and cheaper transportation. This will translate into cheaper consumer products. The government should stop giving cash palliatives but implement capital projects that ease businesses.

The government should be honest and transparent in dealing with petroleum subsidy issues. Delaying the subsidy removal until after the election is purely political, unpatriotic, and patronizing. Punishing Nigerians after using them for electoral votes is treason.

Ahmed Adamu, PhD
Petroleum Economist
ahmadadamu1@gmail.com