Lessons for East Africa from Nigeria fuel crisis on how to handle subsidies

The Nigerian government took a major political gamble and withdrew petroleum fuels subsidies on New Year day, resulting in pump prices increasing about two-folds.

The government action prompted public protests and union-led strikes. Later talks between the unions and the government resulted in price reductions that reinstated about half of the subsidies, but with a message that the rest would be withdrawn over time.

Fuel subsidies are when a government, for whatever social or fiscal reason, undertakes to absorb part of actual petroleum supply costs resulting in lower prices.

In Nigeria oil products are also tax-free.

Before the withdrawal of subsidies, gasoline pump price in Nigeria was about Sh38 a litre compared with Sh107 a litre in Kenya. The subsidies were estimated to cost the Nigeria about $8 billion annually, at a time when it is said to have difficulties in funding infrastructure and social projects.

Nigeria is a key producer and exporter of oil with production of about 2.2 million barrels a day. The irony is that in spite of the endowment with oil resources, the country is a net importer of refined petroleum products.

Nigeria has four refineries owned by the National Petroleum Company with an installed capacity of 445,000 barrels a day.

Its demand for petroleum is about 325,000 barrels a day, which implies that if the refineries were processing at full capacity there would be a surplus for export. Over years, the refineries have been neglected (deliberately or otherwise) without essential maintenance or facility upgrade. As a result, they operate below capacity leaving petroleum imports as the primary supply option.

Here then lies the origin of subsidies as the government decided to top up the difference between local ex-refinery costs and products import value. The government pays importers the cost difference. Many opportunists including briefcase firms have become importers of oil.

It is alleged that imports are over-invoiced by inflating costs; some products imported are never received; others “disappear” once received; while some are re-exported at high profits to neighbouring countries resulting in local shortages. Suspicion of high level corruption in the oil import business is abound.

Subsidies are common in oil producing countries and there is nothing wrong with them as long as they are supported with sound policies.

If an oil producing country is seeking supplementary funding through the Bretton Woods institutions, and yet it subsidises fuel, the chances are that a key condition for budgetary support would be that it institutes reforms to withdraw subsidies. This appears to be what has happened in the case of Nigeria.
Nigeria has been a perfect case study of what can go wrong when an oil producing country does not have policies and strategies that reflect full transparency and accountability in management of the resource.

The country appears to have, over time, allowed entrenched vested interests to interfere with the efficient management and regulation of the petroleum sector, resulting in an industry that, in most cases, cannot answer to sensible business or regulatory logic.

Whereas the argument that the removal of subsidies would provide the government with funds for social economic development, Nigerians do not appear to trust that the money saved would translate into tangible benefits because of alleged systemic corruption. Nigerians instead prefer to keep what they already have, and that is subsidised fuels.

President Goodluck Jonathan has won the initial political gamble by pushing through a partial removal of subsidies. By so doing he has made a strong reform message. He will, however, need to immediately follow this through with concrete oil industry reforms that would re-establish free market principles, and that reduce direct government involvement.