Eurasia Commentary: Fuel deregulation shows Buhari administration’s renewed appetite for reform

The partial deregulation of the down stream sector of Nigeria’s oil industry is broadly in line with our expectations, though we thought the Buhari administration would move more quickly to end the fuel subsidies.

The decision to raise the fuel price from a set rate of N86 per liter to N145 per liter is a big policy shift. It was borne of economic necessity in the face of widespread shortages, price disparities across the country, arbitrage, flouting of the N86 set price, and constraints on limited foreign exchange reserves. While the cost of fuel subsidies had fallen some with the decline in oil prices, fuel imports nevertheless cost $5 billion last year, $7 billion in 2013 and $13 billion in 2011 at its height, when subsidy corruption was completely unchecked.

President Buhari, had until recently expressed misgivings about the costs to the ‘ordinary man’ (also his chief concern on devaluation), but economic necessities forced the policy reversal. The new ceiling was championed by NNPC head and Vice Petroleum Minister, Ike Kachikwu and shows a willingness by Buhari to listen, eventually, to pragmatic technocrats.

The policy does not amount to full deregulation: it maintains a price ceiling, albeit about 67% higher than the set price. The fuel subsidies (which have no funding in the 2016 budget) could still return if global oil prices rise sharply. Opting for a price ceiling model, rather than full deregulation, underscores the administration’s concern of a political fallout from the new policy. After all, former President Goodluck Jonathan faced two weeks of nationwide protests and strikes after temporarily scrapping fuel subsidies in 2012. Union confederations like the Trade Union Congress, along with civil society and aggrieved citizens mobilised a nationwide protest that forced Jonathan to reinstate about half of the subsidy. That may have been a turning point in Jonathan’s administration, helping to propel Buhari to power last year.

This time we are unlikely to see such a show of resistance. The opposition People’s Democratic Party (PDP) will probably look to foment protests in its base regions like the oil-rich Delta. This bears watching but the PDP is dramatically weakened as a political force. The Buhari administration has reportedly consulted with unions and others, gaining grudging acceptance. Unlike the prior administration, which was widely seen as enabling corruption in the subsidy regime, the Buhari is committed to the fight against corruption. The backlash last time was triggered by the sudden, unannounced price hike primarily but also by widespread disgust over corruption.

Also this time, the price increase may not be as jarring (prices nearly doubled in 2012) since fuel sellers have routinely flouted the set price—in March, the average cost of fuel nationwide was about N137. That also implies that the inflationary impact, while real — and problematic at 12.8% – may not be as large as the differential in price points might indicate. Analysts generally expect the price to trade around a band of N135-145 now, not that far from the estimated N137 average. While there is widespread disgust over the fuel market, commuters are as frustrated by the scarcity and long ques as by prices; the partial deregulation should alleviate the scarcity problem, at least over time.
Central bank will review, and likely amend, the foreign exchange regime later this month

The fuel crisis, among other factors, is forcing the Buhari administration to reconsider its increasingly untenable naira policy. Officials understand that foreign exchange scarcity has contributed directly to the fuel shortages. They are getting an earful from both domestic and foreign investors about other negative repercussions, including layoffs, rising inflation, capital flight, ‘round-tripping’ by those lucky enough to have access to the official rate, and slowing growth.

Vice President Yemi Osinbajo (who heads the administration’s economic team) acknowledged to Reuters that the administration is undertaking a “substantial revaluation” of its currency policies, presumably in coordination with the central bank. He declined to say whether this means there will be much-awaited devaluation. We expect the MPC on 23-24 May to consider various options, including maintaining the status quo (somewhat unlikely), adopting a new currency band with a midpoint around N220-230/$, or announcing a dual exchange rate regime of some sort. The modalities of a dual system are unclear but would probably differentiate priority goods (raw materials and other ‘essential’ goods) that would have access to the official rate from non-priority items at weaker rate, like N240-250/$. This would be a partial measure, at best, and would not quickly clear the foreign exchange backlog or import demand, especially as the administration would likely retain its foreign exchange ban on select imports.

This would in effect create a three tiered system; with the parallel rate (currently at around N324/dollar) remaining for restricted goods. The tier system would allow for more tinkering with policy to attempt to stem outflows (which the central bank has favored in the past months). While market participants are skeptical of such a regime, it would probably be an improvement from the status quo.