In favour of an elastic band (for the fuel price)

The authorities have made a bold step with the new pricing regime for premium motor spirit (PMS). The latest published template of the Petroleum Products Pricing Regulatory Agency (PPPRA) for 19 May puts the price of PMS at N140.0/litre and sets the retail price band at between N135 and N145 per litre. The agency’s document to explain the new regime raises interesting questions as to pricing, supply, cross-border trade, inflation, and the FGN’s skills in public relations. Additionally, there is the matter of whether the new regime brings forward the devaluation of the naira exchange rate.

After the announcement of the new regime, government officials explained that the underlying calculations were based on an exchange rate of N285 per US dollar. Since the parallel rate was then hovering around N330, we have to conclude that the assumptions are of a blended rate. Yet the agency’s document is adamant that marketers are to source fx independently of the CBN. So we have to assume that they are blending the parallel rate with fx obtained from the IOCs and other sources. The alternative (and unlikely) explanation is that the marketers are making a loss from selling PMS at N145/litre.

 

On supply, the document states that the regime will bring products to all consumers across the country. We see official estimates that national daily consumption amounts to 45 million litres and that product imports cost US$18m per day. The figure for consumption looks high in our view and that for imports low in the context of balance of payments trends. That said, the question becomes whether supply on the parallel market is on a scale to meet this demand. If it is, other buyers are likely to miss out. We think that this is the weakest point of the new policy.

 

Related to supply is the issue of crossborder smuggling. The document accepts that the new price still leaves Nigerian fuel among the cheapest in the sub-region. We think that the smuggling will ease because marketers no longer have the battle to recover subsidy payments from the FGN and now have what is seemingly a profitable business model. It is also significant that the price of PMS in the neighbouring Benin Republic is very similar to the new band in Nigeria.

 

Opponents of subsidy removal have always warned of the inflationary impact. This has been overstated. The National Bureau of Statistics has a monthly price watch for the price of PMS at the pump across the country: the April report has the average price below the current ceiling on N145 in just ten states of the federation (including Lagos). Prices in the remaining states were driven by scarcity and entrepreneurship. Another risk to the new regime is non-compliance.

 

This has been a bold move, and one that the authorities have managed well. When we recall the sequence of events in January 2012, when the FGN last attempted fuel price deregulation, we can see some lessons learnt. The mass protest by organized labour did not materialise. Perhaps this administration enjoys more popular goodwill than its predecessor or perhaps Nigerians have embraced Tina (there is no alternative). If we think that public relations make a difference, we should note how the new regime has been packaged.

 

The document does not say that subsidies have been removed, only that there is no provision for them in the 2016 budget. Of more substance, it cites Tina and notes that crude prices in April had risen to the point that substantial subsidy payments were looming. It also highlights the dramatic increase in pipeline sabotage as grounds for its action. The new regime, the argument runs, enables the FGN to meet its obligations on health and education spending.

 

The FGN’s vision is that the new price regime will, over time, create 200,000 new jobs in refining and retail. It expects that Nigeria will become a net exporter of fuel by 2019. (The Dangote operation in Lagos State is set to start production in early 2018.) Self-sufficiency has to be the objective in our view because of the benefits for employment, the balance of payments, the public finances and governance.

 

We feel that the vision is plausible and are more concerned by fuel supplies over the next 12 to 18 months. We like the new regime and have three principal concerns. By definition, nobody knows the size of the parallel market so we cannot be confident that it will meet marketers’ demand in full. This, in turn, leads on to the inflationary impact of inadequate supply. We also await the critical point when the template price rises above the retail price band, and trust that the band will be adjusted accordingly.

 

It has been said that the new regime legitimizes the parallel market and therefore brings forward currency devaluation. We are not so sure. Although we continue to see a modest devaluation by year-end, the CBN can “get by” for many months with its existing policies. Its supporting arguments remain valid other than the inflationary impact of devaluation. (The MPC has held firm and yet the headline measure has increased by four percentage points y/y in just three months.) Tina may have been responsible for the new pricing regime but does not yet set exchange-rate policy.

 

 Gregory Kronsten