How To Deregulate Downstream Sector Efficiently, By Esele

Being a presentation of President of  Trade Union Congress of Nigeria (TUC), Comrade Peter Esele, at a  public hearing organised by the House of Reps on the fuel subsidy removal policy on Monday, Jan. 23.

Introduction

THE government is implementing a policy to remove the subsidy on Petroleum Motor Spirit (PMS) because it argues that the level of subsidy being paid by government is not sustainable particularly as subsidy payment now exceeds the annual capital budget of the Federal government.

Government also makes the case that it is important to deregulate the downstream sector of the petroleum industry and by implication allow market forces to determine the pump price. This will enable government to completely get out of the sector so that it can be fully market driven. It is easily agreed that the subsidy that government declares as paid annually is extremely high and not sustainable without it busting the budget. It is also not indisputable that deregulation of the downstream sector will encourage the investment on new refineries and product reception and Distribution infrastructure with all the attendant benefits. However, deregulation and or subsidy removal have to be planned and executed very carefully so that the desired objective is attained.

A shoddy implementation will mean a deplorable setback for all the stakeholders in the industry. This is why my humble self,  the TUC that I lead and the NLC continue to stand firm that government must have a definitive agenda for this programme in order to guarantee its  complete success which will consequently establish a solid foundation for economic growth of the nation.

It should be established from the onset some of the imperatives that are ignored or swept under the carpet by those who are less informed that blur the debate on this issue. Establishing clarity on these issues will make it easy for government to craft the road map towards the efficient delivery of the programme and to earn the people’s trust through a transparent compact that delivers positive dividends to the people. These imperatives are:

Subsidy on petroleum products is removed by a price increase. It is therefore imperative that the level of subsidy is transparently established otherwise the people will see the policy as efforts by the government to under change them;

Price increase does not necessarily equate with deregulation. Deregulation at a point where there is no subsidy on PMS, for example, will need to be underpinned by competition which is the only way to achieve cost control and efficiency in the sector;

Deregulation that jerks up the price a product but is not underpinned as discussed above amounts to a punitive price increase that transfers the burden of paying the subsidy from government’s pocket to the private pockets of the citizens;

A Price increase that happens outside a truly deregulated environment means that the head of the snake is scourged; the snake is alive and will strike another day. This means that a price increase not backed by deregulation will cause another subsidy debate and skirmish further down the road. And this is not in the interest of all the stakeholders.

If the subsidy is not a real cost that is efficiently incurred but represented by inefficiency and or corruption, the people still end up paying for it in the long run as it becomes a direct opportunity cost of capital formation and a discount of the quality and level of services that the government delivers to the citizens: and

If the people end up paying, in the final analysis, directly from their private pockets at the pump station or by the budget deficiency that it creates if the government pays, it become important that the people should reject the inefficiency and corruption that is necessarily embedded in the price irrespective of who is paying

The people therefore have an inalienable right that the government cleans up the mess before the policy of subsidy removal or deregulation is implemented.

The conclusion to be drawn from the above is that deregulation of the downstream sector is the answer. If such deregulation is properly handled in an atmosphere where the inefficiency and corruption are expunged and a competitive environment is created, the result could be a price reduction and not a price increase. It is this upside potential to have a ‘Win Win’ deregulation which a properly planned and efficiently implemented deregulation engenders by delivering a price reduction rather than a price increase that is the focus of this paper.

 

Establishing the level of subsidy

The Petroleum Product Pricing Regulatory Agency (PPPRA) was set up by Act No 8 of May 2003 with the primary mission to eliminate the effect of volatility in international crude oil and products and stabilize domestic prices. It also aimed to guarantee effective products availability and distribution nationwide. The Petroleum Support Fund (PSF) Scheme was set up in 2006 to support the PPPRA mission and the PPPRA had the objective to entrench transparency and accountability in the administration of the Fund on petroleum products subsidy.

In administering the Fund, PPPRA instituted a pricing principle which in its own website is a principle “that engenders healthy competition among industry operators, encourages investment and the maintenance of international standards and practice “. In support of this principle, PPPRA created a template to determine the Landing cost of products.

This Landing cost is applied against the Government fixed ex-depot price of the petroleum product. The difference between the landing cost and the ex-depot price of imported petroleum products is the Subsidy.

By all accounts, the PPPRA has completely failed in its stated objective in the sense that

  •  The template is compiled with bloated costs that discourage competition, the pursuit of efficiency and cost control. Rather it is based on total cost recovery and opaque operations thereby encouraging massive corruption and padded economic rent both of which continuously increase subsidy;
  •  PPPRA has been unable to incontrovertibly establish the quantity of products consumed upon which subsidy is paid. Quantity consumed is a fundamental item of the subsidy equation. Failure on this is a confirmation of PPPRA’s failure on its stated mission; and
  •  To the extent that PPPRA does not insist that subsidy is claimed on confirmed consumed products, PPPRA is thereby, perhaps by collusion with the importers, paying subsidy on products that were never delivered, stolen and lost products and products that are round tripped.
  • It is because of the above that we believe that the PPPRA template is deceptive, anti competition and anti-people. This is why we call its Landing cost template ‘a weapon of mass destruction’.
  • In a regulated environment, the first step towards the injection of efficiency into operations is to have a robust template that encourages operators to compete. The present template does not do this.

 

The Adverse Impact Of PPPRA Template

In a rentier environment, which the PPPRA template entrenches the price that is paid for petroleum products is represented in the following equation:

Actual market price = Market driven cost + inefficiency + corruption + guaranteed profit

It should be borne in mind that the Actual market price is the PPPRA Landing Cost ,which, in itself, is represented in this equation:

Actual market price (Landing cost) = Pump price + subsidy

The above equation clarifies, the impact of inefficiency and corruption on price;

It is needless waste of resources for either government or the people to pay a corruption or inefficiency laden price for petroleum products ;

It behoves on the government to eliminate inefficiency and corruption from Landing cost of petroleum product

A removal of subsidy or deregulation without first addressing the inefficiency and corruption will only transfer the burden to the people and embolden the rent seekers to escalate their activities since the people do not possess the force that government has; and

Deregulation that does not entrench competition will amount to an oligopolistic environment where only the rentiers profit.

 

Creating a competition oriented template

The PPPRA template was crafted from the NNPC point of view and was therefore based on the following faulty parameters

That all costs should be recovered with a guaranteed margin. Of course, NNPC operates an inefficient downstream sector. This accounts for the over padded costs in the template. There is therefore no incentive for operators to be efficient. Those who strive to be efficient are awarded excess profit. This assumption, which forms the foundation of the template must be reversed.

NNPC operates across the entire downstream sector. Consequently, the template views costs holistically from a single source point of view. This is absolutely wrong and does not represent the activities in the downstream value chain. We consider this to be a wrong approach. The various segments of the business do get outsourced and should be considered as such. For example, NNPC outsources the importation process whilst marketing companies outsource the transportation and retail (dealership) element of product marketing.

In an outsourced basis, the most efficient parameters viz volume throughput, costs or rates should be used as standards and not the worst parameters as currently represented by a template that struggles unnecessarily to make NNPC whole. The standards should shut out the worst performers instead of their inefficient standard being applied as the standard for all.

Following from b above, the PPPRA template applies extensive standard costs in its input. A standard is a norm and whatever is considered normal can be used as a standard. The assumed standard level has a salutary effect on costs and their relationship to unit cost in a cost template like is applied by PPPRA because the theoretical standard set for a level of operations regarded as the ideal or maximum level of efficiency can have a distorting effect if the standard is not set at the correct level. Such a standard will not help to control costs, adequately measure or enhance efficiency and above all, will not promote cost reductions when it is absolutely necessary to do so.  An inadequately determined standard which turns out to be incorrect will not only distort unit cost but lead to inefficiencies.

One of the key issues that ought to have been discussed as a prelude to subsidy removal is therefore the appropriateness or otherwise of the standards that have been applied all through the template. It is still of considerable importance that this should be carefully and extensively reviewed.

An empirical review of actual costs in the template should be carried out in order to reduce the landed cost of products. The actual cost of each element should be properly determined, empirically, in order to ensure that the allowance that is given is adequate and not unnecessarily excessive to the detriment of the government and the consumer.

 

Eliminating inefficiency and corruption from product importation mechanism

It is imperative that the government set out a transition period of not more than six months when it will take concrete actions to considerably reduce the inefficiencies embedded in the importation mechanism as a prelude to complete deregulation of the downstream sector.

The steps towards achieving this are set out be

  1. Direct NNPC to dedicate all the crude that it cannot refine to offshore processing. This will ensure that NNPC is not selling this crude for its own account. Most importantly, it will ensure that refinery gate prices based on ‘net back’ pricing is obtained
  2. Eliminate guaranteed margins across the product importation and distribution chain – Government should, as a first step towards deregulating the downstream sector, scrap all guaranteed margins in the template including financing cost.

The different segments of the business that comprise the value chain should be clearly identified and the operators in each segment be made to negotiate their margins. The most efficient or standard cost of the item, empirically verified by PPPRA should be used as template input until the sector is fully deregulated by which time margins will become transaction based and built into market determined pump price. This will drive efficiency in the sector.

Sweep and/or dredge the shipping channels

The import jetties have draft limitations which restrict the size of vessel that can be moored alongside the pier. The draughts of the jetties that are used for the importation and marine product movement are: Atlas Cove (11.0m); Apapa (6.4m), Warri (7.4m); Okrika (9.4m); and Calabar (6.4m).

Consequently larger vessels, typically of average size 45,000 Metric tonnes berths at the Single Point Mooring Buoy (SPM, draught limitation 16m) or Fairway buoy in Lagos, Bonny or offshore Escravos for transhipment. The products are transferred into smaller vessels of between 5,000MT and 20,000 MT for onward delivery in ‘daughter’, ‘grand daughter’ and ‘great great grand daughter’ etc vessels to Atlas Cove, Apapa, Warri, Okrika or Calabar, and even direct sales to customers on the high seas.

The above operational system has the following significant negative consequence

• It is more economical to use larger vessels to import products

• Heavy lightering costs are incurred which are built into the landed cost

• Products are easily round tripped through trans-shipment and ocean sales thus creating systemic corruption.

Government should invest on the sweeping and/or the dredging of the above listed ports. It should be noted that PPPRA uses 5000MT as a base to license importers and 30000MT for Landed cost calculation. This is considered scandalous.

The use of 45000 – 50000MT will lead to a significant reduction in landing cost and eliminate the menace of product round tripping. This project can be achieved in less than six months and the pay back is less than a year.

 

Building Additional more Single Point Mooring (SPM)

Presently, only NNPC SPM and Atlas Cove can take heavy vessels (above 50,000MT) as explained above. In order to improve the product reception infrastructure in support of the swept or dredged jetties, government should build more SPM. These jetties have pipeline throughput availability, thus negating any need to lighter products. This will also reduce if not completely eliminate lightering costs and support the elimination of product round tripping

The government should as a matter of urgency invest in more SPMs. This capital expenditure also has a less than one year pay back.

Removing administrative bottlenecks that delay vessel discharge and causing demurrage

Apart from the vessel discharge bottlenecks whose remedies have been discussed above, the following administrative limitations also cause demurrage:

• Delays in obtaining clearances from DPR, Customs and the Navy.

• Security problems from the Niger Delta militancy activities or from youth restiveness

• Difficulty in settling the ship and shore differences promptly after loading and offloading operations.

• Power outage causing discharge delays

It is imperative that these bottlenecks are removed. This can be done by government directive in less than one week, and should be speedily addressed.

Unbundling of the Pipeline System and creating open access of the pipelines

Some of PPMC’s extensive (5,000 km. pipeline network and 23 depots) product distribution system is currently not in use.  Some sections have been vandalized, and others have just not been adequately maintained, and have doubtful integrity.

PPMC should consider opening the entire network to third party importers and marketers for a throughput fee.  The revenue from such open access should be ploughed into maintaining the system and ensuring, as much as possible, its integrity.

Unbundling will enable marketers to have access from the Jetty head to the storage tank at a fee which will enable them to compare and control their product storage and transmission costs. This will enhance pipeline utilization, reduce bridging and earn PPMC much needed income.

Ensuring Pipeline & Depot Integrity:

Using PPMC’s installed pipeline and depot network would normally be the most efficient way to move products around the country. However, pipeline vandalism and stealing of products are present day realities in our country.  Distribution by road tankers is inefficient and not a viable alternative on the long run.  Government should speedily address this issue before unbunding the pipeline system. This too can be squarely addressed in less than six months.

Demurrage

PPPRA’s template currently apply 14 day demurrage at $28000 day. This is absolutely unreasonable. When the reasons given above for discharge delay are addressed, efficiency will be injected into the process and considerably reduce demurrage .The demurrage rate is a quoted spot rate (AFRA). The rate by day therefore is verifiable. This rate should be applied on an allowable three (3) day demurrage period for both mother and shuttle vessel discharges.

National Strategic Reserve

NNPC has the responsibility to guarantee product security for the nation. The pipeline network and its 26 depots made this task a relatively easy one in the 80s and 90s. The MT TUMA was also in active service in support of this goal.

However, the vessel lost her certificate to operate as a result of not being dry-docked. Consequently TUMA has not been actively engaged since May 2002. .

Consequent on the above, NNPC now relies on vessels in the high seas to provide the strategic reserve. The holding of these vessels on the high seas accounts for a significant portion of the 14 day demurrage that is built into product landed cost. This is wrong as it gives undue advantage to importers who do not have this strategic reserve responsibility.

The M.V. Tuma, a vessel capable of holding 120,000 – 140,000 metric tons of products was, until 2002 anchored offshore Lagos and used as strategic storage for products.  The vessel apparently lost its sea worthiness certification and departed in 2002, (ostensibly for dry-docking) . The Tuma should as a matter of urgency re-enter the system as a PMS storage facility to further reduce demurrage and storage cost.

Paying Subsidy on Products delivered to retail outlets

PPPRA established the following basis of determining the volumes on which subsidy is paid:

Between 2006 and June 2009, the guidelines provided that Claims will be based on the duly verified volume of products lifted out of the depots (Depots belonging to NNPC/PPMC, DAPPMA, Major Marketers and IPMAN) by the PPPRA to approved retail outlets.

Similarly, the PSF Guidelines, issued by PPPRA and effective from June 2009  provided  that Claims shall be based on the duly verified shore tank volume ie the volume of product that was actually discharged in Nigeria.

The method used from 2006 to 2009 meant that subsidy could be paid on products not delivered into retail outlets but smuggled out of the country, the method applied from July 2009 is even criminal as it meant that subsidy could be paid on products that are round tripped, products lost or stolen after delivery and products that are not delivered to retail outlet and therefore never consumed in Nigeria.

Firstly, it is imperative on government to carry out an audit of the products actually consumed in 2006 – 2011 on which the Federation paid subsidy. This is the only way to expose the massive fraud that has been perpetrated against Nigeria.

Secondly, government should legislate that subsidy can only be paid on products delivered to retail outlets and thus consumed in Nigeria.

The issues listed in a – i above are imperative steps that must be taken before deregulation. They can all be carried out in six months and will have the following impact

Taken together, they will lead to a drastic reduction in product Landed Cost. It is the firm belief that PMS would have a Landed Cost of less than N60 per litre after the measures are implemented

Individually and collectively, the measures have a payback of less than one year.

The second issue is the “disconnect” between the government and the people.  This disconnect is epitomized by the following question: who is best able to carry the load occasioned by the garbage of corruption and inefficiency represented in the bloated subsidy?  Is it the government that is currently carrying it on the peoples behalf or the downtrodden, recession stricken masses?

We posit that it is the government for the simple fact that the masses cannot influence or change anything in the system. And the fact that government’s long years of monopoly in the industry created the garbage and so, it must clean it first.

If government abandons the people to the wolves in the sector, it will not take time before they devour the people and tear their bones to shreds.  We are sure that this is not the objective of government.

It is government’s responsibility to challenge the institutional and structural imperfections in the system, take them on, fight them, defeat them and have a lean and fit system to bequeath to the people.  If for nothing else, the structures, institutions, corruption and inefficiencies that threaten to swallow all of us like roaring lions in the sector are all the creation of government.

Government must therefore not cowardly shy away from taking them on and defeating them as a prerequisite to withdrawing from the sector.  We also recognize that government will always have a presence in the sector as an umpire or a regulator but not in the dictation of prices.

Government must therefore implement these measures given the highlighted benefits.

 

CONCLUSION:

The following must guide the action of the federal government if we are serious as a nation to bury this “subsidy monster” permanently.

These are Revamped regulation to back subsidy removal

Government should pass a robust law to underpin deregulation such that some of the issues discussed above that need to be made permanent are underlined by the law of the land

The use of import licenses is outlawed; competition in the downstream sector is entrenched; and PPPRA is given teeth as an effective regulator and ombudsman.

Government should immediately embark on the programme to raise the capacity utilization of our refineries to international levels. This is why we would like to see the immediate publication of the TAM agreement signed between the government and the foreign contractors said to have constructed the refineries, who are now supposed to handle their repairs. We want to see the timelines and deliverables, as this is key to removing the present burden of over – priced petroleum products from the back of the already impoverished Nigerian masses.

We do not understand the logic behind the phased TAM programme by the NNPC for the existing refineries in an emergency situation like ours. It shows that as far as government is concerned, the current distorted petroleum products market that has given rise to the last protests nation-wide and the lives that were lost does not ring bell in their conscience.

Was it the same organisation that constructed all the existing refineries? Why not take on the TAM of the four refineries simultaneously to bring all of them on stream this year rather than having to wait till 2014 as being pursued by the NNPC? Does it not show that somebody or a group is interested in seeing the present fraud in the sector continue?

As a follow up to the above, we call for the immediate commencement of work on the three Greenfield refineries proposed by the government in order to expand existing capacities making it possible for us to lay to rest finally the monster called “fuel subsidy”.

Government should, as a matter of urgency, ensure that a robust Petroleum Industry Bill (PIB) that will solve the problems of both the downstream and the upstream sectors of the petroleum industry is passed into law, thereby optimizing the benefit to the people of the oil and gas sector which is a finite resource. We therefore welcome the Committee that has been set up to actualize this objective and urge that its membership be enlarged to include more Labour representatives so that its various components would be thoroughly examined and brought in line with current and future realities.

In any event, it is imperative that Government should make it clear to the people what the funds generated from subsidy withdrawal will be spent on. There is no doubt that our decaying infrastructure can do with part of the money.  Without transparency regarding the use, the funds could easily disappear into the pocket of political fat cats! This is why we believe that a further restructuring of the Belgore Committee to make it more inclusive and efficient has become highly imperative.

Moreover, the urgent need for an immediate audit of the Downstream sector of the Petroleum Industry becomes imperative. It is important that we know what is the actual quantity of PMS consumed daily, the total subsidy on it, those who received the said subsidy, who paid them, if N240b was budgeted for subsidy this current term, how did it become N1.3tr and where did the extra funds come from and who appropriated them?

It has also become imperative that government immediately constitutes and inaugurates the board of the National Council on Public Procurement in line with the Public procurement Act 2007. The refusal of the federal government to do this 5 years after its enactment calls into question the seriousness of the government in pursuing transparency and due process in all matters covered by the Act which includes such transactions as involved in the subsidy management. It is our position that doing this would immediately inject transparency in the sector and ensure that Nigerians and Nigeria are no longer made to carry burdens of corruption and failure of government to govern.

Palliative measures

It is only after the above are carried out that the actual level of subsidy (if any) can be established. The subsidy level needs to be known before the related palliatives are discussed.

Has the government done what it ought to do before taking the action of January 1st 2012? The answer is an emphatic NO.

Deregulation does not make economic sense when driven by Petroleum Products import.

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