Phase Out Fuel Subsidy And Replace With Crude Oil Subsidy: Harnessing Dangote Refinery As a Hub of National Prosperity -By Kenny Oladipo

Word Bank and Federal Government estimate that nearly 90 million people fall below the poverty line in the country at a baseline of $1.90 (684 Naira) a day. Representing 45% of the population, the highest ratio relative to population in all of the known universe. Last year Nigeria overtook India as the country with the largest number of people living in extreme poverty. A new World Bank Report released on December 2, 2019 warns that Nigeria will have 25% of world’s poor without reforms and could slip into another recession if crude oil price drops 25%. The economy is expected to expand 2.1% in 2020 and 2021 while the growth rate increases by 2.6%. World Bank projects that at the current trajectory by 2030 the number of Nigerians living in extreme poverty could increase by more than 30 million.

The raging question then is, how did the country fall so drastically into this conundrum within a short period of time and what are the measures to adopt to reverse the trend and bend the poverty curve downwards. The unavoidable devaluation of the currency from N140 to $1 in 2014 to N360 to $1 in 2016 invariably swept nearly 36 million people below the poverty line by default. The recessionary pressure that forced Government’s hand increased poverty rate by 72% ab initio, and it’s been a difficult climb out of the ditch ever since. That said, the simplest way out would have been currency revaluation, but given the existing economic fundamentals that option is unsustainable, and if currency revaluation is off the table then some other options have to take its place on it. A notable option is to phase out the current fuel (refined petroleum products) subsidy regime, and front load the subsidy into crude oil supply to local refineries to bring down refining cost and subsequently pump price.

Fuel subsidy policy is a sensitive political and economic issue and successive administrations often steer clear from proposing bold policy prescription to rein in the massive drain to the financial health of the country. Fuel subsidy program is without question a real damper on the economic growth of the country; a self-evident truth one would say. However, given the political risk and the attendant economic disruption a sudden removal of such subsidy will present, conventional wisdom always tilts in the direction of caution, and this political calculation has limited Government’s ability to come up with big and bold ideas for lasting solution. Truth be told, these are extraordinary times and extraordinary measures are appropriate to roll back the scourge of poverty in the country. Full disclosure, while this is not an attempt to join the pressure campaign of organizations like IMF and World Bank that keep advocating for fuel subsidy removal out of lack of basic understanding of the unique set of circumstances the country faces. It is a call for repurposing the subsidy from the front end of the supply chain to the back end of it.

To be clear, all developed economies in the world have varying degrees of subsidy in place in critical sectors of their economy. The US gives over $86B annually as Farm Subsidy to support food security and nutritional assistance to people in need. Likewise, China supports manufacturing sector by offering more than $1T in financing and subsidies. And at no time had IMF or World Bank admonished either of these countries to drop such government’s initiatives and interventions. So any self-serving demand that Nigeria drop fuel subsidy regime reeks of calculated and targeted hypocrisy. Because in Nigeria fuel subsidy is more than just an economic necessity, it is arguably the most consequential policy that separates the nation from chaos.

One good news coming out of the country is the near completion of Dangote Refinery in Lagos, with installed capacity to process 650,000 barrels of crude oil per day. Folks, that’s a massive production capacity and if national planners can harness this incredible crude oil processing plant and make it the central hub of economic growth, prosperity may subdue poverty over time and the resulting economic security can displace all forms of insecurity bedeviling the nation in short order. To accentuate the tremendous economic benefit of this project to the overall economic growth of the country, it is apt to describe with granularity the petroleum refining process, cost of production and distribution of the product, taxes and other relevant information.

A barrel of oil is equivalent of 42 gallons or 159 liters of the product. And in every 159-liter barrel of crude oil, 73 liters of gasoline (petrol), 35 liters of diesel, 20 liters of jet fuel/heavy fuel, 6 liters (142,200 BTU) of propane gas and 34 liters of other products like butane, kerosene, asphalt and sulfur can be produced. Also, the refining cost of a barrel of crude oil in percentage is classified as follows; cost of crude (48% – 51%), refining (23%), taxes (18%), distribution and marketing (8 – 10%). From the cost breakdown, it is clear that the bulk of the overall refining cost is on the cost of crude oil and therein lies the opportunity to perform a subtle tweak to the overall cost curve.

On average, close to 60 million liters of petroleum products are used up on a daily basis in the country, which comes to about 450,000 barrels per day. According to OPEC, Nigeria produces between 1.8m bbls (off-peak) and 2.2m bbls per day. Outside of this OPEC allocation quota, there is excess capacity production of about 500,000 bbls per day that NNPC has in stock on a rolling basis allocated for domestic consumption. Also, the cost of extracting a barrel of crude oil from an oilfield in Nigeria is between $15 and $22, and the current BRENT price hovers around $70/bbl. So, there’s a profit margin of between $40 and $55 for every barrel produced. Because most oilfields in Nigeria are joint venture projects with international oil companies (IOCs), typically on a 60-40 profit sharing basis, NNPC makes 60 cents on a dollar of the profit. Based on the current profit profile, NNPC makes minimum of $24 per barrel, translating to a minimum of $48m (1.7B naira) per day in profit at 2 million bbls daily production. And as identified above, NNPC holds a floating excess production capacity of around 500,000 bbls which are sold to off-takers like Vitol, Trafigura and 13 other companies in exchange for refined petroleum products, under an arrangement known as Direct Sale and Direct Purchase DSDP. Few of these companies have their own refineries therefore cannot optimize refining cost of the products to lower production cost and have to buy at prevailing global prices. A weakened naira is another factor contributing to the high landing cost of the product. Practically speaking DSDP awardees have no other choice but to sell the products back to NNPC at higher landing cost. Hence, the main reason why fuel subsidy regime persists and remain indispensable to the country’s economic model. NNPC has been fortunate that the price of crude oil is still below $70, any significant spike in global price will undoubtedly make the subsidy regime practically unsustainable.
Having burrowed into the basics of the oil production, refining and marketing structure, this working knowledge can then be exploited to offer reasonable solution to the fuel subsidy crisis. If NNPC produces excess capacity of about 500,000 bbls of crude oil per day, and Nigeria uses minimum 445,000 bbls of crude oil per day and has a refinery with a capacity to refine 650,000 bbls of crude oil per day, then it can be projected that the fuel subsidy regime can be gradually phased out with minimum fuss or disruption to the economic or political situation of the country. And here is the working theory, let’s assume that NNPC sells the excess capacity of 500,000 bbls to Dangote Refinery at 67.5% of PLATTS price and get Dangote Refinery to sell the big 3 refined petroleum products (PMS, AGO, DPK) back to NNPC at 75% of the current pump price of N145/liter. The pump price of gasoline can drop by 12.5% – 15% after accounting for distribution and marketing cost which is about 10%. To keep this in perspective, it costs approximately $2/bbl to ship petroleum products from loading port to destination port. And for 500,000 bbls/day domestic consumption, it translates into $1m per day and $365m/$366m per year just for transporting the products to the country from source. If all domestic fuel consumption is processed locally then the shipping cost is eliminated, saving NNPC a total of $365m (131B Naira) per non leap year.

Before anyone says this isn’t feasible, let’s do the math together here. First, NNPC selling excess capacity to Dangote Refinery doesn’t impact Government revenue in any material way, since national budget is based on a revenue stream from OPEC quota only, which will not be affected in this sort of arrangement. Second, the IOC’s profit of about 40% is still intact while selling at 32.5% discount, it is the NNPC that will have to take 10% profit to make this work. And forgoing 32.5% margin that would have accrued if product is sold at full price as profit to NNPC now becomes the new crude oil subsidy to replace the current refined petroleum products subsidy regime. The beauty of this strategy is the fact that Government wouldn’t have to budget funds for this subsidy because it’s frontloaded and it’s essentially a cost of doing business. If greed at the top level of NNPC echelon and the Presidency will not stand in the way, then this can be considered a viable solution to the existential threat to the national financial health occasioned by the fuel subsidy boondoggle. Third, Dangote Refinery will make sizable profit even if it sells refined products like gasoline (PMS), diesel (AGO) and kerosene (DPK) at 75% of today’s pump price, and here’s why. As stated earlier, about 50% of the refining cost is due to the cost of crude oil alone, and only 23% is chewed up by the actual refining process itself. So if NNPC and Dangote Refinery enter into such an arrangement, the cost of refining a barrel of crude oil by the refinery will drop by at least 25%. Keep in mind that other products like jet fuel, asphalt, heavy base oil, petrochemical derivatives are produced in the same barrel, and the refinery is allowed to sell those products at 100% global market price. In addition there is another 200,000 bbls/day that the refinery can still absorb for export only (this 200,000 bbls are to be sold to the refinery at Platts price with nominal discount as typical). Only gasoline, diesel and kerosene are to be sold back to NNPC at 75% of today’s pump price. Selling other products at 100%, will ensure the refinery operates at reasonable profit, while also bailing the country out of a financial mess in the process. To further incentivize the refinery, Government can mandate the Works Ministry to insert a clause in every road project contracts that minimum of 75% asphalt/bitumen to be used on all new roads and resurfacing in the country must be sourced locally. This way we boost the economy by being cyclical in our approach to national resources and looping the system fundamentally in critical sectors of the economy.

Now, how does this concept dovetail into the anti poverty programs already in place. As earlier noted, the devaluation of naira by nearly 200% caused a 72% spike in poverty rate, and to really address the issue, the strength of the currency cannot be overlooked and it begins with reducing both the cost and volume of fuel importation into the country. Once Dangote Refinery comes online, Government can begin to save over $3.6B (1.3T naira) that’s currently being spent on fuel subsidy. Fuel subsidy alone is about 15% of the national budget of 8.6T naira. That’s a ridiculous amount to be bleeding out of an economy on a yearly basis, and the outrage ought to be universal across the country. If fuel importation dials down to almost zero, naira automatically appreciates in value by at least 20%. A 20% improvement in currency strength lifts 6.6 million people out of poverty in a whiff. The savings made by the subsidy removal can then be cycled back into the economy with a laser focus on poverty amelioration in the short term and near total eradication of the scourge in the long term. According to the UN, the basic necessities of life are food, clothing and shelter and if the country is serious about reducing poverty then cheap food items and affordable housing need to be at the front and center of Government’s policies.

One of the primary effects of a 12.5% – 15% reduction in the pump price of gasoline and diesel is the corresponding decrease in transportation cost across the country. If there’s a noticeable drop in transportation cost, then food items cost will follow and the effects will trickle down to every other aspect of the economy. Another effect is the improvement in disposable income of the population thereby boosting the purchasing power of the people. For instance an average household will have 5% to 10% more money to spend on food and other life’s necessities that directly improve their well-being rather than waste on transportation cost and inflated market price for basic needs. More money in people’s pockets translates into a vibrant local economy from the rural areas to the cities, as more and more people have a little bit more to spend on tangibles. To put hard numbers on it, if 50 million working adults in the country on a conservative estimate save 10 naira on transportation-related cost per business day for 260 business days in a year, the economy will receive 130B naira in direct spending on other essentials that would have otherwise frittered away into intangibles. The multiplier effect of this economic stimulus can be profound and significant in the overarching poverty alleviation policy.

With savings made through the elimination of the fuel subsidy, about 50% of the $3.6B can be invested in food security and nutritional assistance to the populace. There’s a saying on my side of the rainbow that “if lack of food is taken out of poverty, the effect of poverty naturally abates”. One bright spot of the economy is Agro-business, which accounts for about 24.4% of the GDP and if Government can turbocharge this sector by channeling substantial resources from the fuel subsidy savings, then broad-based and shared prosperity is within reach. If this sector can expand to account for 35% of the GDP in the next 5 years, then an additional 40 million jobs would have been added to the economy from Agro-business alone (a 1% GDP increase as a share of the economy in Agriculture supports over 4 million new direct and indirect jobs). Agriculture, food, and related industries contributed $1.053T to US GDP in 2017, a 5.4% share of the overall GDP. To put in proper context, US Agricultural sector supports 21.6 million full and part time jobs, representing 11% of total US employment. If a country that practices high end technology and advanced mechanized farming can generate 21.6 million jobs at just 5.4% of the GDP, one can only imagine the sheer magnitude of jobs that can be supported by Agriculture in Nigeria.

Once the people transition from survival mode to productive and investment mode, the natural order of peace, security, tolerance and love of country automatically kicks in. Government has a significant role to play to beat back the ravaging hunger and pervasive poverty in the land by refocusing on the basic needs necessary for basic human dignity. The other 50% can then be spent on infrastructure, education and primary health care facilities.

In closing, there’s a useful management tool called the Boston Matrix that can help planners prioritize Government’s or Organization’s interventions to derive maximum effect, a literal bang for every buck. The tool breaks cost and corresponding impact into 4 quadrants. Low Cost/Low Impact; High Cost/High Impact; High Cost/Low Impact and Low Cost/High Impact. Every planner is advised to always start a project on the Low Cost/High Impact side of the Matrix first. Unfortunately, the poverty alleviation policies of the country is heavy on High Cost/Low Impact column and that’s one of the reasons these programs are yet to make any meaningful impact on people’s lives. The fuel subsidy regime is a High Cost/Low Impact proposition and it’s time to move away from that idea, and consider the Low Cost/High Impact of crude oil subsidy instead. Because it is the right thing to do. While Dangote Refinery is expected to be commissioned by the end of 2020, and production to follow sequentially. Now is the time for NNPC and Presidency to put a policy structure in place to evaluate, analyze and calibrate the pace and sequence of weaning the nation’s economy off the fuel subsidy teats. Existing refineries in Port Harcourt, Warri and Kaduna should also be revamped to support the new Refinery, by acting as a buffer whenever Dangote Refinery is offline for routine shutdown maintenance and can be used as a redundancy system to keep supply undisrupted with their production capacities. In the event that local refineries cannot come online fast enough by December 2020, then NNPC can revise the current DSDP program to go full blown barter system by 2021. In this case NNPC sells crude oil at 35% discount of dated BRENT price to DSDP participants, and in return they supply refined products at 85% of the current pump price at the ports. Hence, the need for subsidy to avoid pump price hike ceases to exist. If this course of action is adopted and well executed, then come 2023 Nigeria would have become a net exporter of refined petroleum products and a more vibrant economy that’s capable of lifting millions out of poverty. So, let’s roll up our sleeves, and get to work. Because when we collectively put our shoulders to the wheel of progress and push in lock step it moves forward. Change doesn’t just roll in on the wheel of inevitability, rather it takes common purpose and conscious effort to make it a reality.

Kenny OLADIPO
Houston, TX
@kindodey
A Reliability Engineer and Energy Consultant in the Oil Industry, Power and Utilities who writes opinions of national relevance periodically.