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Chapter 1. Case Studies in Fuel Subsidy Reform

Author(s):
Trevor Alleyne, and Mumtaz Hussain
Published Date:
August 2013
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Ghana33

Context

Ghana is a country of over 24 million people, rich in natural resources, including arable land and minerals (Table 1). Ghana has recently discovered offshore oil reserves, and 2011 was the first full year of production. Although Ghana’s oil reserves are relatively small on a global scale—with production from the current Jubilee field expected to peak at 120,000 barrels a day—there is considerable upside potential from new discoveries. Moreover, Ghana is in the process of building up infrastructure for the commercial use of its gas reserves, with potentially significant benefits in terms of reducing energy costs and developing downstream industries.

Table 1.Ghana: Key Macroeconomic Indicators, 2000–2011
20002003200820102011
GDP per capita ($US)4005631,2661,3581,580
Real GDP growth (percent)4.25.18.48.014.4
Inflation (percent)25.226.716.510.78.7
Overall fiscal balance, cash (percent of GDP)−6.7−3.3−8.5−7.2−4.1
Public debt (in percent of GDP)123.382.833.646.343.4
Current account balance (percent of GDP)−6.60.1−11.9−8.4−9.2
Oil imports (percent of GDP)−7.1−5.0−8.3−6.9−8.3
Oil exports (percent of GDP)0.00.00.00.07.2
Oil consumption per capita (liters)n.a.91.191.498.7110.7
Poverty headcount ratio at $1.25 a day (PPP) (percent of population)39n.a.30n.a.n.a.
Sources: International Energy Agency; World Development Indicators, World Bank; and World Economic Outlook, IMF.
Sources: International Energy Agency; World Development Indicators, World Bank; and World Economic Outlook, IMF.

Since 2004, deregulation has allowed oil marketing companies to enter the market for importing and distributing crude oil and petroleum products. Until that time, the Tema Oil Refinery (TOR) had a monopoly on the production and importing of refined products. Since then, deregulation has allowed oil marketing companies to enter the market for importing and distributing crude oil and petroleum products. Under the current system, a pricing formula exists for all petroleum products. The current price-adjustment mechanism is the result of 2005 reforms, although it has not always worked as originally envisaged. The National Petroleum Agency (NPA), also established in 2005, reviews fuel prices twice a month. It provides recommendations to the minister of energy on adjustments to cost-recovery levels, based on a backward-looking formula incorporating changes in world fuel prices in the preceding two weeks.

The decision to adjust pump prices is at the discretion of the executive. If price increases are warranted but not implemented, the cost of subsidies is in principle borne by the budget. However, in the past, TOR carried the cost of the subsidy, and underpricing of petroleum products saddled TOR with large losses that spilled over into the financial sector as nonperforming loans. The government was forced ultimately to clear TOR’s arrears to the banking sector at a large budgetary cost. Since October 2010, a hedging scheme using call options also has provided some temporary protection against upward movements in oil prices. The government purchases monthly call options that generate revenue in the event of upside shocks to global oil prices; this revenue is used to cover temporary delays in adjusting domestic petroleum product prices to cost-recovery levels (IMF, 2011).

Experience with Fuel Price Adjustments

The past decade has been marked by several attempts to deregulate fuel prices in Ghana (Figure 1).

Figure 1.Ghana: Fuel Price Developments, 2000–2012

Sources: National Petroleum Agency (Ghana); and IMF staff estimates.

  • In 2001, a 91 percent adjustment of petroleum pump prices was driven in part by the desire to restore TOR’s financial health. Delays in adjusting petroleum prices during 2000 led to large accumulated losses for the state-owned public energy company, which reached 7 percent of GDP (IMF, 2001). The reform was soon abandoned, however, in the face of rising world prices and a depreciating currency. TOR’s losses were largely absorbed by the state-owned Ghana Commercial Bank, whose solvency was threatened.
  • In early 2003, recognizing the unsustainable financial position of both TOR and Ghana Commercial Bank, the government renewed its commitment to cost-recovery pricing with a 90 percent increase in pump prices. Facing widespread opposition to the price increase, the government partially reversed the price increase in the run-up to the 2004 elections and it abandoned cost-recovery adjustments until 2005. In 2004, the subsidies to TOR reached 2.2 percent of GDP, and the company continued to borrow from Ghana Commercial Bank to finance its operations (IMF, 2005).

The deregulation of petroleum product pricing in 2005 was accompanied by strategic measures meant to ensure broad popular support for the reform. The strategy was supported by research, communication, and programs to mitigate the impact on the most vulnerable groups:

  • Research. A poverty and social impact assessment (PSIA) studying the impact of fuel subsidy removal revealed that the program was poorly targeted, with the rich receiving the lion’s share of the benefits (Coady and Newhouse, 2006).
  • Communication. The government engaged in a widespread communications campaign, including public addresses by the president and the minister of finance, explaining the reform’s benefits. The results of the PSIA were made public and discussed in a dialogue with various stakeholders, including trade unions. The government also explained how resources freed from subsidizing energy products would partly be reallocated to social priorities (Global Subsidies Initiative, 2006).
  • Assistance to the poor. The government introduced a number of programs aimed at mitigating the effect on the most vulnerable, including the elimination of fees for state-run primary and secondary schools; an increase in public-transport buses; a price ceiling on public-transport fares; more funding for health care in poor areas; an increase in the minimum wage; and investment in electrification in rural areas.

The administration of the publicly released price-adjustment formula was transferred to the newly established National Petroleum Agency (NPA). The delegation of regulatory powers to the NPA was meant to isolate the decision to adjust prices from political intervention. Prices were adjusted by an average of 50 percent, and the government remained committed to regular adjustment for several years. In the wake of the 2007–08 global fuel and food crisis and in the run-up to the 2008 elections, however, automatic adjustment was temporarily suspended.

The NPA remains the main regulatory agency and publishes the price adjustments required for cost recovery on a biweekly basis. When an upward price adjustment has been required in recent years, the shortfall has often been covered by the budget or more recently by hedging profits. This has resulted in infrequent and large price adjustments, when hedging profits were exhausted and the fiscal burden became too onerous. Prices were adjusted twice in 2011, by 30 percent in January and 15 percent in December. Prices have not been adjusted in 2012 (with the exception of a small downward adjustment early in the year), and the gap between domestic and global oil prices, exacerbated by a depreciating currency, has increased substantially (IMF, 2012a, 2012b).

Mitigating Measures

Following the 2005 fuel price reform, the government introduced a number of programs aimed at mitigating its effect on the most vulnerable. (See bullet on “Assistance to the poor” above).

Lessons

A number of lessons can be drawn from Ghana’s experience in the past decade:

The durability of reform depends crucially on political will and the independence of regulatory agencies from political interference. Without these conditions, it is difficult to maintain an independent regulatory agency. The NPA is not free to adjust prices without the consent of the executive: it has adjusted prices only three times (once downward) since January 2011. Although democratically elected governments have stronger mandates to implement difficult reforms, commitment to automatic adjustment often falters in the run-up to elections.

A constant dialogue with stakeholders and civil society at large about the cost of subsidies is necessary to maintain commitment to the reform. Recent attempts at adjusting prices have not been accompanied by an extensive public information campaign similar to the 2005 effort. Price increases have been irregular, difficult to anticipate, and usually announced shortly before being implemented. This can result in strong opposition by various stakeholders, including powerful trade unions, and can undermine the government’s effort. The 2005 campaign was also successful because it engaged civil society and powerfully demonstrated the cost of fuel subsidies by sharing the results of the PSIA.

Supportive research and analysis are important for convincing the public of the benefits of reforms. During the 2005 reform, the PSIA was crucial in demonstrating the costs of subsidies. It also outlined that fuel subsidies were a poor policy measure in the fight against poverty: in Ghana, less than 2.3 percent of outlays on fuel subsidies benefitted the poor.

Visible mitigating measures increase the likelihood of success. Although fuel subsidies are ill targeted, they are a direct transfer to most if not all citizens, their benefits are immediate and easy to understand compared to other social programs, and the individual cost of their removal is swift and substantial—particularly for the poor who have no income cushion, unless they receive alternative compensation. A key element of a successful reform is, therefore, the efficient and visible reallocation of the resources saved through the removal of fuel subsidies to programs with immediate benefits to the most vulnerable. An expansion of cash transfers through the Livelihood Empowerment against Poverty (LEAP) program and additional spending on health and education subsidies would be good candidates.34

Namibia35

Context

Namibia is one of sub-Saharan Africa’s richest countries, with a relatively stable macroeconomic environment (Table 2). Income inequality and unemployment are very high, however. Mineral exports, transfers from the Southern African Customs Union, and prudent fiscal policy in the past have helped the Namibian government sustain economic growth, while maintaining fiscal and current account surpluses. Inflation in Namibia is closely linked to South Africa’s inflation (its currency is pegged to the South African rand) and has remained within single digits since reaching a peak of 11.9 percent in August 2008 driven by a surge in international oil prices. The Namibian economy is sensitive to changes in international fuel prices owing to the relative importance of energy-intensive industries such as fishing and mining.

Table 2.Namibia: Key Macroeconomic Indicators, 2000–2011
20002003200820102011
GDP per capita ($US)21402608427652445828
GDP growth (percent)4.14.33.46.64.9
Inflation (percent)9.37.210.44.55.8
Overall fiscal balance (percent of GDP)1−0.9−6.12.4−4.2−11.3
Public debt (percent of GDP)120.426.418.216.227.4
Current account balance (percent of GDP)7.96.12.80.3−1.7
Oil Imports (percent of GDP)3.54.52.45.35.9
Oil exports (percent of GDP)0.00.00.00.00.0
Oil consumption per capita (liters)n.a.491.5596.2731.0812.9
Poverty headcount ratio at $1.25 a day (PPP) (percent of population)n.a.31.9n.a.n.a.n.a.
Sources: International Energy Agency; World Development Indicators, World Bank; and World Economic Outlook, IMF.

Figures are for the fiscal year, which begins April 1.

Sources: International Energy Agency; World Development Indicators, World Bank; and World Economic Outlook, IMF.

Figures are for the fiscal year, which begins April 1.

Namibia is characterized by political stability and a relatively well-functioning democracy. The ruling political party is dominant and has won elections with large majorities since independence in 1990. Labor unionization is fairly high, and the largest trade union federation, the National Union of Namibian Workers, is a strong political ally of the ruling party.

Namibia has a wide range of formal publicly funded social welfare programs. Social security, welfare, and housing spending averaged 5 percent of GDP in 2005–11. The government’s income support grants include a universal social pension system for the elderly and the disabled, a variety of grants for children, labor-based work programs, and shelter and housing programs. Despite some weaknesses of inclusion and exclusion errors, anecdotal evidence suggests that Namibia has a well-targeted social safety system.

The downstream market for liquid fuels in Namibia is administered through acts of parliament that set out clear parameters to calculate fuel prices. According to the acts, the prices of petrol and diesel are regulated, whereas the prices of all other petroleum products are determined by market forces. The country has no refining capacity and imports its refined fuels mainly from South Africa through the port of Walvis Bay. The Ministry of Mines and Energy (MME) regulates the industry while the Namibian Petroleum Corporation (Namcor), a state-owned enterprise, acts as an operational arm of the government in the market. There are five private companies involved in the marketing of petroleum products, namely BP, Caltex Oil, Engen, Shell, and Total. Each private company supplies its own network of distribution outlets, but all share import and storage facilities at Walvis Bay. In 1999, Namcor was mandated by the government to import 50 percent of Namibia’s petroleum leaving the other 50 percent for private companies. That share was recently reduced because of Namcor’s operational difficulties.

Price setting of fuel pump prices for diesel and petrol is based on a formula with three components. The three components are the basic fuel price, based on the international spot price; domestic fuel levies and taxes; and the so-called slate account, which is essentially used to smooth volatility in local pump prices. The slate account, monitored by the MME, is a notional record used to keep track of the degree of under or overrecovery by fuel-importing private companies. However, the price formula is not completely automatic, as the MME has some discretion on how much pass-through to allow with underrecoveries absorbed by the slate account.

Experience with Fuel-Price Adjustments

According to the MME, the original motivations for deregulating fuel prices in Namibia were to eliminate fuel subsidies (paid out of the National Energy Fund [NEF]) and to respond more efficiently to changes in international oil prices. Several problems associated with the managed petroleum and petrol-product scheme may have motivated the reforms (Amavilah, 1999). First, the NEF compensation scheme came with fiscal costs amounting to about N$170 million between 1990 and 1996, about 0.2 percent of GDP (Figure 2). Although the fiscal costs paid out of the NEF seem small in percent of GDP, they do not include transfers that may have been paid directly to Namcor, or quasi-fiscal costs arising from losses incurred by the company. Namcor sometimes receives direct transfers from the government because it does not participate in the slate program and is therefore not compensated for underrecovery through the slate account. The subsidies may also have reduced incentives for petroleum firms to improve their efficiency to help offset their losses.

Figure 2.Namibia: National Energy Fund and Slate Account, 1990–2011

(N$ million)

Source: Bank of Namibia, Quarterly Bulletin, March 2005.

After the adoption of the new price mechanism, the slate account is supposed to be balanced through price adjustments. In particular, the price adjustment formula should adjust prices so that the value of the cumulative slate balances is kept within a predetermined level of N$3 million. In practice however, balancing the slate account has sometimes involved transfers from the budget to the NEF and then to the slate account (see Figure 2). The wholesale prices of all petrol grades and diesel are published in a government gazette at each price adjustment. Tax revenue data are published in budget documents.

The MME used a structured, balanced, and consultative approach to price deregulation and subsidy removal. The National Energy Council, chaired by the minister of mines and energy, established the National Deregulation Task Force in 1996 to examine fuel-price deregulation through a consultative process. This culminated in the publication of the White Paper on Energy Policy in 1998 (Namibia, 1998), articulating, among other issues, the importance of keeping targeted subsidies to remote areas, deregulating gradually, and enhancing transparency in government fuel-tax revenue. The fuel price mechanism with quarterly price reviews was adopted in 1997.

NEF expenditures to cover subsidies only started to decline after 2001. That was a full three years after the release of the White Paper on Energy Policy, an indication that the implementation of fuel subsidy removal takes time. In addition, as shown by the slate balance in Figure 2, close to full cost recovery by private firms only came after 2001.

Domestic fuel prices in Namibia increased steadily from 2003 onward and more than doubled from early 2007 to a peak in July 2008. In response to the 2007–08 fuel-price shocks, the authorities replaced the quarterly fuel price adjustments with monthly fuel-price reviews to increase pass-through. However, the MME did not allow retail prices to rise as fast as world prices, transferring funds from the NEF to the private petroleum firms to compensate them for keeping prices below cost recovery and thus subsidizing users, including the powerful interest group of taxi drivers. However, in July 2008, the MME announced that the NEF had come under financial pressure owing to underrecoveries and was no longer in a position to cushion increasing fuel prices.

Overall, although fuel prices have generally moved in line with international oil prices, the government has from time to time accommodated pressures to limit the full pass-through of changes in international prices. In the 2006–07 budget, the government made a one-off budgetary provision of N$206 million (0.4 percent of GDP) to offset the NEF’s accumulated losses. The government also faces contingent liabilities arising from Namcor’s operational losses. In 2009, Namcor had operational losses of N$257 million, prompting the government to award it a N$100 million grant and a bailout package to the tune of N$260 million (0.5 percent of GDP) as well as a portion (7.6 cents a liter) of the existing fuel levy to help boost the state-owned oil corporation’s finances. In February 2011, Namcor lost its mandate to supply 50 percent of Namibia’s total fuel requirements because of operational difficulties.

Mitigating Measures

The fuel-price smoothing mechanism has been complemented by several mitigating measures to address the increases in fuel prices. Unlike its SACU counterparts, Namibia did not experience violent protests in response to rising fuel and food prices, although tax drivers complained when fuel prices increased. This might be partly explained by the MME’s fuel-price smoothing mechanism and other mitigating measures that were put in place in 2008 to address poverty and alleviate the temporary impact of high fuel and food prices. Mitigating measures included a zero-rate value-added tax on selected food items, rebate facilities for food importers, and a food distribution program to feed the most vulnerable. In addition, rural pump prices are subsidized as part of the socioeconomic policy of the government. This is achieved by subsidizing transportation costs to remote areas to ensure that the pump price in remote areas is not inflated by retailers’ transport costs. Claims on actual road deliveries are submitted by the oil companies to the MME for reimbursement from the NEF.

Lessons

Comprehensive planning and gradual implementation were key to success. The Namibian authorities undertook comprehensive planning, which included broad consultation with civil society, culminating in a comprehensive reform plan that retained a targeted subsidy for remote areas.

Reforms were implemented gradually. This allowed enough time for consensus building between the government and various stakeholders.

Price adjustments that employed smoothing mechanisms helped prevent social unrest. The reform established a quarterly (later monthly) price adjustment mechanism in line with changes in international prices but incorporating a price-smoothing mechanism to avoid sharp price adjustments. This, along with the introduction of other mitigating measures, allowed Namibia to manage the large price shocks of 2008 and 2011 without social unrest.

Depoliticization of the price adjustment mechanism has been made difficult by legal obligations to the state-owned energy company. The legally stipulated participation of the state petroleum company in the importation and supply of petroleum products seems to have prevented a full depoliticization of the price adjustment mechanism (i.e., allowing prolonged underrecoveries). This in turn has resulted in large losses for the company that have had to be covered by fiscal transfers. This suggests the need to carefully design price smoothing mechanisms.

Niger36

Context

Niger is a large and land-locked country that is extremely vulnerable to external shocks, mostly to climatic conditions and commodity prices (Table 3). In the past decade, growth has been slowly gathering momentum, though it has also suffered important setbacks. Niger’s medium-term growth potential is linked to the expansion occurring in the oil and mining (uranium) sectors. The country recently became a fuel exporter, and uranium production is expected to double in the near future with the coming onstream of an important mine currently under development. In addition, the country has the potential to become a crude oil exporter, with five new oil production sharing agreements just signed. A new pipeline to link Niger with the Chad-Cameroon pipeline is planned.

Table 3.Niger: Key Macroeconomic Indicators
20002003200820102011
GDP per capita ($US)155.0223.8361.0363.6420.7
Real GDP growth (percent)−2.67.19.610.72.2
Inflation (percent)2.9−1.810.50.92.9
Overall fiscal balance (percent of GDP)−3.8−2.81.5−2.4−3.0
Public debt (percent of GDP)118.890.121.023.729.2
Current account balance (percent of GDP)−6.7−7.5−13.0−19.9−24.7
Oil imports (percent of GDP)4.02.43.84.74.7
Oil exports (percent of GDP)0.00.00.00.00.0
Oil consumption per capita (liters)n.a.n.a.36.433.134.3
Poverty headcount ratio at $1.25 a day (PPP) (percent of population)n.a.n.a.43.6n.a.n.a.
Sources: International Energy Agency; World Bank, World Development Indicators; and IMF, World Economic Outlook.
Sources: International Energy Agency; World Bank, World Development Indicators; and IMF, World Economic Outlook.

Niger ranks at the bottom of the United Nations Development Programme’s Human Development Index, with per capita GDP in PPP terms of US$720 in 2010, one of the lowest in the world. Niger´s government is highly centralized. The current authorities have been in power since April 2011, following a one-year transition to democracy after a February 2010 coup d’état. Since then, the political situation has been stable, although according to the World Bank (2012), there is a risk of political fragility “where failure of the Government to deliver tangible results could result quickly in the loss of popular support and a political stalemate.”

With the start of operations of its new oil refinery (SORAZ), fuel imports have come nearly to a halt since early 2012. Niger was an oil importer until end-2011. Its market size is small, with annual domestic consumption of about 7,000 barrels a day. The state-owned company SONIDEP has a monopoly on imports and distribution. The new refinery is expected to reach a maximum capacity of 20,000 barrels per day of fuel including gasoline, diesel, and liquefied petroleum gas (LPG). About one-third of the petroleum products produced by SORAZ feeds the domestic market, with the rest exported. SONIDEP is in charge of marketing the petroleum products.

This case study focuses on the period until end-2011, the period in which Niger was an oil importer. It builds on IMF technical assistance support provided to Niger in 2001 to elaborate a pricing formula akin to a full pass-through rule for the automatic adjustment of the price of imported petroleum products. In 2010, a note was prepared by the IMF Fiscal Affairs Department to support the authorities in their intention to eliminate the posttax fuel subsidies, in the context of discussions with the IMF to prepare an assessment letter.

Experience with Fuel Price Adjustments

According to the formula established with the help of technical assistance from the IMF in 2001, automatic pass-through of international prices would be achieved through a flexible, transparent, and automatic mechanism. The retail price would be adjusted monthly whenever the change in international prices was above CFAF 5. Otherwise, the price at the pump would not change and taxes would counteract the increase or decrease in prices. The pricing formula included fuel import costs (CIF import price at the port); estimated costs and margins of importing and distributing fuel to domestic consumers (storage and distribution margins); and net fuel taxes (ad valorem customs and value-added taxes and specific excise taxes). A multisectoral body was envisaged to be statutorily in charge of applying the formula; however, this body was never created.

As international prices started to increase in 2005, an explicit subsidy component was introduced in the formula. The subsidy was initially used to smooth domestic prices. Then, as international import prices increased rapidly and steadily up to mid-2008, the subsidy component rose to keep domestic retail prices fixed for extended periods. The increase in international prices and the depreciation of the euro resulted in a significant increase in the subsidies in 2010. Because fuel prices were substantially lower in Niger than in some neighboring countries, increased smuggling contributed to a strong rise in fuel imports.

Changes in import prices without corresponding pass-through to retail prices resulted in a reduction of government tax revenue from fuels. The net fiscal contribution of fuel taxes decreased from 1 percent of GDP in 2005 to 0.6 percent in 2009 and to 0.3 percent in 2010. The cost of the subsidy on petroleum products amounted to more than 1 percent of GDP. Although this pattern applies to all products, the tax decline in gasoline was more pronounced, going from a peak of 0.8 percent of GDP in 2005 to 0.3 percent of GDP in 2009. Net taxes on diesel also declined from 0.3 percent of GDP in 2005 to 0.2 percent of GDP in 2009. The net tax on kerosene was continuously negative over this period, although the fiscal cost of this measure has been limited, as the share of kerosene consumption is fairly low.

As the subsidy reached unsustainable levels, the authorities decided to start implementing a strategy to gradually phase out subsidies. The size of the subsidy, together with its very regressive distributional impact, was a critical factor in the authorities’ decision to eliminate it. Indeed, the population groups that benefited more from the subsidy were the higher income groups, who consumed more gasoline. While this is particularly the case in gasoline consumption, it is less so in the cases of kerosene and lamp oil, which are more widely consumed by lower-income groups. Fuel prices were increased by 12 percent in mid-2010 (Figures 3 and 4).37

Figure 3.Niger: Fuel Price Developments, 2005–2011

(FCA franc per liter)

Sources: Country authorities; and IMF Fiscal Affairs Department data.

Figure 4.Niger: Macroeconomic Developments and Energy Subsidy Reforms, 2008–2011

(percent of GDP or rate)

Source: IMF staff estimates.

The agreed reform contained two steps. First, international oil price variations would be passed through to domestic prices starting in June 2011. Second, the existing subsidy would be gradually unwound over the following 12 to 18 months. Fuel prices were increased by about 8 percent in mid-2011. As a result, the subsidy was significantly reduced, though not completely eliminated, and the total amount devoted to fuel subsidies in 2011 was kept below the 2010 level (1.1 percent of GDP).

Country-specific circumstances and the political situation played key roles in the design and pace of the reform. First, the imminent start of domestic fuel production introduced urgency in the phasing out of the subsidies. The authorities thought that it would be politically unacceptable to increase prices exactly when domestic production was starting. In fact, the society was expecting the opposite. Second, the initial reforms (in late 2010 and early 2011) were implemented by a transitional government that believed it had less legitimacy to embark on such a sensitive reform process.

To increase public awareness about the dimension of the problem, for the first time the budget explicitly reflected the costs of the subsidy. This helped create an appropriate environment for the subsidy’s elimination. In addition, and to help overcome vested interests and gain support from the civil society, the government introduced public information campaigns pointing out the regressive nature of the subsidies and linking the savings from petroleum price increases to priority social spending.

The authorities opted for a consensual approach to the reform, incorporating all relevant shareholders. They established a committee (the “Commité du Differé”) to discuss the best way to approach the reforms and their subsequent implementation. In this context, dialogue and consensus building were key elements in the positive outcome of the process.

As a result of the reform, retail prices started increasing in June 2011, and continued to increase through August 2011, remaining fixed again from September until the end of the year. Indeed, the monthly cost of the subsidy reached nearly CFA franc 4 billion in May 2011, and was reduced to half of that from August onward. The authorities decided to stop the price increases in September because they believed the prices were then aligned with prices in the region.

However, prices were set below international prices once Niger started producing fuel domestically. As a result of an agreement between the authorities and the foreign investor in the petroleum sector, SORAZ started selling its fuel products at CFA franc 336 a liter for gasoline, and CFA franc 340 a liter for diesel, which are below the international prices. The prices were fixed for the first six months of operation of the refinery, with refined products’ prices set by a formula linked to world market prices after that period. Nonetheless, the prices did not change. More recently, an agreement has been reached between the government and the transportation trade unions aimed at developing proposals to further lower retail fuel prices. As a result, the fuel tax (taxe intérieure sur les produits pétroliers, TIPP) will be reduced from 15 percent to 12 percent starting in 2013.

The overlap of the subsidy reform with the start of fuel/oil production makes Niger a very special case. As a result, it is difficult to assess at this stage how durable the fuel subsidy reform would have been if domestic production had not started at the same time.

Mitigating Measures

The more recent fuel price reform was accompanied by mitigating measures to protect the poorest segments of the population from increases in transportations costs. Following negotiations with the civil society and private sector operators, a direct subsidy to the transport sector was introduced (tickets modérateurs), because this sector was the most affected by the increase and the poorer people were the ones who used more public transport.

The costs of the subsidy policy were still reduced significantly because the costs of the mitigating measures (less than 0.1 percent of GDP) were significantly lower than the subsidy itself. The discontinuation of the subsidy on fuel products created room for a 19 percent increase in social spending in the 2012 budget compared to 2011, with particular emphasis on investment in education. The public wage bill was increased to accommodate the recruitment of 4,000 teachers in early 2012.

Lessons

The extent of the fuel subsidy problem must be understood. Determining the distributional incidence of the subsidies can also help to ensure commitment to the reform.

Promoting an understanding of the issues by society as a whole is important. Being transparent about the costs of the subsidy by an explicit budget line proved very useful in Niger.

Planning an adequate public information campaign also played a crucial role in ensuring the support of the society for reform. In Niger, there were debates on TV and radio about this issue.

Adopting a participative approach to decision-making was also useful, particularly through the establishment of an ad-hoc and inclusive committee.

Sufficient time to explain, negotiate, and implement the reform must be allowed. Building reform momentum, stakeholders’ consensus, and social support requires time. In Niger, ensuring that all stakeholders were on board and agreed with the main elements of the reform took about six months.

Engaging partners can help to ensure that there is sufficient information about the problem and put pressure to launch the reform process. A delicate equilibrium needs to be reached between encouragement and ownership of the reform process.

Ensuring that mitigating measures reach the most affected groups is crucial. These measures can take the form of targeted subsidies based on a detailed analysis of which would be the most affected vulnerable groups.

It must be recognized that fuel subsidy reform becomes more complicated when a country becomes an oil exporter. At such times, it might be more difficult to resist civil society’s the expectations and pressures from the civil society to significantly lower pump prices.

Nigeria38

Context

Nigeria is the world’s fifth leading oil-exporting country (Table 4). The oil and gas sector accounts for around 25 percent of GDP, 75 percent of general government fiscal revenue, and over 95 percent of total exports. Nigeria’s federalist fiscal relations are quite complex and driven by substantial (and constitutionally mandated) oil revenue-sharing among the federal government, 36 (oil-producing and non-oil-producing) states, and various local governments.

Table 4.Nigeria: Key Macroeconomic Indicators
20002003200820102011
GDP per capita ($US)390.0524.31401.21465.11521.7
Real GDP growth (percent)5.310.36.08.07.4
Inflation (percent)6.914.011.613.710.8
Overall fiscal balance (percent of GDP)12.4-4.31.7-4.20.1
Public debt (percent of GDP)84.263.911.615.517.2
Current account balance (percent of GDP)12.5-5.914.15.93.6
Oil Imports (percent of GDP)5.12.55.24.97.9
Oil exports (percent of GDP)49.839.240.632.736.9
Fuel consumption per capita (liters)n.a.98.688.079.293.5
Poverty headcount ratio at $1.25 a day (PPP) (percent of population)n.a.n.a.n.a.33.7n.a.
Sources: International Energy Agency; World Bank, World Development Indicators; and IMF, World Economic Outlook.
Sources: International Energy Agency; World Bank, World Development Indicators; and IMF, World Economic Outlook.

Nigeria has administratively set maximum prices for kerosene and gasoline and an indicative price for diesel. At the core of this system, which was established in 2003, is the Petroleum Products Pricing Regulatory Agency, which sets these prices every month. This agency applies import parity but is also expected to stabilize prices, which it does with the help of the Petroleum Support Fund (PSF). When total costs are below the maximum price, the marketer benefits from an “overrecovery;” if costs are above the maximum price, there is an “underrecovery.” Any overrecoveries are paid into the PSF, supplementing the funds appropriated from the budget, while underrecoveries would be compensated from the PSF. The Petroleum Products Pricing Regulatory Agency posts product pricing templates for kerosene and gasoline on its website. They show the maximum prices but also the estimated costs of importing fuel—the so-called landing costs—and the costs of domestic distribution, decomposed into trading margins and fees, all of which are regulated.

Nigeria has subsidized kerosene and gasoline at a substantial cost to the government (Figure 5). Domestic fuel-price setting has never been responsive enough to changing international prices. Importers have typically been unable to recover costs, and so from the beginning the PSF never received payments, only made them. As the gap between the administered price and the import parity price increased, subsidy costs rose from 1.3 percent of GDP in 2006 to 4.1 percent of GDP in 2011 (Table 5). In 2011 the budget appropriation for the PSF was just 0.6 percent of GDP and funding for the subsidies came from Nigeria’s oil stabilization fund (the Excess Crude Account). The price gap has encouraged widespread smuggling to neighboring countries and other abuses (e.g., overinvoicing of gasoline imports) that have contributed to the escalating costs.

Figure 5.Nigeria: International and Domestic Fuel Prices, 2006–11

(Difference between world price and domestic price, U.S. per liter)

Sources: IMF Fiscal Affairs Department and IMF African Department.

Table 5.Nigeria: Developments in Fuel Prices and Fuel Subsidies, 2006–12
20112012
20062007200820092010Est.Proj.
Fuel Subsidy (billion Naira)12512906373997971,7611,570
Fuel Subsidy (percent of GDP)11.31.42.61.32.34.73.6
Fuel prices (Naira per liter)
Diesel (deregulated)819011894112152144
Kerosene (subsidized)50505050505050
Gasoline (subsidized)65707065656597
Sources: Nigerian authorities and IMF staff calculations and projections.
Sources: Nigerian authorities and IMF staff calculations and projections.

The subsidy regime has also been a disincentive to investment in domestic refining capacity. None of the 20 refinery licenses issued since 2000 have been used. Although Nigeria produces some 2.5 million barrels of oil a day, it is heavily dependent on the import of fuel products. Its four state-owned refineries, operating sometimes at only about 20 percent of capacity and rarely above 40 percent, meet only about 20 percent of the domestic demand.

Experience with Reform

In mid-2011 the government decided to radically curtail gasoline subsidies and waged a public campaign the rest of the year to convince the population. The debate on removal of fuel subsidies was initially supported by several state governors, who wanted to free up resources to be able to pay their civil servants the new minimum wage. This proposal was hotly debated in the press, by business and civil society groups, and it was debated in the National Assembly during the rest of the year, with the government strongly trying to make a convincing case. On January 1, 2012, the price of gasoline was raised to a cost-recovery level—a 117 percent increase. The price of kerosene, a cooking fuel used mainly by poorer households, was not changed. However, in response to intense social unrest, the government scaled back the price increase to 49 percent by mid-January. Evidently, despite six months of debate, the measure did not enjoy sufficient public support.

The main plank in the government’s campaign for the subsidy removal was the Subsidy Reinvestment and Empowerment (SURE) Program. The SURE program was announced in November 2011. It was preceded by public statements by the president and budget documents (e.g., the 2012–15 Medium-Term Expenditure Framework and the Fiscal Strategy Paper) highlighting both the costs of the subsidies and the need to spend more on safety nets for the poor to mitigate the effects of the subsidy removal and on the construction of new refineries and the rehabilitation of existing ones. The SURE brochure summarized the government’s case for subsidy removal (Box 1), spelled out how much the federal government and states and local governments stood to gain from the subsidy removal, and announced how the federal government would spend the money saved.

Box 1.Nigeria: Rationale for Subsidy Removal

The government summarized its case for subsidy removal in the SURE brochure:

  • Fixed prices have led to a huge unsustainable subsidy burden.
  • Fuel subsidies do not reach intended beneficiaries, and they benefit mostly the rich.
  • Subsidy administration has been beset with inefficiencies, leakages, and corruption.
  • Subsidy costs have diverted resources away from investment in critical infrastructure.
  • Subsidies have discouraged competition and stifled private investment in downstream petroleum.
  • The huge price disparity has encouraged smuggling to neighboring countries.

According to the SURE brochure, savings from the removal of the fuel subsidy would be channeled into “a combination of programs to stimulate the economy and alleviate poverty through critical infrastructure and safety net projects.” Capital projects would be selected in line with the government’s Vision 20:2020 development strategy, in power, roads, transportation, water, and downstream petroleum. The potential impact of the subsidy removal on the poor would be mitigated “through properly targeted safety net programs.” The SURE brochure provided details on the various projects and programs to be undertaken, from the specific road segments to be built to the maternal and child health services to be upgraded.

The SURE program envisaged the creation of a specific subsidy savings fund to finance its spending initiatives. The fund itself and the specific spending programs would be overseen by an 18-person board, with a chairperson appointed by the president, and including only four government representatives and other members made up of respected individuals from a wide cross-section of civil society. The board would seek technical assistance from internationally reputed consulting firms, while an independent body would report to the board directly on implementation.39

The government’s attempts to win support for its subsidy reform met with strong opposition from powerful sectors of society. In early December 2011, the National Assembly came out against the removal of the gasoline subsidy, claiming that the measure was premature and not supported by firm data underpinning the size and incidence of the subsidies. In response, the Ministry of Finance presented a Brief on Fuel Subsidies, laying out once again the case for removal, and supporting it with data on the explosive growth of the subsidies and comparing their costs with the government’s capital expenditure and borrowing requirements (Okonjo-Iweala, 2011). In addition, several senior officials gave interviews and speeches during the last two weeks of December. However, trade unions were also voicing their strong opposition to the measure, echoing a widely held view that the proceeds from the subsidy removal would most likely go to fund wasteful government spending (including to corrupt politicians) rather than projects to benefit ordinary Nigerians (Okigbo and Enekebe, 2011). State governors who had generally supported the reform earlier were now silent. Throughout the period, the government had deliberately refrained from setting any date for the planned removal of subsidies.

The January 1, 2012, announcement came as a surprise and set off widespread protests across the country. On January 9, the two large union federations launched a national strike. Certain parts of the country experienced a near breakdown of law and order and there were a number of deaths related to violence and acts of intimidation associated with the strike. On January 15, the president announced that the January 1 price increase would be partly reversed and the new maximum retail price for gasoline would be N97 (US$0.60) a liter, a 40 percent increase over its end-2011 level. However, he emphasized that the government would continue to pursue full deregulation of the downstream gasoline sector. The SURE program would go ahead but would be scaled back, in line with the reduced subsidy savings. The president also announced that the legal and regulatory regime for the petroleum industry would be “reviewed to address accountability issues and current lapses.” Unions called off their strike that same day.

Mitigating Measures

The SURE program outlined a variety of social safety net programs to mitigate the impact of removing the subsidy on the poor. The programs included:

  • Urban mass transit. Increasing mass transit availability by facilitating the procurement of diesel-run vehicles (subsidized loans, reduced import tariffs, etc.) to established operators. In the first step of this program, the government intended to import 1,600 buses within months.
  • Maternal and child health services. Expanding the conditional cash transfer program for pregnant women in rural areas; and upgrading facilities at clinics.
  • Public works. Providing temporary employment to youth and women from the poorest populations in environmental projects and maintaining education and health facilities.
  • Vocational training. Establishing vocational training centers across the country to tackle youth unemployment.

Lessons

A well-thought-out public information and consultation campaign is crucial to the success of a reform. Although the government campaigned vigorously for removal of the subsidies, the measure was still highly controversial when it went into effect. The backlash had been predicted. The public communication campaign lasted only six months, and there was no broad popular consultation. The ministry of finance produced several short briefs to support its proposal, but these were issued several months into the campaign, and there was no comprehensive report.

The government must establish credibility for its promise that the proceeds from the removal of the subsidy will actually be used for the benefit of the broad population. Notwithstanding the laudable objectives of the SURE program and the plans for oversight by a highly reputable board of directors, the new administration had yet to establish that it truly would live up to commitments. On the contrary, it suffered from a very negative image of government held by the general public. As such, the subsidy reform was viewed very suspiciously, and the general public simply did not believe that the government would live up to its commitments.

Thorough research on the costs and beneficiaries of subsidies is important for bolstering the case for subsidy reform. The absence of good quantitative information on the state of Nigeria’s refining industry and of the fuel subsidy mechanism itself allowed spurious arguments, often made by parties with vested interests, that government investment in the state-owned refineries and/or measures to stop abuse by marketers were preferable to removing the subsidies. In addition, the claim that subsidies mostly benefited the poor had been based on anecdotal evidence rather than on research based on household survey data.

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