Nigeria: Selected Issues

Selected Issues

Abstract

Selected Issues

Fuel Subsidies-Latest Increase and Implications of a Change in the Regulated Gasoline Price1

The implicit cost of fuel subsidies is significant. Analysis based on Nigerian household data shows that a removal of the implicit subsidy (through an increase in the regulated price of Premium Motor Spirit, PMS) would reduce income inequality and, if combined with targeted transfers, could result in a decrease in the poverty gap while leaving significant fiscal space for other productive expenditures. To avoid a re-emergence of fuel subsidies, a deregulation of fuel pricing or the implementation of an independent and automatic fuel price-setting mechanism will be necessary. In the interim, the cost of currently below-cost recovery regulated prices should be explicitly stated in the budget.

1. Nigeria’s regulated price for PMS is no longer cost-reflective and is lower than in most comparator countries. In May 2016, faced with fuel shortages and severe external and fiscal pressures, the Nigerian government increased the regulated fuel price significantly (by 68 percent, to Naira 145 per liter)—making the level appropriate in the context of premium gasoline prices of just above US$500 per ton at then prevailing oil prices of US$45 to US$50 per barrel and exchange rate of 197 Naira/US$. Since then, the price of PMS has remained unchanged. Oil prices are now hovering above US$60–65 per barrel, Rotterdam Platts prices increased, and the exchange rate has further depreciated in windows reflective of market rates, while fuel imports are still priced at 305 Naira/US$. As a result, the regulatory fuel price cannot fully cover the cost of fuel importation and distribution. Oil companies in the downstream business have relied on their allocation of fuel imports by the national oil company (NNPC) for distribution. The cost incurred by the NNPC in absorbing below market costs results in lower net oil revenue transfers to the federal government and reduced transfers to state and local governments. In contrast, fuel prices in comparator countries have increased significantly, and are on average substantially higher than in Nigeria.

Figure 1.
Figure 1.

Selected Emerging and Developing Countries: Average Gasoline Price, 2016 vs. Latest 2018

(US$ per liter)

Citation: IMF Staff Country Reports 2019, 093; 10.5089/9781498306225.002.A002

Note: Nigeria’s PMS price converted at N/US$ 253 and 305 in 2016 and 2015, respectively.Source: FAD Fuel Survey Database, IMF staff calculations.

2. As a result, implicit subsidies have increased markedly; removing them would increase fiscal space. In 2018, the cost of delivering a liter of Premium Motor Spirit has exceeded the regulatory retail price of Naira 145 by some 40 percent. At this level of price under-recovery, and assuming consumption of about 37 million liters in Nigeria per day, the implicit cost to the budget could amount to 0.5 percent of GDP in 2018, compared to just 3 to 4 percent in tax revenues), and even 0.9 percent of GDP under publicly announced import numbers of 55 million liters per day that are used to build strategic reserves and are to a large extent diverted through smuggling into neighboring countries. The exchange rate margin created through pricing fuel imports at N/US$ 305 instead of the market rate (N/US$ 360) creates an additional implicit subsidy that is not accounted for in the analysis but would add around 20 percent to the cost. A removal of subsidies would therefore imply increased fiscal space.

Figure 2.
Figure 2.

Decomposing the Cost of One Liter of PMS

(Naira)

Citation: IMF Staff Country Reports 2019, 093; 10.5089/9781498306225.002.A002

3. However, a price adjustment would reduce households’ purchasing power, calling for an analysis of the impact by income groups, in particular for poorer households.

  • With transport prices currently estimated at 6.5 percent of the consumption basket based on current CPI weights, the direct first-round impact on the overall price level in Nigeria of a 40 percent fuel price hike would be around a 2½ percentage points increase. The inflationary impact from this “one-off” increase would affect households with varying income levels differently.

  • To estimate the distributional impact, incidence analysis is used to assess the implications of a 40 percent price increase (recovery of current costs) on households’ budgets, based on the 2015/16 representative Nigeria General Household Survey that captures 5,000 households across all states. The approach assumes that demand for PMS is inelastic, implying that the direct impact on households’ budgets is proportional to their consumption levels. It takes into account that a price increase results in an indirect impact on households’ budgets by increasing the prices of other goods and services (such as transport and goods that require transport, see above).

4. The analysis shows that increasing retail prices would reduce income inequality but increase poverty levels.

  • Richer households tend to spend a larger share of their income on petrol than poorer households (Figure 3). The same relationship holds for fares and other transport-related expenditures (Figure 4). Not surprisingly, a fuel price increase is therefore progressive, i.e. it disproportionately reduces the disposable income of richer households, and thus decreases income inequality (here measured by the Gini coefficient) by ¼ point.

  • However, the negative impact on poor households’ purchasing power results in increasing the poverty gap by 0.4 percentage points and the poverty headcount by 1.2 percentage points (Figure 5, part (1)).

Figure 3.
Figure 3.

Petrol Expenditure by Income Percentile

Citation: IMF Staff Country Reports 2019, 093; 10.5089/9781498306225.002.A002

Figure 4.
Figure 4.

Fares and other Transport Expenditures by Income Percentile

Citation: IMF Staff Country Reports 2019, 093; 10.5089/9781498306225.002.A002

Figure 5.
Figure 5.

Distributional and Poverty Impact from a Regulatory Fuel Price Increase

Citation: IMF Staff Country Reports 2019, 093; 10.5089/9781498306225.002.A002

(1) Impact from the price increase to cost recovery levels(2) As in (1), but transfers to the poor to keep the poverty gap constant(3) As in (1), but transfers to the poor to keep the poverty headcount constant

5. The cost of measures to mitigate the adverse impact on the poor are relatively small and would amplify the reduction in income inequality from the price increase.

  • To assess the cost of compensatory transfers to the poor, the analysis chooses households to benefit from transfers through proxy-means testing. The proxy-means test identifies poor households that should receive the transfer based on their predicted household expenditure based on a range of indicators that may be easily verifiable in practice (state in which household resides, rural vs. urban location, ownership of a refrigerator, ownership of a car, electricity expenditures). A scenario that keeps the poverty gap (the mean shortfall of the total population from the poverty line) constant, would imply transfers with at a total cost of just Naira 63 billion, less than a tenth of potential savings through the price increase. Income inequality would decline further (by 0.6 point). However, even with the compensation, the poverty headcount would still increase by 1.1 percentage points (Figure 5, part (2)).

  • To eliminate this increase in the poverty headcount based on the national poverty line, transfer packages would need to be scaled up further, to Naira 239 billion—still just about a third of potential gains of the reform at current prices and costs, excluding administrative cost of such transfers, see IMF (2018) for caveats around the design (including challenges to scale up administrative capacity in the short term). In such a scenario, the poverty gap would decrease even compared to the situation before the price increase, and income inequality would decline significantly (by 1.3 points, Figure 5, part (3)).

  • Safety nets could be scaled up as part of a wider project to increase the National Social Safety Net (World Bank 2018).

6. The impact of an increase in PMS prices is thus expected to be overall positive if compensatory measures to protect vulnerable households are introduced. In addition, these effects do not take into account a number of other positive implications of the price increase in productive fiscal expenditures (e.g. infrastructure) that could have positive growth and distributional implications that would help compensate for adverse effects on demand from higher input costs, which are not taken into account in this analysis.

7. Fuel price reform requires increasing transparency, ensuring timely adjustment of prices to cover costs based on market conditions, and participation at the state level:

  • Transparency. Independently from a price adjustment, the budget should communicate any foregone benefits of the implicit fuel subsidy transparently by including them as an explicit item into the budget and communicating domestic PMS consumption levels. In addition, if the government wishes to share costs across state and local governments, then these should be explicitly shown and implemented, possibly through a cost-sharing formula, rather than indirectly through lower net oil revenue transfers from NNPC to the government.

  • Price-setting mechanism. To eliminate the subsidy in a sustainable manner, an increase in the regulated price should be accompanied by an implementation of an independent and automatic fuel price-setting mechanism. As part of the mechanism, regulated prices would be reviewed regularly to avoid the re-emergence of fuel subsidies. The pricing formula could include a best-practice smoothing mechanism to avoid disruptive adjustment in cases of large oil price shocks and volatility, while guaranteeing a pass-through of oil prices over the medium term (see, e.g., Coady and others (2012) for design and implications). For example, Chile’s scheme consists of a two-part fuel tax, with one part indexed to inflation, and the other adjustable. A gradual adjustment is also possible. For instance, India raised the price of diesel every month from Jan 2013 to Oct 2014, until the unit subsidy was eliminated, and then let it follow international price fluctuations.

  • Deregulation. Alternatively, deregulating fuel prices to allow for market pricing would achieve a similar effect with less control on profit margins but savings in costs of regulation.

  • Communication. Designing and implementing an effective public communication strategy will be critical to implement the fuel price reform.

References

  • Coady, D., J. Arze del Granado, L. Eyraud, H. Jin, V. Thakoor, A. Tuladhar, and L. Nemeth. 2012. “Automatic Fuel Pricing Mechanisms with Price Smoothing: Design, Implementation, and Fiscal Implications.” IMF Technical Notes and Manuals. Washington, D.C.: International Monetary Fund.

    • Search Google Scholar
    • Export Citation
  • IMF. 2018. “Distributional Impact of Fiscal Reforms in Nigeria.” Nigeria: Selected Issues. IMF Country Report No. 18/64. Washington, D.C.: International Monetary Fund.

    • Search Google Scholar
    • Export Citation
  • World Bank. 2018. “Nigeria – AFRICA- P151488- National Social Safety Nets Project – Procurement Plan (English).” Washington, D.C.: World Bank Group.

    • Search Google Scholar
    • Export Citation
1

Prepared by Monique Newiak (AFR) and Stephen Younger (Commitment to Equity Institute).

Nigeria: Selected Issues
Author: International Monetary Fund. African Dept.
  • View in gallery

    Selected Emerging and Developing Countries: Average Gasoline Price, 2016 vs. Latest 2018

    (US$ per liter)

  • View in gallery

    Decomposing the Cost of One Liter of PMS

    (Naira)

  • View in gallery

    Petrol Expenditure by Income Percentile

  • View in gallery

    Fares and other Transport Expenditures by Income Percentile

  • View in gallery

    Distributional and Poverty Impact from a Regulatory Fuel Price Increase