The Nigerian downstream sub-sector spans across various economic activities ranging from retail outlets, trucking, product pipelines, jetties, terminals and depots, and marine vessels. This once-thriving sector has a turnover in excess of N5 trillion and provides direct and indirect employment to over 380, 000 Nigerians.Growth has since declined or stagnated due to reduced investments occasioned by product price fixing, bridging product supply, insecurity, irregular gas supply, pipeline vandalism, inadequate pipeline infrastructure, and general inconsistencies in government policy. These challenges are further exacerbated by Nigeria’s inability to refine adequate petroleum products domestically in order to meet local demand, exposing the downstream and indeed the entire country to foreign exchange volatility and constrained access to foreign exchange.
This state of affairs resulted in an over-dependence on imports to supply the domestic market. It also had the effect of discouraging the private sector playersfrom importing products that are yet to be fully price deregulated like PMS. The charts below show the sources of petroleum products supply for the period 2011 to 2018.
It is expected that the passage and implementation of the Petroleum industry bill (PIB) would signal the revival and resuscitation of the sub-sector for growth.
Review of Key PIB Downstream-related Provisions
1. Price deregulation of Petroleum Product Prices – section 205 of the bill provides that wholesale and retail prices of petroleum products shall be based on un-restricted free market pricing conditions. This is very welcome as price-fixing with attendant fixed and thin margins has led to low levels of investment and divestments from the sub-sector.
2. License Regime for downstream operations –section 174 created a regime of licensing for petroleum downstream operations. Seven downstream specific license types were created (bulk petroleum liquids storage licence, Petroleum liquids transportation pipeline licence, petroleum liquids transportation network operator licence, wholesale petroleum liquids supply licence, petroleum product distribution licence, petroleum product retail licence, and licence to construct and operate a facility for the production of petrochemicals.
3. Commercialization of NNPC – section 53 of the bill provides for that NNPC Limited and any of its subsidiaries shall conduct their affairs on a commercial basis in a profitable and efficient manner without recourse to government funds and their memorandum and articles of association shall state these restrictions; NNPC Limited shall operate as a CAMA entity, declare dividends to its shareholders and retain 20% of profits as retained earnings to grow its business. Section 64(m) and 317(6) declares NNPC Limited as the supplier of last resort for petroleum products to ensure energy security. This shall be for a period not exceeding 6 months and all costs associated with this role shall be for the account of the federation.
4. Enhanced Regulatory Environment –section 29 provides for the creation of a dedicated midstream and downstream regulator, with clear and specific powers to regulate the midstream and downstream. This is another plus as it focuses regulation even thoughthere are concerns about the possibility of internal regulatory conflicts/overlaps with the Upstream and environmental regulators.
5. Open Access Regime for Monopoly Infrastructure – section 179 provides for third party access relating to midstream and downstream petroleum liquids operations where such infrastructure is deemed monopoly infrastructure by the Authority; in the manner prescribed by the Act, the regulations, codes and other guidelines issued by the Authority under this Act; and on commercially viable terms based on a cost reflective pricing methodology.
6. Assignment or transfer of Licenses or Permits – section 117 creates a consent regime that requires Authority’s prior approval before licenses and permits can be assigned or transferred to other parties similar to what is obtainable in the Upstream.
7. Creation of the Midstream and Downstream Gas Infrastructure Fund –section 52 creates the Midstream and Downstream gas infrastructure fund, funded by a 0.5% levy on wholesale price of petroleum products and natural gas sold in Nigeria. This brings the total levy on wholesale sales to 1% excluding VAT.
8. Licensing regime for product Importation – while section 174 did not create a license for importation of petroleum products, section 317(8) provides that the Authority may apply the backward integration policy in the downstream to encourage local refining. It provides for allocation of importation quotas based on local refining performance as defined by the Authority and all imported volumes must conform to Afri-5 standards.
Matters Arising
The debate for a fully price-deregulated market has been on for a long time with government pushing forward a reform agenda that will ensure local self-sufficiency in refining and the opportunity for export of refined products, ensures regular and uninterrupted domestic supply of petroleum products, attract investment in refining, transportation and distribution infrastructure, create value across the entire chain, and provide gainful employment and enabling Nigerians to acquire technical know- how in refining and distribution business.
The PIB provides the legislative framework in accomplishing the above-stated reform objectives, however;
The PIB Section 317(8) clause Moves Nigeria from Monopoly with Price-Controls to an Oligopoly
Section 317(8) is reproduced below;
(1) The Authority may apply the Backward Integration Policy in the downstream petroleum sector to encourage investment in local refining.
(2) To support this, licence to import any product shortfalls may be assigned only to companies with active local refining licences or proven track records of international crude oil and petroleum products trading.
(3) Import volume to be allocated between participants shall be based on criteria to be set by the Authority taking into account their respective refining output in the preceding quarter, share of active wholesale customers, competitive pricing, prudent supply, storage and distribution track records.
(4) To safeguard the health of Nigerians, imported petroleum products shall conform to the Afri-5 specification (50ppm sulphur) as per the ECOWAS declaration of February, 2020 on adoption of the Afri-Fuels Roadmap.
The implications of Section 317 sub section 8 are:
· only parties with active refining licences or proven track record of international trade in crude oil and/or petroleum products will be allowed to import products.
· Local refiners are exempt from the Afri-5 product specification.
If the intention of the PIB is to liberalize the downstream, clause 317(8) effectively undermines this objective as it raises the barrier to entry and further limits or restricts petroleum product supply sources. To effectively liberalize the subsector for efficiency, removing price control alone is not sufficient. The conditionsprecedentfor a liberalized market are shown below.
Local refining is good and should be encouraged. Backward integration is one way to achieve that.However, backward integration as a policy can be implemented without sacrificing competition, but rather through the use of fiscal incentives. Protection clauses like 317(8) will only serve to eliminate competition and are not suited for critical sectors like the downstream. It must be noted that for Nigeria, Petrol is an essential product and it will be imprudent to create an oligopoly for such a vital product.
After an extensive review of Local content policies and backward integration in Nigeria, McCulloch et al., (2017) had advised:
1. Don’t try and make one size fit all. Backward integration policies should be nuanced by the circumstances of the sector, rather than blanket policies being applied.
2. Do the maths. Evaluation of backward integration should consider both whether it creates jobs and boosts investment and value added in the sector, but also the impact of local content policies on consumers. The government should avoid forms of backward integration policy that provide long-term benefits for a sector or a handful of firms while imposing much higher costs on consumers.
Much as we have not seen the backward integration policy document as it relates to the downstream, it is important that the following questions be answered before this can be applied. Is the Nigerian downstream suitable for backward integration? and how does this affect the consuming public? Will it deliver efficiency, competitive prices and growth to the subsector?
Section 317(8) of the PIB kills price competition. The clause effectively restricts the importation of ALL PETROLEUM PRODUCTS, including diesel, aviation fuel, lubricants, base oil – products which are already price deregulated, to a few operators, resulting in an oligopoly for the downstream sub-sector which is contrary to the vision of a competitive and deregulated sector. The desire to protect “infant” industries by protecting them against competition comes at a huge cost to the consumers and overall market development. While the intention to grow and protect local refining is valid and worthy, it must be balanced by the need to protect the consumers and all other stakeholder including government. Indeed, such protection is presently un-necessary in light of the opening up of continental trade via AfCFTA. AfCFTA will guarantee a much larger market for continental refiners that they would not need to lock-out local markets to survive.
One reason given for escalating volumes of PMS import is smuggling of products across the borders. While this practice is deplorable and a crime against Nigeria, as it takes money from the federation account that otherwise would have been deployed to development activities and transferred into private pockets; it is however, a response by the “economic” man to take advantage of the arbitrage opportunity created by the huge disparity in product prices (see figure 4 below) within the region. This will abate significantly once price control are removed and prices are allowed to respond to market dynamics.
This policy is predicated on the assumption that it will help resolve our current forex challenges. While local refining capacity (used domestically or exported) will help with the exchange rate, it is also important to note that if the government sells crude to the refineries in local currency as being proposed, it will reduce our forex earnings significantly (oil and gas contributes 97% of forex earnings presently) and further exacerbate our foreign exchange challenges.
Nigeria is presently rehabilitating the 210,000 BOPD Port Harcourt Refinery and it is expected to be completed in early 2023. Work is ongoing also on processes to rehabilitate the Warri and Kaduna Refineries. These rehabilitation works will be funded by third party financiers who would recover their investments from operating profits over time. None of these refineries is Afri-4 compliant and would require huge sums to upgrade them to produce Afri-5 spec products. The commitment by the ECOWAS Ministers is that domestic refiners within the sub-region should be Afri-5 compliant by 2025. This presents a significant challenge to the domestic refiners especially NNPC.
The rehabilitated Port Harcourt Refinery would only have run for less than two years before the deadline for Afri-5 compliance meaning further upgrades would need to be carried out in the 2023-25 timeframe, when NNPCmay still be obligated to the financiers of the rehabilitation, and may not have own resources to deploy for the upgrades. It is indeed advisable that the rehabilitation packages for the WRPC and KPRC should include upgrade to Afri-5 standards. Simply put, the insertion of the Afri-5 requirement in law would challenge funding and rehabilitation of NNPC owned refining capacity which are currently inactive.
What does this mean for Nigeria, the Downstream and Consuming Public?
Loss of Competition and Potential for inefficient Pricing:A key requirement for competitive market and pricing is the presence of many buyers and sellers. This clause will restrict the supply side to an oligopoly or more precisely two players only (duopoly). Given that section 205 had removed all price controls, petroleum product prices would invariably be set, whether collectively – in a cartel – or under the leadership of the dominant player, rather than taking prices from the market. Profit margins would therefore be higher than they would be in a more competitive market, gouging the consumers. There will also be no incentive for the two suppliers to be efficient as they can seamlessly pass-on the cost of their inefficiencies to the public. It is therefore very important that policy steps that would lead Nigerians to pay higher than normal prices, and expose them to the dangers of price fixing and/or tacit collusion should be avoided as it would not be in public interest. Studies have shown that monopolies and oligopolies do not allow for efficiency and proper market behaviour.At the moment, NNPC is the sole importer of petrol and reported import volumes are far in excess of what might be expected signalling poor monitoring and leakages. NNPC has a huge deficit in payments to the Federation Accounts. Monopolies reduce accountability.
Several studies have evaluated the impact of the backward integration policy and import restrictions in the cement and sugar industry. One of such study by Oji et all (2014) looked at the effect of this on prices of cement and concluded:
This study found that; the backward integration policy on cement increased the output of cement tin Nigeria: the deregulation of cement manufacturing industries did not increase the contribution of the sub-sector to Nigeria’s economic development; the restriction of license to import cement in Nigeria has led to the empowerment of the local cement producers; and importation of cement did not
account for the rising cost of cement in Nigeria. we recommended among others for the review of the backward integration policy and its import licensing system in order to accommodate the interests of both manufacturers and importers in the industry;
Loss of Jobs: Our estimate is that the downstream currently employs about 165,000 direct and more than 230,000 indirect employees. This means this subsector employs the greatest numbers in the oil sector. From tank farm operators, filling station staff and operators, to independent depots and tanker drivers. A significant portion of the over 33,000 retail stations, especially those serving low traffic, non-urban remote locations may close down due to the effect of this policy. The creation of oligopolistic market by this provision, runs contrary to the stated intent of the law, and would result in significant loss of business by existing players in the downstream and attendant loss of jobs. We estimate that more than 150,000 direct and indirect jobs would be lost. We also think, business failures in the downstream would have a domino effect on the entire economy. For instance, the sector is currently exposed to the banks to about N1.3trillion (includes oil servicing companies). A downstream with a monopoly will cause a crisis to the sector as many companies will be unable to service their loans and other obligations.
Loss of tax Revenues:PWC in a commissioned report estimates that the downstream has a total annual tax contribution in excess of N140bn. This includes CIT, Education tax, PAYE, NSITF, ITF, VAT, and withholding taxes. We think this significantly understates the tax contributions of the sector. Much of these contributions to public finance would be lost if this clause is implemented as proposed as most of these tax-paying businesses would have to wind down as the thin margins available from the value chain will be insufficient to sustain them in operation.
Potential for Corruption: Today, NNPC is the sole importer of PMS. With clause 317(8), a few more players who have local refining capacity would join. We believe that placing a sub-sector that is vulnerable to corruption entirely in the hands of a single or few organisations would be extremely dangerous as the mix of monopoly power and lack of transparency could only but be a recipe for enhanced corruption risks. Liberalizing the sub-sector by reducing the barrier to entry, leading to more participantswould ultimately lead to reduced corruption and concentration risks.
Fuel Quality Specification: Subsection (4) codifies the decision of ECOWAS Council of Ministers of Hydrocarbons in February 2020, which recommended product imports to meet AFRI 5 specs by 2021, and ECOWAS refineries to meet AFRI 5 specs by 2025. We believe that product specifications should not be hardwired in legislation but the Authority should be allowed (within its powers) to do so via regulations recognizing the dynamic nature of the market.
A case for Competitive Markets – Nigeria’s Experience with Diesel Price Deregulation
Domestic diesel prices were de-regulated in 2009. The market has since then been supplied through a combination of local refining and importation, retail (market) prices over the period is a testament to the effectiveness of competitive markets. The chart below shows the retail prices of diesel from 2015 to February 2021.
From the chart, it is clear that aggregate national prices have tended to track the Brent crude oil prices indicating a response of local prices to developments in the international crude oil markets. Which is an important feature of an efficient market. The difference in prices across the states is a reflection of their respective distances from the source of supply. This also depicts an efficient market as prices are determined by the dynamics of demand and supply with many suppliers and buyers. If we have market restrictions and a heightened barrier to entry, the price outcomes would have been less transparent and efficient.
A comparison of local retail prices of diesel across the ECOWAS sub region and selected oil producing countries also show that diesel prices in Nigeria are market determined and efficient and are at levels that reflect our relative advantages of economies of scale and absence of direct government taxation.
It is not surprising therefore, that smuggling is not a major issue with diesel because the price differentials are not too significant and as attractive as that of Petrol, hence much smaller quantities of diesel are leaked across the borders.
While imports averaged 77% of total supply in the period 2011- 2018, this is being reversed as domestic production is ramping up with additional diesel production capacity from Niger Delta Petroleum Resources Refinery at Ogbele, Waltersmith Refinery at Ebigwe, and soon to be commissioned Edo and OPAC refineries. We believe that with time, local diesel production will exceed demand and Nigeria would be in a net export position. Presently, a total of 23 refineries with a combined capacity of 940,000 barrels of oil per day (BOPD) have been licensed and are at various stages of development.
Recommendations
To achieve the stated objectives of the industry reform agenda (of which PIB and a liberalized downstream are key pegs), we recommend that:
· Ensure that the market is competitive without restrictions that creates a monopoly or oligopoly and undermine the effect of removal of price control on the market.
· Allow markets to determine price while the Authority focuses on qualitycontrol, measurement and market efficiency. This will unlock and unleash the potential of the downstream. We believe the PIB and its reforms could move sectoral contribution to Gross domestic product (GDP) from 8.5% to more than 15%. That is significant. What this means is that a monopoly or oligopoly could further significantly reduce contribution. The PIB should support growth.
· To support increase in local refining, set up a realistic timetable that details a roadmap after consultation with key stakeholders on incentives that will be provided and this should not be hardwired in legislation. The Authority should be given a timeframe to accomplish this.
· Examine critically the existing clauses in the PIB that are anti-competition and not in the interest of Nigerians, and expunge them.
· Seek inputs from the Federal Consumer Protection Council to ensure that the PIB is reflective of fair-trade proposals that benefits the generalityof Nigerians
Conclusion
Nigeria has long awaited this moment. When competition and efficiencies will be unleashed on the downstream sub-sector to; ensure that petroleum products prices are determined by market forces, absence of government control in the pricing process except for tax purposes, freedom of marketers to source petroleum products locally and internationally, freedom of domestic refiners to purchase crude oil from local and international sources for local processing, freedom of refineries to enter into processing agreement with marketingcompanies on the basis of market determined fees, and right of access to supply and distribution infrastructure subject to regulated tariffing. The PIB has attempted to deliver on all these but clause 317(8) may inadvertently torpedo all of this efforts. It needs to be expunged from the bill to guarantee sustainable sub-sectoral growth and viability.Brief on PIB and Nigerian Downstream f1