Fuel subsidy : Who is subsidising who? (1)

“WHO is subsidising who? The Nigerian oil industry was developed with Nigerian capital. Most of the experts are Nigerians, if you go to the fields. It is Nigerian capital; it is Nigerian oil. What I understand that Nigeria should charge Nigerians is the cost of one barrel at the wellhead and then the cost of transportation to the refinery, the cost of refining it and its cost at the pump. If anybody says he is subsidising anything, he is a fraud. So all these people talking about subsidy, who is subsidising who?” General Muhammadu Buhari (rtd), 2011

A first year student of refinery economics knows that the “crack spread” is a simple way to determine the profitability of a refinery at the margin. The crack spread is the difference between the sales prices of the refined products (PMS, AGO, HHK) and the price of crude oil. A 3:2:1 crack spread means that at the margin, 3 barrels (bbls) of crude oil will produce 2 bbls of Premium Motor Spirit (PMS) and 1 bbl of Automotive Gas Oil (AGO) or Household Kerosine (HHK).

A barrel of Nigerian oil now cost about $40. One bbl of PMS at N87/litre cost N14,159 or $71.87 at a CBN exchange rate of N197/$1. The PPPRA product pricing template of December 3, 2015 put the cost of AGO at N96.91/litre or N15772 ($80.06) per bbl. Thus, the gross cracking margin for an average refinery in Nigeria is [(2*71.87) + 80.06 – (3*40)] or $103.8 per bbl. The 3:2:1 crack spread is $103.8/3 or $34.6 per bbl.

We can substitute HHK for AGO. At N50/litre, one bbl of HHK cost N8137.5 or $41.31. Therefore, the gross cracking margin using PMS and HHK is [(2*71.87) + 41.31– (3*40)] or $65.05 per bbl. The 3:2:1 crack spread is $65.05/3 or $21.68 per bbl. It is empirically impossible to convince anyone that Nigerian refineries cannot operate profitably under an incorruptible efficient management or that a fuel subsidy exists. What exist is the looting of public resources by a cabal aided by a corrupt bureaucracy and gross mismanagement.

Today, you can buy a gallon of PMS from a Valero gas station in Houston, Texas for as low as $1.55 or N78.8 /litre. Prices range from $1.55 to $1.99 per gallon throughout the state. The $1.55/gallon price consists of USA Federal/State taxes (19%), Distribution and Marketing (11%), Refining Cost/Profits (13%) and Crude oil cost/profit (56%). Therefore, without any taxes, the PMS in Houston would cost 19% less or N63.83/litre. Unconvectional (shale) oil production has replaced all oil imports in Texas. They produce all their oil like Nigeria.

Texas has 26 refineries with a capacity of 4.72 million bbls per day. Most refineries operate at a minimum of 85% efficiency. The market operates on a production-pricing model. West Texas Intermediate (WTI) crude cost $36.45/bbl, refining cost/profit cost $8.46, Distribution/Marketing cost $7.16/ bbl and Federal/State tax cost $12.37/bbl. Therefore, a bbl of PMS is about $64.44 or N78/litre. It is therefore clear that if we build more refineries to meet all our domestic demand ( plus export) and eliminate corruption, we will not have a corruption subsidy.

In Nigeria, the PPPRA pricing template of December 3, 2015 declared that a litre of PMS in Nigeria cost N96.18 without any taxes. Distribution margins made up 16.1% (N15.49/litre) of this amount. The rest (N80.69) is the landed cost of the imported PMS. Platt Oil, a foreign institution, determines the C+F price of imported PMS and therefore, the landed cost. The landed cost, in turn, determines the PMS OMP price by PPPRA. The PMS price in Nigeria is therefore determined by a foreign body. It is obvious that this World Bank/IMF inspired import-parity-pricing model is wrong, anti-development and generates a fertile environment for massive corruption. Petroleum products prices should be determined by a production cost-pricing model as explained by President Buhari above.

This was the case before the World Bank/IMF convinced the President Obasanjo to impose an import parity-pricing model on NNPC and the Nigerian economy as a whole. The World Bank is currently putting pressure on President Buhari to raise fuel prices using the import parity-pricing model.

In 1995, under the Petroleum (Special) Trust Fund (Amendment) Decree No.1 1995, the cost PMS was set at N11/litre. The real cost of PMS using a production cost-pricing model was N5.68/litre. Crude oil cost/profit made up 43.37% (N2.35) of this amount. The Marketers’ Allowance made up 22.88% (N1.30), Excise Duty & VAT was 5.81% (N0.33) and NNPC Cost/Margin was 29.93% (N1.70). The excess (N11-N5.68) or N5.32/litre was used to fund the PTF.

The prevailing exchange rate was N133/$1 and oil prices were $17.3/bbl. There was no fuel subsidy or a corrupt cabal. Therefore, before the discussions on fuel subsidy begins during the upcoming FEC meeting, President Buhari should ask his ministers a few simple questions: How much does a litre of PMS actually cost? How much PMS do we produce, import and consume daily? What is “fuel subsidy”? How much “fuel subsidy” actually exist? What is the impact of the removal of this fuel subsidy on the Nigerian masses/economy? Who is subsidising who?

In December 2011, prior to the opening salvo of the fuel subsidy struggles, I wrote; “At the refinery gate in Port Harcourt, the cost of a barrel of Qua Iboe crude oil is made up of the finding /development cost ($3.5/bbl) and a production/storage /transportation cost of $1.50 per barrel. Thus, at $5 per barrel, we can get Nigerian Qua Iboe crude to the refining gates at Port Harcourt and Warri. One barrel is 42 gallons or 159 litres.

The price of 1 barrel of petrol at the Depot gate is the sum of the cost of crude oil, the refining cost and the pipeline transportation cost. Refining costs are at $12.6 per barrel and pipeline distribution costs are $1.50 per barrel. The Distribution Margins (Retailers, Transporters, Dealers, Bridging Funds, Administrative charges etc) are N15.49/litre or $16.58 per barrel. The true cost of 1 barrel of petrol at the Mobil filling station in Port Harcourt or anywhere else in Nigeria is therefore ($5 +$12.6+$1.5+$16.6) or $35.7 per barrel . This is equal to N33.36 per litre compared to the official price of N65 per litre. “ .

This PMS price was determined using a production cost-pricing model. Therefore, it is not dependent on the uncertainties of PMS market prices as determined by Platts Oil. We will proceed to update this analysis in light of December 2015 conditions. The funding/development cost has not changed from $3.50 as the 445000 bbls of domestic crude oil is still been produced from more or less the same wells. The Distribution margin is still N15.49/litre or $12.80/bbl. A 10% increase due to recent FGN investment in the repair and turn around maintenance of our refineries raises refining cost to $13.86/bbl.

The major change has occurred in pipeline transportation. The NNPC claims that pipeline sabotage and theft of petroleum products are responsible for the poor domestic refinery output and disrupted pipeline supply. The NNPC declared that it lost 531 million litres of PMS (51.07 billion Naira) in the first 9 months of 2015 due to sabotage of our petroleum product pipeline and theft of products. Most of this loss occurred in the 30 miles Atlas Cove/Moisimi pipeline. The same problem exists in the Bonny-Port Harcourt (34 miles) and the Escarvos-Warri crude oil pipelines which supply domestic crude to the Port Harcourt and Warri refineries respectively.

• To be continued tomorrow.

• Dr. Agbon Izielen is an oil expert based in Texas, USA.