The Mathematics of Petrol Subsidy and Pricing in the Nigerian Context

Day-B

In recent times there have been a lot of social, economic and political discussions on the subject of petrol subsidy in the country. Some argue that there is no more subsidy, while others say subsidy still exists. The only way to decide who is right or wrong is to analyse the various cost components that determine the pump price of petrol at the petrol stations. We need to develop a cost model for petrol price and the simplest way of doing this is to come up with a formula.

 Let us identify the direct and overhead cost factors or accounting variables that determine the retail price of petrol sold by NNPC/ PPMC  to major marketers. Each of these factors will be represented by alphabetical symbols as follows:

P_$  = the price of a liter of petrol in dollars at the point of    

         discharge at NNPC depot in Lagos (Atlas Cove), that is, ex-refinery cost  in Europe plus transport and insurance(CIF).

D = import duty or excise duty charged by customs (if any)

R =  exchange rate of Naira to the dollar (N/$) as determined by Central Bank governor

P_N = Price of petrol in Naira after conversion from dollar to Naira by NNPC

C_F = fixed overhead costs in naira ( premium, NMDPRA fees, inspection fee, margin, local transport in Lagos)

By simple arithmetic

Petrol price in Naira =  Price in dolars x N/$ exchange rate x import duty

i.e  P_N  =  P_$ x R x D       Let us assume there is no duty on imported petrol, that means D=1, thus we have

P_N = P_$ x R       i.e.  price of imported petrol in Naira is equal to landing price in dollars times the Naira/dollar exchange rate.

We can add overhead cost to this to get the final market price, P_M , of petrol, so we have

P_M  = P_$ x R + C_F  ………………………….. equation 1

Where P_M  = market price (ex=Lagos).  To avoid complicating the formula I have not added the transport cost to the hinterland and marketers’ profit margin. 

We now have an equation with four variables or unknowns.

However based on the above costing template release by NNPC on Tuesday 17^th September,  we now know the value of two of the variables, landing cost of petrol in dollars, P_$ = $0.52 and overhead cost , C_F = 107.61 Naira,

So substituting in equation 1 above, we have a formula

P_M = 0.52R  + 107.61    Naira per liter

 For those familiar with secondary level further maths, this is the same as the general equation of a straight line_,  Y = mX + C _. For practical purposes, I have assumed that the landing cost of imported petrol or ex-refinery cost in dollars and the overhead cost  are fixed. Consequently, the general formula for determining the final market price of refined petrol in Nigeria ( ex-Lagos) is

P_M  =   0.52R + 107.61 Naira per liter (ex-lagos)

In this final formula, naira/dollar exchange rate, R, is the only unknown independent variable.

We need to introduce another final variable, P_G  which is the political price at which the petrol is sold to the public. That brings us to the final equation/formula

Subsidy =  P_M  – P_{G   ………………  equation 2}

( P_{M = market price}   P_G = government price)

That is, subsidy is equal to the difference between the market price of petrol  and the price at which government directs NNPC to sell the commodity to the public.

For the sake of those who are not familiar with mathematics or algebra, I will interpret the above equations in simple lay man’s language by the following statements:

FACT 1:  The dominant factor that determines the real pump price of petrol in  Nigeria is the naira to dollar exchange rate. The contribution of the international price of crude oil is minimal and almost constant.

FACT 2: Subsidy is actually the discount that NNPC offers local buyers by selling petrol below the actual market price, P_M

FACT 3: Subsidy removal is just another way of saying that no more discount is offered to Nigerian buyers

FACT 4: The existence  or non-existence of subsidy depends mainly on the exchange rate  of Naira to dollar.

FACT 5: Whenever the Naira to dollar exchange rate varies, the pump price of petrol must be adjusted upward (or downward) in order to make it equal to the market price so as eliminate subsidy ( or avoid overpricing)

FACT 5: The de facto or dominant  institution  that actually  determines the price of petrol in Nigeria as of today is the Central Bank.  It is neither His Excellency, the  President, nor NNPC the importer .

The president came out with a policy that there should be no more fuel subsidy.  It is now the responsibility of NNPC in conjunction with Central Bank to implement the policy in monetary terms.

I can prove the above statement by simple arithmetic.

When on May 29, 2023, the President removed oil subsidy, the official CBN exchange rate of naira to the dollar was about N470 to $1. Immediately, NNPC adjusted  the price to about N600/liter (ex-Lagos) in order to make the pump price equal to market price, thereby eliminating subsidy.

For reasons best known to it, CBN decided to float the Naira. Consequently, the exchange rate rose from 460 to 1,600 Naira to the dollar. In fact it temporary rose to about 1,900 in the parallel market before it stabilized to 1600 after CBN intervention.  NNPC did not immediately adjust the pump price to reflect the new exchange rate. That means pump price is now less than market price, so subsidy was back. Then in August, 2024, NNPC now decided to apply the new exchange rate in formula 1 above in order to eliminate subsidy. Consequently, the pump price of petrol rose to N986/liter ex-Lagos.

If the Central Bank again in October decides that the exchange rate of Naira to dollar comes down to 1000, the pump price of imported petrol will be adjusted downwards to N627/liter by NNPC based on formula 1 above assuming the landing price in dollars remains the same.

Also if on the other hand the Cardoso-led Central Bank again in November decides that the exchange rate of Naira to the dollar is goes up to N2000 to the dollar, then NNPC will again have to adjust the pump price of imported petrol upwards to N1,147 per liter ex-Lagos in order to again eliminate subsidy.

It can be seen from the above analysis that the CBN is the one dictating the price of petrol through its exchange rate monetary policy.

CRUDE OIL SALE IN NAIRA: Again the President Tinubu has come up with another good and wonderful landmark policy that crude oil being sold to local refineries should be priced in NAIRA, the local currency. Now back to implementation; how will NNPC implement this new policy?

Will they just multiply the OPEC Brent crude price by the prevailing Naira exchange rate to the dollar in order to get the price of local crude in  NAIRA? Simple arithmetic. If they do that, then we are back to square one.   The pump price of petrol will go up and down in accordance with the Naira dollar exchange rate set by the CBN. In the alternative, will they set a Naira value for the Nigerian crude without reference to OPEC dollar price and the CBN exchange rate?  How NNPC implements the presidential directive as from 1st October, 2024 will determine whether or not petrol pump price in Nigeria will become independent of CBN dollar exchange rate for ever so that subsidy too can disappear for ever.  That will be double independence celebration for us.

Also, how will the increase in local refining capacity affect Nigeria’s foreign exchange liquidity position? By the time Dangote’s refinery and the 3 NNPC refineries start working at full capacity, how many barrels of crude oil per day will they be consuming?  There was a time Nigeria was producing 2.3 million barrels per day but presently production has dipped to about 1.5 to 1.7 . If Dangote alone consumes 600,000 per day and you add the consumption by the other 3 refineries; how much crude will be left for export. With oil accounting for over 90% of our foreign exchange income, can the dollars we earn from the  balance being exported support our import bill? To remain in our comfort zone, it may be necessary for Nigeria to ramp up her crude oil production beyond current levels. The $25 Billion inflow from diaspora remittances and Forex from LNG gas export may not be enough to compensate for the short fall. I leave that arithmetic to NNPC and Central bank.

In the alternative, Nigeria can re-direct her business strategy by becoming a net exporter of refined petroleum products instead of being an exporter of raw crude oil. That will even earn us more forex income as a result of local value added.

Finally, whatever strategy is adopted, the hard fact is that, we as Nigerians must decrease or reverse our ever-increasing appetite for imported goods and raw materials in order to conserve foreign exchange and to tilt the international balance of payments in our favour

Day-B writes from Abuja