EFFECT OF FUEL SUBSIDY ON THE ECONOMY OF NIGERIA

CHAPTER ONE

INTRODUCTION

1.1   BACKGROUND TO THE STUDY

Nigeria is the most populous country in Africa with a 2011population of 162.5 million.It possesses28percentof Africanprovenoil reserves, second after Libya, and it is the top producer of African crude oil, producing 24percentof 2010 Africanoil production equaling2.4 million barrelsper day(bpd)(UN, 2011). At the same time, Nigeria's share inworld production remainedalmost constantaround threepercent. Nigeria ranksamong the top 12 world producers of oil in 2011 (BP, 2012).

Nigeria started subsidizing its petroleum industry in the 1980's after the state-owned company, the Nigerian National Petroleum Corporation (NNPC), had planned to unify the price of crude oil in accordance with the global market. But then-incumbent president, OlusegunObasanjo, said average Nigerians would not be able to afford a gallon of petrol at the pump. Instead, President Obasanjo introduced subsidy plan to keep the price of petrol low.

A subsidy is a form of financial aid or support extended to an economic sector (or institution, business, or individual) generally with the aim of promoting economic and social policy. Although commonly extended from Government, the term subsidy can relate to any type of support - for example from NGOs or implicit subsidies. Subsidies come in various forms including: direct (cash grants, interest-free loans) and indirect (tax breaks, insurance, low-interest loans, depreciation write-offs, rent rebates). Furthermore, they can be broad or narrow, legal or illegal, ethical or unethical. The most common forms of subsidies are those to the producer or the consumer. Producer/Production subsidies ensure producers are better off by supplying market price support, direct support, or payments to factors of production. Consumer/Consumption subsidies commonly reduce the price of goods and services to the consumer. For example, in Nigerian, it was cheaper to buy petrol some years back because of fuel subsidy.

Whether subsidies are positive or negative is typically a normative judgment. As a form of economic intervention, subsidies are inherently contrary to the market's demands. However, they can also be used as tools of political and corporate cronyism. Although subsidies can be important, many are ‘perverse’. To be ‘perverse’, subsidies must exert effects that are demonstrably and significantly adverse both economically and environmentally. A subsidy rarely, if ever, starts perverse, but over time a legitimate efficacious subsidy can become perverse or illegitimate if it is not withdrawn after meeting its goal or as political goals change.

Despite being Africa’s largest oil producer, Nigeria still relies heavily on imported refined oil. Its four refineries Port Harcourt I and II, Warri and Kaduna have a combined capacity of around 445 thousand bpd, which covers 63 percent of domestic demand. However, these refineries are running far below their capacity due to operational failures, poor maintenance, sabotage on crude oil pipelines feeding refineries, theft, and fire (EIA, 2012; Businessday, 2013). In 2009 and part of 2010, particularly low refinery runs forced the country to import about 85 percent of its refined oil needs. Other estimates show the domestic refineries to satisfy a maximum of 25 percent of domestic consumption (Rice, 2012).

With the proclaimed objective to alleviate high levels of poverty, the Nigerian government subsidizes private consumption of imported refined fuels to maintain a stabilized price at the consumer pump. The dollar value of the subsidy increases with increasing refined oil prices or increased import volumes. Rising world fuel prices have caused this subsidy to increase significantly over recent years; damaging the country’s fiscal health and economy (Rice, 2012; BBC 2012a, 2012b). The Nigerian Petroleum Products Pricing Regulatory Agency (PPPRA) determines the daily and monthly subsidy rates as follows: the subsidy is determined daily and monthly by PPPRA based on the gap between the expected price of imported fuel, including margins, and the pre-established, regulated, domestic price.

Though the subsidy helps the poor, by keeping Nigerian prices lower than world prices, the biggest beneficiaries have been importing companies and local wholesalers (The Economist, 2011)that smuggle some of the subsidized fuel into neighboring countries and sell it at higher prices (The Economist, 2012). Illegal trade is not well recorded in official trade statistics, which makes it difficult to analyze. According to the BBC (2012a, b), however, the Nigerian government paid the subsidy on 59 million liters of fuel a day in 2011, although domestic consumption in Nigeria was approximately 35 million liters a day. Thus, fuel importers were paid hundreds of millions of US dollars to import fuel that was never delivered to the Nigerian people.

For the past 30 years, governments have attempted to remove the fuel subsidy due to the damaging fiscal impact (Adenikinju, 2009). From a political economy perspective, subsidy removal is difficult because it impacts a broad spectrum of Nigerian households. Despite the majority of the subsidies benefiting wealthier households, lower and less volatile fuel prices are popular to all population segments. For these reasons, attempts to remove the subsidy have always generated opposition from consumers. Moreover, there is the presumption that any price increase will fuel inflation and reduce economic welfare (Adenikinju, 2009).

1.2   STATEMENT OF THE PROBLEM

Nigeria is not a special case regarding its refined fuel subsidies. Governments of other countries do spend several billion dollars on various sectors subsidies. However, fuel subsidies have proven to disproportionally benefit wealthier citizens that consume relatively larger amounts of fuel to power their autos and homes. For several years now, fuel subsidy has been proven to have fraudulently siphoned several billions of dollars from the Nigeria treasury. Therefore, the study is examining the effect of fuel subsidy on the economy of Nigeria. According to World Bank (2009), if fuel were not subsidized, Nigeria government should also encourage investors and firms to invest in activities that would be unprofitable.

1.3   OBJECTIVES OF THE STUDY

The following are the objectives of this study:

1. To examine the effect of fuel subsidy on the economy of Nigeria.
2. To identify the advantages of fuel subsidy to Nigerians.
3. To determine the disadvantages of fuel subsidy.

1.4   RESEARCH QUESTIONS

1. What is the effect of fuel subsidy on the economy of Nigeria?
2. What are the advantages of fuel subsidy to Nigerians?
3. What are the disadvantages of fuel subsidy?

1.5   HYPOTHESIS

HO: Fuel subsidy does not promote Nigerian economy

HA: Fuel subsidy does promote Nigerian economy

1.6   SIGNIFICANCE OF THE STUDY

The following are the significance of this study:

1. The findings from this study will educate the Nigerian general public on the effect of fuel subsidy on the Nigerian economy. It will also enlighten the public on the pros and cons of fuel subsidy.
2. This research will be a contribution to the body of literature in the area of the effect of personality trait on student’s academic performance, thereby constituting the empirical literature for future research in the subject area.

1.7   SCOPE/LIMITATIONS OF THE STUDY

This study is limited to the economic implications of fuel subsidy payment in Nigeria