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Editorial Last Updated: Jan 11, 2016 - 2:49:09 PM


Whom Does The Nigerian Fuel Subsidy Subsidise?
By Dr. Gary K. Busch 11/1/16
Jan 11, 2016 - 2:42:06 PM

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There is a recurrent crisis in Nigeria about the price of refined oil products on the Nigerian market. This is not a new crisis; only a different chapter in a long crisis relating to the refining of crude oil.

Crises over subsidies and the price of refined products were a feature of the Babangida, Abacha, Obasanjo and Jonathan governments. Each was accompanied by civil disorder among the populace and industrial action by the national unions, especially those in the oil industry.

The problem with the rise in fuel prices is that most Nigerians live on or just below the level of poverty at less than USD$2.00 per day and are dependent on low-cost fuel for transport, for providing electricity to their generators in the absence of any regular power supplies, and for cooking. With fuel costs rising, almost every aspect of a Nigerian’s life is made costlier and uncomfortable. He cannot pay for the transport to work or school and the shops and markets can’t function because they rely on generators for power. The price of fuel is a critical factor in the lives of the people. As Nigeria is one of the most important producers of light, sweet, crude oil in the world, they cannot understand why fuel should be expensive in the domestic market.

In the absence of a domestic refining industry Nigeria exports crude oil and imports gasoline (Prime Motor Spirit), kerosene and diesel. There was an effort in 2002 to improve the situation when the government issued eighteen new licenses to build refineries in Nigeria. There was a tender round in May 2002 and a number of indigenous firms won licenses to build refineries. However, none of them were able to get foreign technical partners and the required funding for the projects. Most of the invited technical partners have shunned the downstream sector of the industry as it was fraught with corruption as the winners of the tenders had to make the necessary payments for the issuance of the license and needed substantial ‘up front- cash from their prospective technical partners.

The indigenous companies were expected to raise offshore loans and to help in the production of Basic Design Packages to be submitted during the second phase of licensing exercise. Experts say that for the kind of design required by the Ministry of Petroleum Resources for the project, the local companies needed to invest, up front, about US$360 million to prepare the document, adding that getting the money and the expertise that will handle the job required the participation of foreign technical partners. Without such a professional document raising funds either from the local banks or international financial institutions would have been an insoluble problem for the operators. The locals either did not have the money to spend or relied on selling the rights to their foreign partners who would pay for the Basic Design Package. The prospective partners were not willing and, about five years later, the government revoked these licenses.

There have been several well-publicised announcements of proposed new refineries but these have all been delayed, abandoned or unfunded. Right now Nigeria is lucky if it can meet 17% of domestic demand from local refining.  In 2010, Nigeria consumed approximately 280,000 bbl/d of oil.

The country has four refineries with a combined theoretical capacity of around 445,000 bbl/d. As a result of poor maintenance, theft, and fire, none of these refineries have ever been fully operational. In 2009 and some of 2010 these refineries operated at their lowest levels of between 0% and 30% of capacity, and led to the country importing about 85 per cent of its fuel needs. By early 2011, operational capacity increased but the country still required product imports to meet demand. So, in its wisdom, the government said that they estimated the domestic market required the refining of 445,000 barrels a day of crude to supply the local market. They would deliver these barrels of oil at the domestic price to those companies who would export the crude oil and import the refined products; some directly and some through major international traders like Trafigura

The NNPC

The root of Nigeria's problems can be found at the Nigerian National Petroleum Company. This is the most important constraint on Nigeria's economy and the mother lode of Nigeria's corruption.

Key among the problems of the NNPC is the question of imported refined products and the fact that Nigerian refineries are inadequate and ill-maintained.

Shortly before Obasanjo took office on May 29th 1999, the country was importing petroleum products at the cost of $234.00 per ton during the Abacha and Abdulsalmi Abubakar regimes, but shortly after Obasanjo assumed office, this was reviewed upward without rhyme or reason to $569.55 per ton, a whopping 143%. Statutorily, it is not the responsibility of the NNPC headquarters to import refined products; it is the responsibility of its subsidiary company, PPMC, a limited liability company with a bona fide Board. The PPMC should have been allowed to determine its market requirements, advertise for tender, select the competitive offer and, only when its board approved, a recommendation to the NNPC Board would be forwarded through the Managing Director of NNPC to the President for approval. However, this was never allowed to happen. The issue of fuel importation was personally handled by Obaseki and Obasanjo using the CBN account at the inflated price of $569.55 per barrel when the on-going market landed price was less than $300 per barrel. The balance per barrel disappeared.

The major problem is the total failure of the refining capacity controlled by the outstandingly inefficient Nigerian National Petroleum Company (NNPC). Nigeria’s total refining capacity is 445,000 barrels per day, installed in three stages between 1965 and 1989. A modest capacity of 35,000 bpd was installed in Port Harcourt in 1965 amid the political turmoil which led to the Biafran War in 1966. This was expanded to 60,000 bpd in 1971 preparing for the post-war oil-led economic boom. This was the period that saw an eight-fold crude production increase from 1969 to 1974.

It took another eight to nine years before the Warri and Kaduna Refineries were commissioned (within a year of each other) with capacities of 125,000 bpd and 110,000 bpd respectively, coinciding with the 1979/80 upstream production peak. Production was again on the upsurge when the most modern of the three refineries was commissioned in Port Harcourt in 1989 with a capacity of I50, 000 bpd. The timing of these investments was very significant as they coincided with major increases in crude oil revenue accruing to the Federation. It was the Government's intention to plough back revenue surpluses in order to further add value, cater for domestic needs and conserve foreign exchange.

In 1988 there was the addition of a polypropylene and carbon black unit in Warri and a linear Alkyl Benzene unit in Kaduna. The policy was definitely well intentioned, but the implementation has left much to be desired, especially in the area of maintenance. This disregard for maintenance prevails throughout the downstream sector. The Eleme Petrochemical Plant, a major downstream strategic investment, went the same way as the refineries. Streamed in 1994/95, with an installed capacity of 125,000mt/yr of polyethylene and 80,000 mt/yr of polypropylene, this plant was intended to meet the needs of a wide range of industries and have plenty left for export. Unfortunately, slow policy implementation led to serious cost overruns and globally mistimed completion. The loans persist with huge accrued interest, while capacity utilization continued on a downward trend, occasioned by missed maintenance schedules as well as by knock-on effects from problems at Port Harcourt Refinery's Olefins Plant. The history of the refineries tell the story.

The Refineries

Port Harcourt Refinery: The last but one Turn Around Maintenance (TAM) carried out in 1994 was followed six long years later by another in 2000. The power unit remains its main problem. The premier unit was neglected until 1993/94 when it was rehabilitated, but ever since then, it has had to remain shut in favour of the main one because of power limitations, or because of crude allocation, which historically have sometimes proved inadequate.

Warri Refinery: Another example of inadequate maintenance led to catastrophic system failures such as the main Crude Heater blow up of 2000. The last full TAM was 1994. There has not been one since. Capacity utilization was a mere 37.4% in 1995 down from 72% in 1992. It has declined since then.

Kaduna Refinery: Inadequate maintenance, combined with internal staff relations (as in Warn) and a lack of resources for maintenance were a major factor in the poor refinery performance. Problems with the FCC (‘cracker'), water intake and cooler units are a regular occurrence. The 1992 TAM ran over budget and was never satisfactorily concluded, while the one started in 1998 has still to be concluded; there were two TAMs in between which were funded but never started

Capacity utilization dropped from 73.9% in 1988 to a mere 42.4% in 1995, with debilitating results on the economy and people's daily lives, especially in the northern part of the country where Kaduna is the only hub. These have declined further, year-by-year. The estimated remedial costs are monumental, especially for Warri Refinery (nearly N28 billion) and Kaduna (N2 billion). There is no way the government was willing to pump in these huge sums of money, and has sought any number of shortcuts to relieve itself of the responsibility.

Nigeria has already issued several licenses for the repair and maintenance of the refineries. A lot of money has been paid, but very little maintenance actually completed.

New refinery tenders were issued. The local Nigerian companies who won the tenders for this were not able to attract overseas firms willing to co-operate with them, nor have they been able to raise the capital needed to perform these tasks.

Since the preliminary licences for new refineries were issued in May 2002, none of the 18 companies submitted any report on the progress of its work to the Petroleum Ministry. Finally, the NNPC withdrew the licenses it had awarded to 18 companies to set up oil refineries; five years after the companies failed to commence work. The companies, which were granted licences include Akwa Ibom Refinery and Petrochemicals Ltd, Badagry Petroleum Refinery Ltd; Clean Waters Refinery, Ilaje Refinery and Petrochemicals, Niger Delta Refinery and Petrochemicals Ltd, NSP refineries and oil Services Ltd, Ode-Aye Refinery Ltd, Orient Petroleum Resources Ltd, Owena Oil and Gas Ltd, as well as Rivgas Petroleum and Energy Ltd. Others are: Sapele Petroleum Ltd, Southland Associates Ltd, Southwest Refineries and Petrochemicals Ltd, Starex Petroleum Refinery Ltd, the Chasewood Consortium, Tonwei Refinery, Total Support Refineries, and Union Atlantic Petroleum Ltd. Each is associated with a leading politician-businessman.

These licenses have now expired, unused. Nigeria had attempted to get foreign investors to build new refineries but their attempts have always failed. The primary reason for the failure in building new refineries was that the importation of fuels is a giant cash cow for Nigeria’s elite and they were unwilling to lose this revenue stream.

Importation of Refined Products and the Fuel Subsidy:

In 2009 and some of 2010 these refineries operated at their lowest levels of between 0 and 30 per cent of capacity, and led to the country importing about 85 per cent of its fuel needs. By early 2011, operational capacity increased slightly but the country still required product imports to meet domestic demand. So the government said that they estimated the domestic market required the refining of 445,000 barrels a day of crude to supply the local market. They would deliver these barrels of oil at the domestic price for crude to major international companies like Trafigura and Glencore who would export the crude oil from Nigeria and import the refined products back to the country. This was arranged by the Oil Minister, President Obasanjo who was doubling up his roles in defiance of a Constitutional inhibition on holding two office of state.

When these refined products returned from the overseas refineries to Nigeria they were handled by local oil traders. The list of these traders is very revealing; as a substantial number are linked to ex-Presidents Babangida and Obasanjo or their immediate circle. Obasanjo personally didn't waste his time in immersing himself in that part of the industry. His son and the sons of some of the other politicos operated the fuel import business into Nigeria. To assist them the government paid the local traders a subsidy, a ‘fuel subsidy’ to keep the market price down for local consumers. These were substantial sums. The fuel subsidy figures paid to the marketers were trillions of Naira. This was a high reward for keeping the price subsidised; in recent years the range has been 400% to 550% paid to the marketers who would then demand a lower price from the Nigerian public. A recent parliamentary report showed that in the last two years the oil traders had siphoned off US$6.8 billion for fuels they supplied and often didn’t supply to the market. They received the subsidy payment for the fuels they didn’t supply to the public in addition to the fuels they did supply.

While this is a shocking amount of money to have been paid to the fuel marketers, it is a pale understatement of what they actually earned from the export of crude and the import of fuel. Unfortunately to understand this one needs to understand how the refining process of oil takes place.

How Oil Is Processed

In the oil industry one speaks of crude oil in terms of barrels, sulphur content (sweetness), viscosity (API gravity) etc. The international price is quoted in terms of ‘marker crudes (West Texas Intermediate, Brent, Bonny, Dubai and Isthmus). The price differs among them based on a variety of relatively stable factors. However, the market in refined products is very different. This is based on the ‘netback' of the crude being refined. That is the value of all the petroleum products which are produced in the refining process. To understand this, it might be useful to sketch out what happens when crude oil is refined.

The problem with crude oil is that it contains hundreds of different types of hydrocarbons all mixed together. You have to separate the different types of hydrocarbons to have anything useful. Fortunately, there is an easy way to separate things, and this is what oil refining is all about. Different hydrocarbon chain lengths all have progressively higher boiling points, so they can all be separated by distillation. This is what happens in an oil refinery - in one part of the process, crude oil is heated and the different chains are pulled out by their vaporization temperatures. Each different chain length has a different property that makes it useful in a different way. Most Nigerian crudes are refined in a ‘straight-run' fractioning of the oil content and do not require additional catalytic refining. A typical fractioning column looks like this:

The various components of crude oil have different sizes, weights and boiling temperatures; so, the first step is to separate these components. Because they have different boiling temperatures, they can be separated easily by a process called fractional distillation. The steps of fractional distillation are as follows:

1. You heat the mixture of two or more substances (liquids) with different boiling points to a high temperature. Heating is usually done with high pressure steam to temperatures of about 1112 degrees Fahrenheit / 600 degrees Celsius.

2. The mixture boils, forming vapour (gases); most substances go into the vapour phase.

3. The vapour enters the bottom of a long column (fractional distillation column) that is filled with trays or plates.

The trays have many holes or bubble caps (like a loosened cap on a soda bottle) in them to allow the vapour to pass through.

The trays increase the contact time between the vapour and the liquids in the column.

The trays help to collect liquids that form at various heights in the column.

There is a temperature difference across the column (hot at the bottom, cool at the top).

4. The vapour rises in the column.

5. As the vapour rises through the trays in the column, it cools.

6. When a substance in the vapour reaches a height where the temperature of the column is equal to that substance's boiling point, it will condense to form a liquid. (The substance with the lowest boiling point will condense at the highest point in the column; substances with higher boiling points will condense lower in the column.).

7. The trays collect the various liquid fractions. These fractions include:

Volatile gases – Propane, butane

Naphtha or Ligroin - intermediate that will be further processed to make gasoline

Gasoline - motor fuel

Kerosene - fuel for jet engines and tractors; starting material for making other products

Gas oil or Diesel distillate - used for diesel fuel and heating oil; starting material for making other products

Lubricating oil - used for motor oil, grease, other lubricants

Heavy gas or Fuel oil - used for industrial fuel; starting material for making other products

Residuals - coke, asphalt, tar, waxes; starting material for making other products

Each crude oil, because of the structure of its hydrocarbons, produces different quantities of each fraction. Sometimes the trays can be positioned to get a little more of one substance. In the winter, in North America, the ‘bottom end of the barrel' increases in value as cold weather requires heating oil. The ‘top end of the barrel' is better in summer because more gasoline is used.

However, the refining of oil is not additive in that you cannot get out of the barrel more than you put in. Therefore, when making a market in refined products the ‘net back' of the products becomes important. That is, each fraction has a variable price. So, if one can get 16% of the product as gasoline then that 16% quantity times the market value of the product gives you the value of the gasoline. If the residuals are 40% then the volume of the 40% times the price of the residuals gives you the value of the residuals, and so on. The sum of all the products of percentage volume times the current market price for those products gives you the net back value of the barrel of oil. From this one can deduct the cost of transport, the loss of volatiles during shipment and the insurance costs.

The Netback Value of Nigerian Crude

Nigerian oil is sold into the market based on the netback price. For example, a recent analysis of the netback on Bonny Light shows:

That means that the value of the products of the various products produced in the processing of Bony Light is $24.11 per barrel. There are 7.51 barrels of Bonny Light to the metric ton. It costs a flat $10.62 per each metric ton to produce. With Worldscale 125.8% for the shipping the addition costs of the netback reduce the value by $1.78 per metric ton with a processing loss of value of $0.05 per metric ton. With insurance this means that a $24.11 price for each barrel of oil will yield a netback value of $20.35.

The important point of all this is, if the crude oil exports of the 445,000 barrels a day are only bringing back to Nigeria the PMS, kerosene and diesel, where is the value for the rest of the barrel? The netback value of the gasoline, kerosene and diesel is $14.33. Where has the remaining value of over $6.25 per barrel gone? Who has the money for the butane, propane, residual oils, asphaltenes, etc. which are an inevitable result of the refining process?

These favoured exporters of oil from Nigeria of 450,000 per day which are not able to be refined in Nigeria are getting the oil at source at a considerable discount. Including shipping costs to the US Gulf the net cost is under $25.00 a barrel. They are shipping back to Nigeria the PMS, kerosene and diesel which they sell to the NNPC at the world price for these products. They are not charging to the NNPC the netback value of the crude, but only the world price for the parts of the refined barrels they bring back.

Not only are they making a substantial profit on the difference between netback and market prices, they are also earning about $5.25 a barrel for all the products they do not return. That is a bonus of over $2.8 million a day (N 558 million) in addition to the profits made on the differential between netback and world market prices.

To compensate the importers for making such a profit the NNPC pays them an additional bonus, the “fuel subsidy” to reduce the market price in Nigeria to the customers.

The Fuel Subsidy

The new Buhari government has pledged to investigate the missing funds. However there already exists a full report by Price Waterhouse on the US$20 billion missing from the NNPC and a 205-page 2012 parliamentary report which uncovered a long list of alleged wrongdoings involving oil retailers, Nigeria's Oil Management Company and the NNPC

According to that report, a total of 15 fuel importers collected more than $300m two years ago without importing any fuel, while more than 100 oil marketers collected the same amount of money on several occasions. The report states that the importers had stolen US$6.8 billion in the years 2010 to 2012.

The annual $8bn fuel subsidy means prices are lower than in neighbouring countries - and many Nigerians see cheap fuel as the only benefit they get from their country's oil wealth, much of which is pocketed by corrupt officials.

Nigeria spends N220bn ($1.1bn) per annum ostensibly to subsidize an average of 750,000 metric tonnes per quarter of refined products. This amount is the equivalent of 4.89% of its budget and 2.04% of its export revenues to subsidize consumption. The opportunity cost of this scheme is a significant shortfall and an accumulation of contractors, salary and cash call arrears.

The current fiscal problem facing Nigeria is further impetus to re-move the subsidy. Between 2006 and 2013, the government spent over N5.42 trillion on subsidy, which was 15.57% higher than the 2014 national budget of N4.69 trillion. For the 2015 budget, a total sum of N220 billion has been allocated to the subsidy.

If the subsidy were removed today, under existing rates, the pump price would jump to approximately N130, which is the total open market price if one considers both the landing cost of petrol at N115.77 and the margin for transporters and exporters of N15.49 as of May 10, 2015.

However, the real netback value of a gallon of gasoline is USD$ 0.178 or N35.6. That is for a gallon. There are 3.78 litres per U.S. gallon. That would make the true price of the litre of gasoline N9.42 plus the “landing margins” of N15.49 or a total of N24.91. So, even using the importers own figure of their profits the proper price for gasoline should be under N25 per litre. In addition, they are earning an addition N24 per litre on the refined products they do not bring back to Nigeria.

So, they question should be asked “To whom is the subsidy being paid?” It isn’t the NNPC and it isn’t the Nigerian people.


Source:Ocnus.net 2016

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