Why we must deregulate now

Risks in the downstream sector of Nigeria’s energy sector are currently elevated as a result of the falling naira currency. Nigerian banks, which are hugely exposed to the sector, are warning that the downstream oil and gas business may experience significant pressure from the naira’s devaluation.

Problems in the downstream can be traced to the continued insistence by the Nigerian government to subsidise the use of fossil fuels in the country. The value of currently outstanding subsidy payments was put at N300 billion by investment firm Renaissance Capital in a December 1 note, with the FGN committing to clearing about half of this amount before the end of the year.

The implication of these delays is that the banks intermittently halt lending to the petrol importers when their subsidy debts reach internal limits, which has often led to queues in the country.

Oil and gas (including solid minerals) now takes the lion’s share of Nigerian banks’ outstanding loans, with its proportion doubling to 22 percent in FY13, vs. 11 percent in 1Q08. Stress is beginning to show in the sector in the form of non-performing loans (NPLs), as its percentage is higher than the banking industry-wide average. Oil and gas lending made up 10.6 percent of NPLs in Rencap’s universe of 10 banks under coverage as at 9 months 2014.

One reason for the riskiness of the downstream sector was that for the bills of lading executed before the devaluation, the subsidy repayment will be based on the pre-devaluation exchange rate and only bills executed after the devaluation will be refunded using the devalued exchange rate. This implies that the company bears the loss of the devaluation. Already, some banks in the country have stopped funding the importation of petroleum products due to the inability of the marketers to repay loans incurred to finance importation.

The root of this problem lies in the fact that while Nigeria may be a net oil exporter, the country remains dependent on refined product imports to meet domestic demand as the subsidy regime which encourages corruption keeps the country’s four refineries perpetually decrepit. The products are usually imported by local companies from international oil trading intermediaries.

Another problem is that the country still owes those international intermediaries substantial arrears and has already had to resort to so-called oil-for-product swaps to ensure imports keep flowing, albeit on terms which look increasingly unfavourable.

We believe the country should as a matter of priority deregulate the downstream oil and gas sector to eliminate the current atmosphere of chaos, opacity and corruption in the sector. Companies operating in the downstream must be able to survive as other Nigerian companies do, without the government guaranteeing a profit in the form of a dubious handout called fuel subsidy.

It is instructive to note that other serious emerging markets such as India, Indonesia, and South Africa have eliminated or moved to remove subsidies on fossil fuels. Subsidies are bad economics because they distort the efficient allocation of capital.

Nigeria has spent an average of N1 trillion a year in the past two years on subsidising petrol and kerosene. We believe the government should channel its scarce resources to areas such as health care and education, while the private sector should be incentivised to build refineries in Nigeria (as the Dangote Group is doing) to bridge the gap between domestic demand and supply of refined petroleum products.