How not to remove fuel subsidies …. The vicious cycle of foreign exchange liberalization on fuel prices

Since the President announced the removal of fuel subsidies on May 29^th, 2023, it has been difficult to estimate the accurate subsidies been paid by the government. The government is only not transparent, it is also not clear what volume of petroleum products is imported into the country and how demand and smuggling across the border is changing in response to changes in prices.

Fuel prices, demand, and the level of smuggling area also affected by changes in the exchange rates while lags in timing for payment and receipt of imported products also makes it difficult to estimate levels of subsidy. Finally, the government /NNPC has not been forthcoming about the dynamics of the volume of fuel imported since the announcement of the removal of fuel subsidies by the President. 

Though there are many variables, and these variables are shifting, ThinkBusiness analysis show that the most devastating effect on fuel prices have come from changes in the exchange rate. As argued in the piece [insert link] the floating of the Naira on June 14^th have been done without understanding its implications on fuel prices. This means that the government did not think through the implications of another major policy so soon after removing fuel subsidy before going ahead. 

It shows a gross lack of understanding of how reforms are handled that President Tinubu and his team thought that the two policies could not be contradictory in the short term. Without the exchange rate volatility that followed exchange rate reform, the removal of fuel subsidy would have been a one shot increase in price. 

The exchange rate changes, therefore, contributed to the rise in fuel prices more than any other thing. In June 2023, crude oil prices averaged about US $71 per barrel, about the same price this week. Since June 2023, whereas crude oil prices have been largely flat as shown in fig. 1 Nigeria’s fuel prices has increased by over 500 percent, as shown in fig. 2.

Fig. 1. Nigeria’s Crude oil prices, production, and OPEC Quota.

The table below compares the price changes in fuel in six countries in the last seventeen months since fuel subsidy removal.  Comparing the changes in prices rather than differences in absolute prices allows us to focus on what is driving the changes. Without any change in policy or taxation in these countries, all the other prices responded to changes in the price of crude oil and other internal industry conditions, but Nigeria largely responded to the changes in the value of the naira against the US dollar.

Fig. 2. The Changes in fuel prices in six countries, including Nigeria 

The president and his team have tacitly agreed that the casual and non-preparedness of the removal of fuel subsidy has led to some chaos. What they have not admitted to is the scale of not only not considering the implications for prices of food and transport, but that the president thought that the market will sort itself and the policy was taken in isolation. 

Fig. 3. The Exchange rate of the Naira against the US dollar. 

Unlike in the past, it thus appears the government is determined to see through the removal of fuel subsidies. From all indications, the government is currently passing on to Nigerians all fuel price changes arising from all the price changes relating to exchange rates, crude oil, transports, and all other related costs. 

However, the complexity and uncertainty surrounding the removal of fuel subsidy and the resultant fuel prices changes can only be minimised through stable exchange rates. With stable exchange rate, fuel prices will now only be affected by changes in the market conditions of the industry and not how the exchange rate shift prices significantly. 

And the entrance of the products from Dangote refinery will not help. Though supply have increased from Dangote refineries and the government has allowed the payment of crude in Naira, it does not change the fact that crude oil and its by products are international commodities and that removal of subsidy automatically integrates the Nigerian market into a global supply and demand chain. 

In the context, the outlook for a stable fuel price is weak. The government has focused on the metric and not the conditions. The government has focused on prices rather than working on the market conditions that improves stability and predictability for Nigerian consumers. And this is the most fundamental flaw of the reforms the government has embarked on. 

Invariably, the government has moved from one price fixing to another. Instead of focusing on improving the market conditions that dictate the price of the fuel and that of the exchange rate, the government has focused on the prices themselves. By focusing on prices, it has now realised that the market conditions do not support the new price targets.