If I got N100 every time I heard the question, "How
can a country blessed with one of the largest
reserves of crude oil be importing fuel?", I would
be a millionaire.
That question is built on the idea
that a country that has crude oil should naturally
be refining crude oil. It turns out that is not the
case as we are learning the hard way. The
reasoning is very simple. To understand this let us
examine a simplified oil industry as in Picture 1
below.
The business of having crude oil and turning it into
fuel to put in your car, or generator, actually
involves five different industries. The first is the
business of finding and having crude oil. The
second is the business of getting that crude oil out
of the ground. The third is the business of
transporting that crude oil to refineries. The fourth
is the business of refining the crude oil, turning
into fuel and other products. The fifth is
transporting the refined fuel to your filling stations
so you can fill up your tank.
Which of these industries does Nigeria have an
advantage? Only one. The business of having
crude oil. We have crude oil and many others
don't. Does Nigeria have an advantage in the
business of getting crude oil out of the ground?
Not really. It is of course cheaper to drill oil in
Nigeria than it is to extract shale oil in Canada.
However if you think of the advantage in terms of
Nigerian firms vs foreign firms drilling for oil in
Nigeria then there is no real advantage. Although
we have tried to rectify this by making that section
of the industry very hostile to foreign firms. It is
kind of working but the side effect of that strategy
is the increase in costs for all firms. Which is not
necessarily a good thing but more on that in a bit.
Do we have an advantage in the transporting of
crude oil? No. Do we have an advantage in the
refining of crude oil? No. Marketing? No. So in
essence the only part of the industry that we have
a real advantage is in having crude oil.
Now think of things from the marketers and
distributors perspective. They are the ones who
really make the decisions on whether fuel will be
imported or bought locally. Two major factors
guide their decision to import or source locally.
First the fuel has to be available to buy locally.
Secondly the fuel refined locally needs to be
cheaper than if it was bought on international
markets. Even if local businesses refine fuel, it
needs to be cheaper than imported fuel, else fuel
would still be imported.
In general fuel will be imported if it is cheaper on
international markets compared to local markets.
Does having crude oil imply that it would be
cheaper to refine locally? The answer is no. Many
countries may not have crude oil, but every
country can buy crude oil. If any country can buy
crude oil then having crude oil is not really an
advantage. International fuel markets are highly
competitive given that any country can buy crude
oil, refine it and sell. So if the local industry cannot
compete on efficiency and costs then fuel will be
cheaper on international markets. And marketers
will opt to import fuel rather than buy locally.
Which then means your local refineries will
disappear.
Why can't our local oil industry compete?
The next obvious question is why our local
refineries cannot compete with international
players. The simple answer is the way our local
industry is structured. Picture 2 below explains it
perfectly.
Basically the NNPC and its subsidiaries run the
entire oil industry. Prices across the entire
industry are also set by the government, with the
exception of the export price of crude oil which is
beyond its powers. In essence you have the perfect
worst case scenario for business. On the one hand
you have a government corporation controlling
everything from oil drilling, to crude oil pipelines,
to refineries, to fuel pipelines, to marketing and
distribution. On the other hand you have a
government that sets prices of everything from the
retail price of fuel to pipeline use chargers etc. Yes
there are independent private players across the
industry but most are mandated to partner in some
form with the NNPC. The result of this industrial
structure is an entire local industry that cannot
compete with international players. First there are
almost no legal private refineries. So we are not
even at the point where locally refined fuel is
available but more expensive. It is not even
available. The government owned refineries are
unsurprisingly in a state of perpetual turn-around
maintenance. And so we import.
So what is the plan?
According to most the plan for the oil industry
revolves around the petroleum industry bill. The
bill aims to break up the NNPCs hold on the oil
industry and make it look something like this see
picture 3 below.
The idea is to break up the industry into bits to
reduce some of the corruption and lack of
transparency. Disclaimer: there are many other
agencies in the PIB not in the diagram above. Plus
the positions of the new agencies in the industry
are not as rigid. Will this new structure lead to the
resurgence of refineries? Probably not. The new
refineries will still have to compete with
international players and it is not clear that they
will be able to do so. The PIB also doesn't say
much about deregulation implying that the
government still plans to keep the price controls.
All this implies that the post PIB oil industry will
probably not be able to compete with international
players. Which means we will probably still import
fuel.
What do we need to do to have a fighting chance?
First we need to get rid of the idea that government
run refineries can work if we just try harder. They
can't. And even if by some kind of miracle they
did finish their perpetual turn-around-maintenance,
they cannot possibly compete with international
players. Its difficult to imagine a scenario where
government run refineries will be more efficient
and reliable than the cut throat international
market.
Second, pricing across the entire industry needs to
be deregulated. The government needs to allow a
more efficient market driven pricing structure from
intermediate supply contracts to the retail end of
the industry. Given that we know government run
refineries cannot possibly compete, the only
alternative is private refineries. But private
refineries will not move anywhere near an oil
industry where the prices are dictated by the
government. Consider the current scenario where
the private refineries have to buy crude oil at
international prices but sell their refined products
at the government mandated prices. No private
player will knowingly enter a guaranteed loss
making business.
Third, we need to use the natural advantage we
have to tip the scales in favor of domestic use of
crude oil. Recall the part of the industry we
actually have an advantage is in having crude oil.
And the determining factor influencing importing or
domestic refining of fuel is the relative price.
Selling fuel to private domestic refineries at a
discount could provide the necessary incentive to
build a refinery. Of course by discount I do not
mean a fixed price for crude sales to local
refineries but a fractional discount. So actual
prices paid will still move in tandem with
international prices. How much of a discount
should be given? Obviously not a Tam David-West
style discount where he argues to just give away
crude oil for free. Intuitively the discount should be
less than the welfare gains from jobs created in
refining, Forex savings from not having to import
fuel, and perhaps even gains from becoming a fuel
exporter. If the discount is larger than the potential
gains then its really just a net loss for the entire
country.
Finally we need to think small and long term. The
government seems to be stuck on the idea of few
giant players with giant mega refineries and short
term profitability. Nothing wrong with having big
players but small players might be key to a fluid
and flexible domestic industry. Strategies for
multiple small players need to be explored. Small
scale refineries with long term crude oil discount
deals and expropriation risk guarantees might be
the best shot we have at domestic refining.
Irregardless of these ideas it may be that the
myriad of problems make domestic refining in
Nigeria impractical. Oil refining is after all a
cutthroat business globally with relatively small
margins. It would be a shame though if we can't
make it work somehow.
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