Africa’s benchmark challenge

Author James Gooder, Vice-President, Crude Oil

When drivers have to queue for hours to fill their cars amid a crippling fuel shortage in Africa’s largest oil producing nation, it is clear that something has gone wrong.

When drivers have to queue for hours to fill their cars amid a crippling fuel shortage in Africa’s largest oil producing nation, it is clear that something has gone wrong.

May’s fuel crisis in Nigeria, whose repercussions are still being felt, had much to do with unpaid subsidies and a system riddled with inefficiencies and graft, but also with regulatory issues replicated in other African countries where pricing is linked to outdated models. Markets change and evolve, but many of the fuel price formulas used in Africa are relics from earlier times, based on benchmarks that lack liquidity, transparency or relevance.

The incoming Nigerian government has a golden opportunity to address these problems to the benefit of taxpayers and consumers, by removing subsidies and aligning prices with international markets. This was abortively attempted in early 2012, causing widespread public discontent. But lower outright oil prices make the present time a more opportune moment if the case for the wastefulness of subsidies can be made.

Nigerians ostensibly enjoy a fixed retail price for gasoline of 87 naira/ litre ($0.44/l). But outside the urban centres of Lagos and Abuja, away from the prying eyes of government inspectors, prices are significantly higher. The official price is well below the cost of landed fuel from the key supply region of northwest Europe, assessed at N111.21/l in the Argus West Africa Oil report on 1 July. But all prices are useless if there is no fuel to be found at the pump.

The government is supposed to reimburse importers the difference between the regulated price and the import price, as Nigerian refineries are unable to meet burgeoning domestic demand. But the import parity reference price used does not reflect the quality of gasoline required in west Africa and is not a price that can effectively be hedged.

International trading firms can benefit from price differences between the gasoline import parity price and Argus’ benchmark northwest European Eurobob barge prices at the expense of the importers that are locked to the government regulated formula. It would be fairer to index against the same price assessment along the supply chain, to iron out distortions, allow hedging and link prices to international market levels.

An active swaps market settled against Argus Eurobob barge price assessments allows participants to lock in the price of gasoline, but not if the import parity formula decrees that importers are compensated according to a different price reference. The people that lose out are the African taxpayer, through inflated subsidy payments, and ultimately the long-suffering African driver, through patchy fuel availability because of this and other factors.

The Nigerian price cap encourages the illegal smuggling of gasoline from Nigeria to neighbouring countries. Much gasoline finds its way to Niger and Cameroon, while Benin has emerged as an informal hub for the distribution of cheap Nigerian gasoline to the rest of west Africa.

LPG — considered by many to be the fuel of the future for Africa and the key to switching rural populations away from firewood and kerosine, with their attendant health and environmental risks — is often priced in Nigeria according to the US Mont Belvieu index. This inland market price on the other side of the Atlantic was chosen in the days when the US was a destination for Nigerian LPG. But since the shale boom, the US has been a net exporter of LPG. The most obvious price reference for the African LPG market is the one for the Amsterdam-Rotterdam-Antwerp (ARA) area in northwest Europe, which is the key destination for African exporters and source for African importers.

Ghana, a growing producer of crude and LPG, took the step in 2011 of linking LPG prices to Argus cif ARA LPG benchmarks, where market liquidity is focused and against which hedging is easily done. This has eased the flow of LPG from the international market to the country, whose LPG production is swelling but not by enough to meet domestic demand of around 230,000 t/yr, compared with Nigeria’s 150,000 t/yr among a population some seven times larger.

Elsewhere in Africa, the story of outdated price benchmark application recurs. In South Africa and its neighbours, the regulated Basic Fuel Price (BFP) formulas are partly linked to Mediterranean fuel prices. But little if any diesel ever makes its way to the country from the Mediterranean, with most supplies coming from the Mideast Gulf and India, and gasoline tends to be imported from northwest Europe. In South Africa, LPG prices are indexed to the price of gasoline, despite LPG not being a transport fuel in South Africa. The authorities are investigating better ways of regulating the LPG market.

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