Transcript Slide 1

AN EVALUATION OF THE WELFARE EFFECTS OF REDUCING
PETROLEUM PRODUCTS SUBSIDES IN NIGERIA
Being a Paper Presented at the 2013 Annual Conference of the Nigerian
Energy Economic Society at Lagos held from 22-23 April, 2013
By
ADAGUNODO Mathew
Department of Economics
College of Management and Social Sciences
Osun State University, Okuku Campus
Okuku, Osun State
Phone No: +234-851134214
E-mail address: [email protected]
OUTLINE OF THE STUDY
The Problem
Objective
Justification
Scope
The Background
Literature Review
Theoretical Framework and Methodology
THE PROBLEM
The downstream sub – sector has been constrained by the poor state of the refineries, which have been
producing at less than 40 percent of installed capacities in the past few years, despite huge expenses
incurred on turn – around maintenance of the crisis ridden refineries.
The downstream sector of Nigeria’s petroleum industry is characterized by supply uncertainty, fuelled by
the mismanagement of the refineries, endemic corruption, lack of transparency, direct government
interference and bureaucratic processes.
.This has led to massive importation of petroleum products by government and major oil marketers.
Petroleum products subsidies have long been features of the Nigerian economy since early 70s in form of
implicit subsidies.
The market is a regulated monopoly in which NNPC serves as a regulator, a distributor, producer in the
industry.
The demand and supply situation is subjected to a subsidy and price fixing effect.
Fuel demand and supply in Nigeria are inelastic.
These subsidies have a number of perverse consequences These include among others: they send false
price signal that encourage overuse of resources, they inhibit the development of substitutes that are more
environmentally friendly and divert scarce financial resources from other social purposes.
THE PROBLEM CONTD
These include among others: they send false price signal that encourage overuse of resources,
they inhibit the development of substitutes that are more environmentally friendly and divert
scarce financial resources from other social purposes.
Subsidies discourage private investors in refineries, place burden on state budget, persistent
fuel shortage, smuggling and adulteration of products.
Energy price increases are usually announced with short notice, and with limited attempts at
explaining the rationale behind the changes. Social unrest was a common response: violence
and protests followed price rises in Egypt (1977), Morocco (1981, 1984), Tunisia (1984),
Jordan (1989, 1996) and Ghana (2005).
OBJECTIVES OF THE STUDY
The main objective of this study is to assess the equity and efficiency of petroleum products prices
reform Nigeria. Hence, this study will specifically:
Examine the structure of petroleum product demand and pricing in Nigeria.
Quantify the magnitude of petroleum products prices subsidies
Estimate price and cross elasticity of demand for petroleum products
Assess the impact of subsidy reform on the welfare of households.
RESEARCH QUESTION
From the foregoing discussion, several questions emerge that:
What are the trends and patterns of petroleum products demand and pricing in Nigeria?
What is the magnitude of petroleum products prices subsidies in Nigeria?
What are the welfare implications of its removal?
JUSTIFICATION FOR THE STUDY
This study identifies some gaps in the literature reviewed, which it proposes to address. For
instance, though some of the earlier studies examined the effect of subsidy reform on household
(Gibson & Oliver, 2008; Andriamihaja & Vecchi, 2007), however, they did not consider Nigeria in
their study
Also, some studies in Nigeria have written on effect of energy pricing (Adenikinju 2000; Iwayemi &
Adenikinju 1996; Nwafor et al 2006) however, their studies focus on macroeconomic impact using
CGE model. The macroeconomic benefit does not automatically transmit to household benefit.
Hossain(2003) just provided framework for petroleum products pricing and considers two years in his
study, it did not consider its impact on the household.
The study intends to bridge this gaps by using marginal social cost approach to estimate the impact of
subsidy reform on household’s welfare
This study also extends the previous work reported in Iwayemi (1994) by estimating impact of subsidy on
each petroleum products.
Analysis of equity and efficiency of petroleum products subsidy removal on household is imperative in an
economy such as Nigeria that is undergoing substantial reform in its petroleum sector.
It is also important to examine the distributional impact across the households with particular emphasis on
the poorest households.
SCOPE OF STUDY
This study will consider the impact of Petroleum Products Pricing reform in Nigeria using partial
equilibrium approach.
It focuses on efficiency of such reform in Nigeria and welfare implications.
The study will combine both household data and time series to estimate the equity and efficiency of
petroleum pricing reform.
The descriptive analysis will cover from 1978 to 2011.
The empirical analysis will make use of the recent household survey otherwise conduct its survey to
capture the impact of the reform on household
BACKGROUND
Nigeria has proven reserve of crude oil of 37.2 billion barrels as at the end of 2010, the tenth largest in the
world and the second largest in Africa behind Libya.
Nigeria with a daily production averaging about 2.4 million barrels is the 8th largest exporter in the world
and largest in Africa.
Nigeria has been trapped in almost three decades of petroleum products shortage and importations.
Nigeria’s four refineries (all producing below 40 per cent of installed capacity while the one in Kaduna is
not producing at all) and twenty two depots are in comatose for effective refining and distribution of her
2.4million bpd produces daily.
This cannot be compared with Venezuela with 14 refineries refining 1.28 million
bpd produces daily. Saudi Arabia has nine refineries, Malaysia has six refineries, and Libya also has six
refineries.
This explains why the price of PMS in Nigeria is one of the most expensive among oil producing
countries, although cheapest among neighboring countries.
A litre of petrol in Kuwait is N30.66k ; Qatar, N33.12k; Saudi Arabia N17.52k; Bahrain N39.42k; Egypt
N46.72k; UAE N54.02k; Iran N58.40k; Malaysia N73.00; Mexico N81.76k; Indonesia N81.14,Russia
N90.52k,Venezuela N5.00k and Libya N15.92
BACKGROUND CONTD
The table 2.3 therefore provides statistical information on the domestic consumption of
the major petroleum products in Nigeria within 1977 and 2010.
Fugure 2.1:Growth Rate of Petroleum Produc ts Cons umption
.8
.6
.4
.2
.0
-.2
-.4
-.6
84
86
88
90
92
94
96
98
00
02
04
06
08
10
Sourc es : CBN bulletin various is s ues and author's es timate
GRA GO
GRDP K
GRP MS
The prices of petroleum products in Nigeria should theoretically be derived from
International Crude oil prices since the marginal supply (litres) comes from
import, it should therefore reflect import price.
The Petroleum Products Pricing Regulatory Agency (PPPRA) was established in
the year 2003 as an autonomous Agency to determine the pricing of petroleum
products in Nigeria.
It is also important to point out that the pricing template which PPPRA uses in
computing the amount of subsidy is biased in favour of importers and overstates
the level of subsidy.
BACKGROUND CONTD
(a) the import prices used in the template are generally higher than the international (spot)
market prices (after adjusting for the difference between “fob” and “cif”);
(b) the template provides for unnecessary financing charges, port and storage charges and
margins for importers, transporters, dealers, distributors and retailers
Since 1973, the uniform prices of PMS (same products price irrespective of location) fixed
by the government have been adjusted twenty-five times (see table 2.5) to adjust the gap
between domestic petroleum product prices and international prices.
140
120
100
80
60
40
20
0
1975
1980
1985
DIESEL
1990
1995
GASOLINE
2000
2005
KEROSENE
2010
BACKGROUND CONTD
The domestic petroleum products prices have been set administratively in Nigeria since
1973, as in most oil exporting countries.
However, when international prices began to rise in 2004, low domestic petroleum
product prices became increasingly out of line with the market value of oil (see table 2.6A
and 2.6B).
Oil prices have increased dramatically since beginning of 2003. Figure 2.3 shows that,
between January 2003 and December 2010, international prices rose significantly (+13 per
cent per year), if not steadily. From $28.77 a barrel in 2003,the price of crude oil peak in
August 2010 at $100.60, and closed at $81.07 in December2010.
High domestic inflation and exchange rate deregulation contributed further to erode
domestic petroleum prices vis –a-vis international benchmarks.
BACKGROUND CONTD
The deregulation of exchange rate in 1999 and the resulting naira depreciation also accentuated a growing
disparity between domestic and international petroleum product prices.
Figure 2.3:Ex hange Rate,Crude Oil Pric es , International and Domes tic pric es of Gas oline
160
140
120
100
80
60
40
20
0
84
86
88
90
92
94
96
98
00
02
04
06
08
10
s ourc es :CBN various is s ues ,NNPC;and author's es timation
E XRA TE
P RINT
P DOM
P ROIL
As international oil prices approached US $110 per barrel and f.o.b. gasoline prices hovered $1 per litre,
Nigeria’s domestic price of US$0.59 per litre of gasoline was clearly out of touch with reality, unsustainable,
and unjustifiable by any economic theory (see table 6c).
The subsidy level in 2008 alone was 150% of capital expenditure of the Federal Government in that
year.
In 2006, subsidy payment on fuel products was 50% the size of Federal Government expenditure.
The estimated subsidy payment is about 400% the budgeted capital expenditures for Human Capital
Development.
BACKGROUND CONTD
December 31, 2011 before the partial withdrawal of subsidy, it stood at 76 naira per litre but
was reduced to 44 naira when the official price of petrol was pegged at 97 naira per litre.Oil
subsidy has moved from being implicit to explicit from 1999.
The figure 2.4 indicates that for each litre of petroleum products sold, N19.4 was spent on
subsidy in 2003.
This implied a subsidy of N153 billion or 1.42% of GDP. By the end of 2008with subsidy
shooting up to N450 billion (see table 2.6C), it went up to 3% of GDP
It increased to N654.762 billion (3.43% of GDP) in 2008.
The government paid N1, 173.2 billion (US$9.7 billion) as a subsidy between 2006 and 2008.
The payment made in the second quarter of 2009 was N406.134 billion (3.43% of GDP).
The subsidy payment in 2010 was amounted 1.25 billion. Nigeria spent 19 percent of her
budget on subsidy payment in 2011. (table 2.6c)
These figures exceed total allocation to priority sectors of our economy. The recent
development has revealed that most of the claims and payments are frauds.
LITERATURE REVIEW
There is rapidly growing literature on energy pricing and subsidies. For clearity of
exposition, the review here is organised into four parts, namely, conceptual issues,
theoretical, methodological and empirical literature. They are discussed in that order.
3.1 CONCEPTUAL ISSUES IN ENERGY SUBSIDY: A subsidy can be
categorized into implicit, explicit and cross subsidies.
Three methods of quantifying the magnitude of subsidies are in the literature
(Koplow, 2009; UNEP, 2008;IEA 1999; World Bank 2010).These are price gap
approach, the program-specific approach and the measure of producer or
consumer subsidy equivalent. (table3.1)
Energy subsidies should be assessed by their relative efficacy, sector efficiency
and cost effectiveness.
Komives et al (2005) proposes two dimension of subsidy performances (i)
Benefit incidence (how well the subsidy targets benefits to poor household as
opposed to other household) Beneficiary incidence (What proportion of poor
households as a whole receive the subsidy).
Two types of elasticity are important when analysing energy market: own price
elasticity of demand; and cross price elasticities of demand.
THEORETICAL LITERATURE
There has been considerable discussion about the traditional view that inefficiencies
result from subsidized energy prices.
Economic theory suggests that subsidies are inefficient because, in the absence of market
imperfections and with convex indifference curves, the value of the subsidy to the
consumer will be less than its cost to the government (see Katz and Rosen, 1994).
When the price deviates from this point of static equilibrium, resource allocation is
inefficient since the benefit to consumers from the last unit of energy consumed are
smaller than the costs involved in supplying the energy service.
The most desirable economic policy is the policy yielding the highest level of welfare.
Hick (1942) introduced measure of consumer’s surplus based on compensating and
equivalent variations in income and total expenditure.
Lau and Stoker (1980, 1981, and 1982) have developed methods of constructing indirect
utility functions and expenditure functions for a population of consumers.
THEORETICAL LITERATURE CONTD
Since the pioneering work of Atkinson (1979) and Kolm (1969) the measurement of social
welfare has been based on explicit social welfare function introduced Atkinson and Kolm
are defined on the distribution of income rather than the distribution of individual welfare.
Muellbauer (1974) has shown that measures of social welfare based on individual welfare if
and only if preferences are identical and homothetic for all consumers.
Roberts (1980b) has derived restriction on preferences under which measures of social
welfare introduced by Muellbeuer(1974) are independent of the prices faced by individual
consuming units. In the absence of restrictions on social welfare functions, individuals
must have identical homothetic preferences.
Most of this studies violate the concavity of social orderings over optimal commodity
allocation.
This study will improve on reviewed studies by specifying welfare function with
heterogeneous marginal utilities to assess welfare and distributional impact of price
reform.
METHODOLOGICAL LITERATURE
Partial-equilibrium as well as general equilibrium model have been used to study the
impacts of fossil fuel subsidy reform. Partial-equilibrium models consider only the product
market in which subsidy reform is occurring (in this case, the energy market) and estimate
price, demand and production changes in fossil fuel as a result of subsidy removal based on
simply supply-and-demand curves and economic assumptions (Von Moltke et al 2004).
Partial equilibrium analyses provide a valuable input into policy dialogue and reform,
especially when combined with qualitative discussion of the likely efficiency effects of
reforms. For example, switching reform to reduction of subsidy on products with inelastic
demands or negative social externalities (such as petroleum products) when these are
initially large can be expected to increase the overall efficiency of the reform system. (table
3.2)
EMPIRICAL LITERATURE
There have been studies on subsidies and economy, and many researchers have directed
the focus of their studies on subsidies as well as household both within and outside Nigeria.
Several findings emanate from various empirical investigations on energy price reform and
petroleum products subsidy in particular and its effect of removal on household welfare.
(table 3.3)
THEORETICAL FRAMEWORK
Specifically following the treatment of Ahmed and Stern (1984), we assume that there are H
households in the economy and denote by Xi h (q), the quantity of commodity i purchase by
household h. We write this quantity as a function of consumer prices only, because we
assume factor income to be fixed. Intuitively, we assume that the producer prices Pi …. PN
of N commodities is fixed and there are no pure profits. Subsidy reduction increases the
consumer prices. (section 4.0) Pi = qi +si
(1)
Aggregate consumption is then given by Xi=
h
i
i=1 . . . . .N
(2)
The government realised certain amount of revenue through subsidy reform
R=
(3)
The starting point is the social welfare function, which aggregates individual welfare levels.
Define the social welfare function over h=1. . . H households
W=W(U1, . . . ,UH)=W(V1(e1, p) , . . . ,VH(eH , p)) ,
(4)
Let we consider the consequences of a marginal change in the subsidy. This change will
affect government revenue.
(5)
= Xi +
k
THEORETICAL FRAMEWORK CONTD
It will also have an effect on social welfare:
=W*(V1(e1,p) , . . . ,VH(eH ,p))-W(VI(e1 ,p) , . . . ,VH(eH ,P))/
=
h
i
h
=
(6)
The approach is based on that pioneered by Bergson (1937). Before deriving the
distributional characteristics, first consider the impact on social welfare from a change in
household expenditure.
h
h
(7)
h
Thus, following Newberry (1995), the distributional characteristics, di for ith good is In money
h
terms, household h is worse off by the quantity consumed,, xi or in utility terms is worse off
by hxih.
(8)
di
Where
is the average of social utility weighs over all households and
is the aggregate consumption of the ith good
=
hx h.
i
H
h
h
i
(9)
THEORETICAL FRAMEWORK CONTD
The change in social utility for a small change in price (e.g., a tax or subsidy on quantities) in
,equation 6 can be approximated to provide a numerical measure of change in social welfare. The
welfare impact of a price change as result of reform is seen to depend on two factors: the
h
h/
distribution of consumption, given social weights =
h)
h
and the level of consumptions among household, given by xih (Newbery 1995).
And h are
total expenditure and size of household h, and is the coefficient of inequality aversion.
i =
/
(10)
Goods with low marginal
cost ratios are those that are candidates for either a tax increase or
=
a subsidy reduction. When all the ratios are the same there is no further scope beneficial
reform. This approach can be implemented by noting that welfare derivative (the
numerator of (10)) is a pure distributional measure for good i and it is the ratio of two
average budget shares:
i
/
(11)
i h ]/
h
The denominator of the marginal social cost ratio represents the efficiency aspect of
subsidy induced price change. A given price change will produce a larger net revenue effect,
the greater is total consumption of the good and the less the substitution away from taxed
goods (Olivia and Gibson 2006).And using (5) and (6)
(12)
THEORETICAL FRAMEWORK CONTD
The denominator of the marginal social cost ratio represents the efficiency aspect of subsidy
induced price change. A given price change will produce a larger net revenue effect, the greater is
total consumption of the good and the less the substitution away from taxed goods (Olivia and
Gibson 2006).And using (5) and (6)
h
i
i
h
/( Xi +
k
)
(13)
Multiply numerator and denominator of equation (13) by price qi leads to an expression
which can be operationalised easily:
h
i
h)
/
i
I
kisk *(pk
k)
(14)
/
) and sk*= */ k,
Where ki refers to the uncompensated price elastici ty (
the subsidy reduction rate as a fraction of consumer price. The equation (14) is the
combination of subsidy factor and cross elasticities.
i
(15)
THEORETICAL FRAMEWORK CONTD
i
The first term of the denominator in equation (15) measures the own –price distortionary effect of
the subsidy. If it is large and positive, as would be the case for a heavily subsidised and price
elastic good, the term will contribute to a small marginal social cost (msci) and would indicate the
low cost of saving fiscal expenditures from decrease in the subsidy on this good. The last term is
the sum of the subsidy factors multiplied by cross price elasticities, and captures the effects on
other goods(and resulting revenue changes) from subsidy reform on good i. The use of the
complete expression in equation (15) integrates equity and efficiency consideration. To illustrate
the trade- off between efficiency and equity, it seems interesting to rewrite (15) as
(16)
i
Let us first consider the case where we would neglect all changes in consumption pattern. If
the assume that ki
Equation (16) then reduce to
i
h
i
h/
(17)
i
The marginal welfare cost of subsidy reform for any commodity, then coincides with the
distributional characteristics of that commodity, as introduced by Feldstein (1972). This
concept summarises the variation of consumption pattern across income classes by
weighting the market shares of the different households in the consumption of commodity
i,using the h’s as weights.
THEORETICAL FRAMEWORK CONTD
If equity does not matter at all, in that case equation (16) reduces to
i
Equation (18) concentrates on efficiency aspects of the reform.
(18)
MODEL
The empirical model applied in this study to get price responses needed for the marginal reform
calculation in equation (15) is almost ideal demand systems (AIDS) model. The model is adopted
due to the following reasons:( a) it is relatively easy to estimate and interpret.(b) It satisfies the
axioms of choice exactly.(c) it is as flexible as other locally flexible functional forms but it has
the added advantage of being compatible with aggregation over consumers. It can thus be
interpreted in terms of economic models of consumer behaviour when estimated with aggregated
(macroeconomic) or disaggregated (household survey) data (Glewwe, 2001).(d) It is derived from
a specific cost function and therefore corresponds with a well-defined preference structure, which
is
convenient for welfare analysis. (e) Homogeneity and symmetry restrictions depend only on
i
the estimated parameters and are therefore easily tested and/or imposed. (f) AIDS provides also
an arbitrary first-order approximation to any demand system. (g) It aggregates perfectly across
consumers without invoking parallel linear Engel curves and finally, it has a functional form
which is consistent with known household-budget data.
The AIDS Model for petroleum products demand can be expressed
it
it
ik
i
t
/ k)
and where, in observation t;
it
th
it is the budget (expenditure) share of the i product
t
is the nominal price of the kth product;
i=1,……..,n
(19)
MODEL CONTD
is total expenditure;
is the random error term
is the translog price index defined by;
t
it
t
=
0
k
k
t=1… T (20)
it
it kt
This price index makes the system non –linear, which normally complicates the estimation
process. In order to overcome this problem, Deaton and Meulbaurer(1980) suggest using
another price index. The only difference between the AIDS and its linear version, the
LA/AIDS, lies in the specification of the price index. Several authors, include Green and
Alston(1991);Moschini(1995);Asche and Wessels(1997), have discussed the relationship the
linear and nonlinear specifications. In several of these studies, Monto Carlo studies were
used to show that the use of differential functional forms of the index in the LA/aids
provides results that compare reasonably well to the AIDS model (Asche &Wessels 1997).
t
The stone’s price index, as suggested by Deaton and Meulbauer (1980), which can be
used to replace the translog price index, is defined as follows:
LogP=
it
i,t
(21)
MODEL CONTD
Eales & Unnevehr (1998) showed that the substitution of the Stone’s price index for the
translog price index causes a simultaneity problem, because the dependent variable it)
also appears on the right-hand side of the LA/AIDS. They suggested using the lagged share
(wi t-1) for equation (19) with the lagged shares into Equation (21) yields LA/AIDS, given by:
(
(
i
(22)
Equation 22 can then be applied to the empirical data, where after the anticipated
parameters can be used to calculate the required elasticities. Compensated and
uncompensated elasticities will be calculated using the formulas.
(23)
= eit
wk/wi))=I,j=1,2,…….,N.
it/w)
(24)
t (wk/wi)
it
it
Where
by wt whereas,
kt
t
i
and
ik
it
ik
otherwise. The average expenditure shares are represented
are RSUR parameter estimates for the LA/AIDS model.
The formula used to calculate the expenditure elasticities can be written as:
t=
1+ (βi/wi)
(25)
DATA USED AND STATISTICAL PROPERTIES OF THE VARIABLES
The annual data from Central Banks and household data from National Bureau of Statistics
(NBS) will be used to estimate the model. The variables will be subjected to statistical tests,
including: Univariate properties of the data, structural breaks, separability and exogeneity
of the expenditure variable.
LIKELY CHALLENGES
Assessing the magnitude of fossil- fuel subsidies and its impact on household is a task
challenged by poor data quality, limited data availability and lack of data comparability as
there is no harmonised or consistent reporting structure for fossil fuel subsidies in Nigeria.
EMPIRICAL RESULTS AND CONCLUSION
Table 5.1 presents expenditure elasticity. The coefficient for AGO and PMS are positive indicating
luxury goods whose budget share rise more than proportionally as household expenditure rises.10
percent increases in total expenditure leads to 2.3 percent increases in budget share for PMS.
Table 5.1
EXPENDITURE ELASTICITY
PRODUCTS
COEFFICIENT
STANDARD ERROR
PMS
0.2361
0.0021
AGO
0.0241
0.069
DPK
-0.3125
0.0131
OTHER CONSUMPTION
0.3061
0.0121
Source: Author’s estimation
Also, 10 percent increase in total expenditure brings about 0.2 percent increase in
budget share for AGO. The total expenditure elasticity for DPK is -0.31 indicating
that kerosene is a necessity. This implies households in Nigeria have larger
proportional increases in demand for this product as their income rises.
Table 6, contains the estimate own-and cross-price elasticities. The own-price as
well as cross – price effects are well determined. All estimated own price elasticities
are negative as they should be. The estimated own price elasticity of demand
found to be -0.2110.
Table 5.2 OWN – PRICE & CROSS PRICE ELASTICITIES
Products
PPMS
PAGO
PDPK
R2 ADJUSTED
PMS
-0.2110
-0.0491
-0.1023
0.61
(0.0121)
(0.0034)
(0.0231)
0.6791
-0.6214
0.7621
(0.4916)
(0.4211)
(0.2124)
-0.3214
0.8216
-0.6093
(0.1321)
(0.0312)
(0.1201)
AGO
DPK
0.53
0.59
Source: Author’s estimation
Specifically, 10 per cent increase in price of PMS will bring about 2.1 percent decline in the quantity
consume by the Nigerian household. This suggests that on efficiency ground, the subsidy on PMS
should be reduced. The own price elasticities are large for diesel and kerosene, justified the removal
of subsidy on AGO and high price of DPK caused a lot of substitution into these products.
Table 5.3 shows the efficiency effects of subsidy reduction on each of the petroleum products,
distinguishing between the terms in the denominator of marginal social cost formula. The first
column indicate subsidy factor (difference between world and domestic price), while the second
column shows the own price elasticities of quantity and quality together. The products of the
first and second columns which is shown as the third column, gives own contribution of price
distortion that would be caused by a marginal increase in price.
TABLE 5.3 Efficiency of energy price reform in Nigeria
–1
Commodities
Agg. Petrol. Products
-1.32
-1.62
2.138
PMS
-1.08
-0.95
1.026
AGO
-1.61
-1.14
1.835
DPK
-0.04
-0.62
0.025
Sources: Authors’ estimation
The table 5.3 above presents efficiency of reduction in energy subsidies. As it can be seen, the own effects
of all energy products are large with the exception of DPK. The reduction or removal of energy subsidy on
PMS would save the largest amount from government budget.
TABLE 5.4a Equity effects of energy price reforms in Nigeria
Commodities
Agg. Petrol. Products
1.00
0.21
PMS
1.00
0.10
AGO
1.00
0.61
DPK
1.00
0.31
Authors’ estimation
The table 5.4a presents equity effects when coefficient of equality aversion is zero (
). That is,
when there is no distribution concern, the marginal social cost of reducing subsidies
on PMS is lowest. AGO has highest marginal social cost among the energy source.
However, marginal social cost for all energy products are extremely low suggesting
reduction of subsidies for all petroleum products.
TABLE 5.4b Presents situation of high inequality aversion
Commodities
Agg. Petrol. Products
0.81
0.07
PMS
0.72
0.09
AGO
0.86
0.04
DPK
1.21
0.19
Source: Authors ‘estimation
The larger coefficient of inequality aversion attached larger value to the product often
consumed by the poor and a relatively smaller value to those consumed by household
that are better off. For, the lower social cost of reduced government expenditure (or
equivalent additional revenue) would come from removing subsidies on AGO followed by
aggregate petroleum products price. Government will incur high social cost if prices of
electricity and DPK were raised. It is advisable that subsidy on kerosene and electricity
should be retained for equity consideration.
6.0 SUMMARY AND CONCLUSION
This study combines time series and household survey data from 5,000 Nigerian
household data using stratified multi stages sampling techniques to estimate a
demand system for petroleum products. This study use marginal social cost
approach to evaluate equity and efficiency implications of petroleum products
subsidy reform in Nigeria. The marginal social cost approach originated with
Feldstein (1972) and Ahmed and Stern (1984) and is based on the optimal
commodity taxation rules derived by Ramsey (1927) and Samuelson (1986).
This study concludes that reduction or removal of subsidy on PMS will save
largest amount from government budget. Where there is no distribution
concern, the marginal social cost of reducing subsidies on PMS is
lowest. AGO has highest marginal social cost among petroleum
products. However, marginal social cost for all energy products
are extremely low suggesting reduction of subsidies on all energy
products in Nigeria
THANK
YOU