10.03.2005 Feature Article

The Case for Deregulation of the Petroleum Sector in Ghana From

The Case for Deregulation of the Petroleum Sector in Ghana From
10.03.2005 LISTEN

The Case for Deregulation of the Petroleum Sector in Ghana On February 18, the government announced increases in the prices of petroleum products of up to 50 percent, bringing the price of a gallon of premium petrol to ¢6666.66 per litre or ¢30,000 per gallon. The price increase is part of a process to deregulate the petroleum sector by involving Oil Marketing Companies (OMCs) in importation, financing, distribution, and pricing. Deregulation will also eliminate budget subsidies and depoliticize the sector, particularly regarding pricing. The subject has generated considerable, sometimes passionate, debate.

The purpose of this article is two-fold. First, it is meant to fill the void in public education, clarify key issues and, thereby, allow informed, impassionate debate. Second, the article is also meant to make a case for deregulation, because we believe that it will better serve Ghana's interest, including that of the poor, than the previous system. We are writing this article for the general public—economists and non-economists alike—and we will try and keep the language as simple as possible. The status quo Before deregulation, Tema Oil Company (TOR) had the sole authority to import crude oil and petroleum products. Retail prices were fixed by government, taking account of TOR's costs, government taxes/levies, and distribution/marketing margins. Since retail prices, however, consistently fell short of TOR's costs—largely because of escalation of world oil prices—government had to pay TOR a subsidy that had risen to nearly cedis 100 billion (i.e. over US$10 million) a month. Maintaining such a large subsidy, however, has enormous costs. In particular:

· A subsidy deprives government of resources that could otherwise have been deployed to more productive ends, such as investment in physical and human capital, and to alleviating poverty through expansion of social services.

· A subsidy reduces the incentive to economize in the use of petroleum products, evidenced by multiple vehicle use by families, traffic congestion, and long stays in traffic and the associated loss of productive time.

· A subsidy provides an incentive for smuggling petroleum products to neighboring countries where prices are higher. This costs the country in terms of foreign exchange to import more oil to meet domestic demand and lost duties on the smuggled products, which benefit private people.

· The management of a subsidy entails a huge bureaucracy with administrative costs.

· Because TOR could not cover its costs—even with subsidies—it borrowed heavily from the Ghana Commercial Bank that put the bank's balance sheet in jeopardy and the whole financial system at risk. The government, at a point, had to take over this debt that had risen to over ¢3.5 trillion (or nearly US$400 million), which becomes part of the public debt to be paid by present and future generations.

· TOR's monopoly, the subsidy, and the retail price-fixing system were devoid of competition that could have benefited the consumer. This aspect will become more visible when OMCs ultimately are allowed to fix their own prices when full liberalization of the market is achieved. What deregulation will entail A deregulated petroleum sector will have the following key features:

· The OMCs will be allowed to import crude oil and petroleum products through open tender, ending TOR's monopoly in that regard;

· The OMCs will set retail prices based on a prescribed automatic formula;

· The price will ensure full cost recovery and include government taxes/levies, thereby eliminating any budget subsidies;

· The pricing system will be overseen by an independent body, on which government will be represented, and is expected to be transparent.

The new retail price announced by government recently includes, in addition to TOR's costs, various government duties/levies, and the question has been raised as to whether these duties/levies were fully justified and whether they could not have been pared down to make the price more affordable. The duties/levies, apparently, serve various developmental and social needs and most of them have been in place for a long time. Oil serves as a uniquely important source of fiscal revenues in most countries. Moreover, the new price of ¢30,000 per gallon of premium petrol compares with about ¢37,000 in Togo, ¢48,000 in Burkina Faso, and ¢46,000 in Cote d'Ivoire, the countries immediately bordering Ghana . These price gaps imply that the incentive to smuggle petroleum products to neighboring countries still exists. The question is whether we have to fully match prices in neighboring countries because of the risk of smuggling. While we do not believe that we should do so, we cannot also afford to lag too much behind. If we make sure that we are operating our systems efficiently, then we can tax enough to minimize the smuggling incentive, while using the raised resources, which would otherwise be lost to smugglers, to fund developmental and social needs.

It needs to be said that the current deregulated system still falls short of full market liberalization, whereby the OMCs will set their own prices, paying TOR its costs and government taxes/levies. Competitive price differentiation could then result from the different distribution margins set by the OMCs and benefit the consumer. The benefits of deregulation and automatic pricing The benefits of deregulation are really the flip side of the costs of subsidization elaborated above, and we will only indicate them for emphasis.

· Deregulation will free resources for government to spend on productive ventures and social sectors, including education and health. Special incentives can also be created for the benefit of the poor as elaborated below.

· A market price will encourage efficiency in the use of petroleum products, including through car pooling, which would reduce traffic congestion, the stay in traffic, and loss of productive time. This will save the country money in terms of reducing oil imports.

· Removing the subsidy will reduce the incentive to smuggle as the domestic price approaches those in neighboring countries. This will save the country foreign exchange, which would have been used to import more fuel to replace the smuggled portion, and also allow government to realize the full complement of duties, part of which would have been lost to smugglers.

· Even more fundamentally, deregulation will depoliticize petroleum pricing and eliminate the speculations, rentseeking, and other practices usually associated with government-announced price increases.

· Automatic pricing should allow the benefits of cost reductions, including through world oil price falls, to be passed on to consumers. The costs of deregulation and how to mitigate them Like every policy measure, deregulation will not be without costs. A cost-benefit analysis always forms a sound basis for adopting a particular policy measure, and we believe that, in this case, the benefits of deregulation outweigh the costs.

The most obvious cost of deregulation is the potential to have cascading price increases from transport, to food, to cement, to rent, and so on. This chain of price increases is inevitable since, in economics, everything affects every thing else, however remotely. Oil is, of course, a unique commodity and its effects are expected to be more pervasive. The associated price increases are, however, expected to cause a one-time jump in overall inflation, which needs not become perpetuating if it is not accommodated, say through monetization of budget deficits and large wage awards. In other words, once fiscal and monetary discipline, and associated exchange rate stability, remains in place, inflation should return to the original declining path quickly.

Since these price increases are, however, inevitable, it will be important to take measures to mitigate their effects on the more vulnerable population. Government has already initiated welcome measures to this end, some of which we underscore below.

· To mitigate transport costs, urban transportation will need to be improved by making available more public transport at subsidized fares. This directly benefits the poor who mostly use public transport. This program should also be extended to inter-city public transport and even beyond to cover the districts to benefit a wider population of the poor.

· The feeder road network needs to be improved to increase accessibility, while facilitating and reducing the cost of carting foodstuffs into the urban areas.

· Also appropriate and laudable is government's decision to absorb the cost of public Primary/JSS education, which directly benefits the poor.

· As government has also done, crosssubsiding petroleum products used predominantly by people at the lower end of the social stratum, such as kerosene and pre-mix fuel, is a step in the right direction.

· Also appropriate is the reduction of business taxes in the budget, which should foster domestic production and benefit the poor. Furthermore, the income tax threshold has been duly increased, making the tax system more progressive and, therefore, pro-poor. Some lessons We come away with important lessons from the debate on petroleum sector deregulation, some of which we highlight below:

· First, universal consumer subsidies that benefit everybody alike—rich or poor—cannot be justified on economic or even social grounds. A subsidy is best targeted to specific, usually more disadvantaged, groups.

· Second, efficiency considerations should be high on our policy scale because, in the end, the wider society will benefit. The western developed countries have made more progress because they often place efficiency ahead of equity—maximizing the size of the cake should be the first consideration and sharing it the second. Even if a country produces oil, it will be inefficient to subsidize it or offer it free to the people. The economy will benefit and the poor will be better off if government uses the saved subsidy for productive investments and to make education, health, or public transportation affordable.

· Third, it is important for policymakers to ensure that they provide enough information on their policies to the public to broaden consensus and ownership and, thereby, increase their acceptability. Switzerland has a system whereby almost every public policy issue is subjected to a public referendum. We cannot, of course, go to that extent, but we should aim to come close.

· Fourth, policies leading to lost opportunities and sacrifices are best sold to the public if they are seen to be consistent with overall policy to reduce non-essential government costs, which often take away money from the poor and benefit bureaucrats.

· Fifth, free, competitive markets are often more efficient and beneficial than systems characterized by controls, restrictions, and red tape that encourage rentseeking and benefit officials at the expense of the poor. Dr. J. K. Kwakye Rockville, Maryland, USA March 5,2005 Views expressed by the author(s) do not necessarily reflect those of GhanaHomePage.

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