By Gibson Masumbu
Government has indicated that it will remove subsidies in line with its quest to attain fiscal consolidation. Government has been providing subsidies that cover farmer input support, electricity and fuel consumption. Government has however also indicated that the removal of subsidies will be done gradually to mitigate adverse impact on the poor.
With regards to fuel procurement, Government says that it will disengage from the procurement of finished petroleum products with effect from March 2017 and going forward, the adjustment of fuel prices will be based on market conditions.
The subject of removal of fuel subsidies is nothing new. Government has been subsidizing petroleum products for years. In 2013 Government removed fuel subsidies arguing that the move would enable the state to have more finances for spending and also to guarantee proper implementation of government programmes and projects. This pronouncement notwithstanding, subsidizing of fuel in the country has continued. Government expenditure on fuel subsidies has ballooned rising to ZMW2.7 billion in 2015 from ZMW1.6 billion in 2013.
Government has been responsible for fuel procurement since 2007. The country procures petroleum feedstock in the form of comingled crude oil, which is refined at Indeni Petroleum Refinery in Ndola. Government has also been procuring finished petroleum products (mainly diesel and petrol) to supplement Indeni’s production. In 2015, 643,000 metric tonnes of feedstock and 815,000 metric tonnes of finished products were imported. The country imports more finished products than the feedstock.
The procurement of fuel is supposed to be a self-financing venture. Through the Energy Regulation Board (ERB), a price regime is structured such that all costs are recouped from the fuel pump prices. However, Government finds itself in a situation whereby it subsidizes the procurement of petroleum. The subsidies usually arise due to the change in costs mainly as a result of exchange rate fluctuations. If the kwacha depreciates, the pump price of fuel is also impacted as the cost of importation is increased in kwacha terms. This is not a problem if this happens once in a while. However, the Zambian kwacha has been depreciating since 2012 reaching ZMW10 per US$1 in 2016. Therefore to avoid increasing the price of fuel so frequently, Government has been forced to subsidize the shortfall.
On face value, there need not be any issues with Government’s position that it will not participate in the importation of finished products and also that prices would be adjusted based on market conditions. As stated earlier, fuel procurement is supposed to be self-financing. However, the biggest challenge regarding pricing of fuel is the exchange rate fluctuations. Should we get to a situation whereby the exchange rate is unstable, the country will experience frequent changes in the pump prices. If the kwacha depreciates at a rapid rate, the price of fuel should also increase in a similar fashion. Maintaining stable macro-economic stability will therefore be critical in this case. It should also be noted that should the kwacha appreciate considerably or the price of crude drop on the world market, fuel pump prices may reduce on the local market. In this way the economy is impacted positively.
Needless to say, the cost of petroleum in Zambia goes beyond the exchange rate stability. There are other factors that have contributed to the high cost of petroleum products in the country that need to be addressed soon. One major contributing factor is that the current procurement model through Indeni has not responded to the market dynamics. Indeni was originally built with a technical configuration to produce comingled crude. In the early days, the market demanded more heavy fuels than light fuels such as petrol and diesel. This meant that the petroleum feedstock had to contain more pure crude oil than the lighter products. The model worked for the market then because crude oil is obviously cheaper than the finished or processed products.
Over the years, the demand for light fuels (diesel) has increased and therefore importation of the co-mingled crude contains more refined products than pure crude. It is the high component of refined products that makes the current model expensive. According to experts ‘this structural absurdity’ is primarily responsible for the high cost of fuel in Zambia. If Zambia imported and refined pure crude oil, the costs of the feedstock would have been cheaper, and the resulting pump prices would have been lower. However, for Indeni to only refine pure crude, it requires upgrading its technical configuration to enable it do so.
It is not very clear what model the Government will employ to fully involve the private sector in the procurement of finished products. What is clear, however, is that it is cost efficient for the country to import refined products than comingled crude. It has also been argued that the country can benefit if the sub-sector is fully liberalized as the private sector would source finished products using shorter routes. However, it is important to ensure that the regulator is well positioned to keep private sector profit motives in check and also that the country has sufficient reserves to cushion any market failure.