By Bode Agusto
Crude oil is one of the principal sources of energy to the World. In 2018, its market share was 34%, other principal sources of energy were Coal and Natural gas with market shares of 27% and 24% respectively.
What does crude oil do for the World?
It helps us to transport our vehicles, power our factories and heat our homes. According to the US Energy Information Administration (EIA), in 2018, the US consumed 20 million barrels of oil per day – 69% on transportation, 25% to power her factories, 3% to heat their homes and the remaining 3% in other areas.
A further breakdown of the 69% or 14.2mbpd on transportation shows that motor gasoline is 45%, Kerosene-type jet fuel is 8% and the remaining 16% is mainly for diesel powered vehicles.
The US is 25% of the World economy, the rest of the Organization for Economic Co-operation & Development (OECD or the rich World) another 25% and China 14%. This means that China and the rich World represent about two-thirds the output of the World. We believe that the pattern of oil consumption in the US is not materially different from that in these countries and indeed the rest of the World.
This means that it is safe to assume that the principal uses of crude oil in the World are transportation, powering industry and heating our homes. It is also safe to assume that about half of the consumption is for transporting vehicles.
What is happening in the automobile industry?
Automobile companies in the World are investing heavily in Electric Vehicles (EV) and Hybrids that will reduce gasoline and diesel consumption and Co2 emission significantly consequently reducing the demand for crude oil significantly.
According to OPEC, the demand for crude oil grew from 77mbpd in 2000 to 100mbpd 2019. This represents a 30% growth during this 20-year period. However, a breakdown shows that all of this growth came from China and the developing World. In fact, the demand for crude oil from the OECD countries was 48mbpd in 2019 same as in 2000. The demand for crude oil in the rich World peaked at 50mbpd around 2005, has dropped to a current level of 48mbpd and is projected to drop even further as the World embraces EVs and Hybrids.
On the supply side, OPEC controls 80% market share of the crude oil reserves of the World, but has only 32% market share of supply. Why? This is because OPEC pursues a strategy of price optimization. This means that the cartel acts as a swing producer of crude oil, bringing just enough crude oil into the market to balance supply after the non-OPEC production (NOPEC) is accounted for. Over the years, this has meant loss of market share to NOPEC members.
NOPEC production has increased from 46mbpd in 2000 to 64mbpd in 2019. This represents a growth of 18mbpd and 13mbpd of this has come from the USA, largely from the fracking of shale. What has this meant for the USA? In 2000 the USA consumed 20 million barrels of oil per day and produced only 7mbpd making it a net importer to the tune of 13mbpd. In 2019 she still consumed 20 million barrels of oil per day but produced 18mbpd and net import was only 2mbpd. Sometime during the next two years, the USA, the largest consumer of crude oil will become a net exporter of this product.
The balance of power in the World crude oil market is shifting from the Saudi-led OPEC to the USA largely as a result of the fracking of shale. OPEC has enlisted the support of Russia in an alliance that is labelled OPEC+ but they are yet to exercise significant control on the price of crude oil. In fact, it seems as if the era when the average annual price of crude exceeded US$100 per barrel has gone for some considerable period and OPEC members must learn to live with an average annual price in the region of US$60 per barrel. What is the outlook for crude oil price over the next decade?
In my opinion, the long-term outlook for the demand for crude oil is weak because as the World continues to be more concerned about the environment, embrace EVs and Hybrids, the World demand for crude oil will begin to fall. This, with rising NOPEC production will therefore continue to put a downward pressure on the price of crude oil. Even if OPEC changes strategy and starts pursuing market share, at best the cartel will sell a little more oil at much lower prices.
Nigeria and the oil curse
What does this grim outlook mean for Nigeria?
Let’s first understand what crude oil has done and still does for the Nigerian economy.
On the external side, crude oil has provided Nigeria with a sizeable amount of USD revenues which we have used to trade with the rest of the World. According to the CBN, during the past 20 years, total USD inflows into Nigeria on the trade side was US$1.5 trillion; US$1.1 trillion or 79% came from selling crude oil and natural gas to the rest of the World and US$0.3 trillion came from remittances from Nigerians working abroad.
Businesses in Nigeria have used these USDs to equip their factories, buy raw materials and some have imported finished goods for resale. Households have used these USDs to buy cars, houses in the UK and the USA, educate their children abroad, buy healthcare from UK and the USA and fly foreign airlines to and from key capital cities in the World. In short, crude oil has helped Nigerians finance a lifestyle that is significantly above our productive capacity.
Even with crude oil, our 200 million people produce goods and services worth only US$0.4 trillion annually, the 320 million people in the US produce US$20.5 trillion annually.
On the fiscal side, crude oil has provided the government with a large amount of oil revenue in the form of oil taxes (PPT, Royalties and rents paid by oil companies on their share of the crude oil produced) and proceeds of the sale of the Government’s equity crude. During the past 20 years, the federation account received NGN 87 trillion in oil revenues and NGN 29 trillion in non-oil taxes making a total revenue of NGN 116 trillion. This money was shared NGN 53 trillion to the FGN, NGN 40 trillion to State Governments and NGN 23 trillion to Local Government Areas.
The NGN 53 trillion of the FGN was spent paying interest on loans (NGN 15 trillion), payroll and pension (NGN 26 trillion) and capital expenditure (NGN 15 trillion).
With respect to money and banking, average annual rate of inflation in Nigeria for the past twenty years is 12%. This means that knowledgeable investors who want to lend money to the FGN for any considerable period will seek a return higher than 12%. If the FGN, who can print money to repay its loans, borrows ten-year money at around 14%, most households will have to borrow for the same tenor at about 20%. How many households can service a ten-year mortgage at this interest rate? Mortgages do not work in high inflation environments!
The long-term rate of inflation in Nigeria NGN is 12% compared with 2% for the USD resulting in a difference of 10%. In spite of this difference, successive Governments have been promising Nigerians stable NGN/USD exchange rates. In reality, exchange rates have moved from NGN110/ US$1 in the year 2000 to a current rate of NGN360/US$1.
In periods of high crude oil prices, Nigeria uses her USD earnings to support the exchange rate but in periods of weak prices she allows sharp currency depreciations. Therefore, exchange rates move in steps instead of a gradual depreciation of close to 10% per annum.
Severe devaluation of the NGN is usually accompanied by a banking crisis. This is because weak crude oil price drives the economy into recession, devaluation increases the financing needs of businesses and those who owe hard currencies suffer large exchange losses. All these weaken the ability of businesses in the real sector to repay their loans resulting in large credit losses that erode banking industry capital.
Government should then use these three sectors – external trade and investment, tax revenues and the financial sector to help businesses and households to thrive. What happens in Nigeria is that we experience economic booms in periods of high oil prices and recession when prices fall.
How should we prepare for life after oil?
Our goals are threefold
These three things are the key determinants of peace and prosperity in a Nation. The output is what is shared amongst the residents of a country, if it is large and growing, there is a lot to go around. If the population is not growing as fast as the output, there is even more to go around on a per person basis. Therefore, both the numerator and the denominator determine the prosperity of nations. If the output is fairly spread, this adds peace to prosperity as people would not need embrace violence in order to access basic services.
Therefore, with respect to output, our objective for the next decade should be to increase output at least two and a half times from USD 400 billion to at least USD1.04 trillion within a decade. This translates to a compounded growth rate of around 10% per annum. During the same period, population growth should not exceed 1.5% per annum. This means that by the end of the decade, Nigeria’s population will be around 232 million and average income per person will be US$4,500 compared with US$2,000 today. With respect to income distribution, the objective should be to use the tax system to ensure that no adult earns less than half the average income per capita.
These objectives might appear ambitious, but I believe with honest and competent management of our economy, we can achieve them. Currently, more than 40% of our working population is either unemployed or underemployed. Getting these people to work alone will boost output significantly.
What’s next?
The next step will be to fix infrastructure principally – electric power, railways and roads.
The FGN should not reverse the privatization of the generating companies (GenCos) and distribution companies (DisCos). She should complete the Power Sector reform focusing on the following three key areas:
Gas
Tariff
The National Grid
With respect to gas, the FGN should stop regulating the domestic price of natural gas. We understand that the principal reason for this regulation is that government wants the poor to be able to access electric power. However, setting gas prices at uneconomic levels discourages investments in gas infrastructure. The owners would rather treat and export the gas at market price and for USD. Again, we have always been told that Nigeria is a gas province that has some crude oil. This means that if we encourage the owners of gas to invest in gas infrastructure, it wouldn’t take them long before they realize that infrastructure cost is sunk cost and start discounting the price of domestic gas surplus to their requirements.
Government should work with the industry operators and evolve a tariff with two principal objectives in mind
An efficient player must be able to cover his cost of capital
Poor households should be heavily subsidized
A poor household could be defined as one who lives in one or two rooms, has a few light bulbs, one electric fan, an electric iron and a refrigerator. It is easy to estimate the monthly consumption of such a household and possible to subsidize consumption up to that threshold heavily. Once the household buys an air conditioner, it begins to pay market price! In substance, we let businesses and affluent households pay for poor households. In my opinion, this will still be cheaper than burning diesel to generate electricity!
The final piece in the electricity reform is the national grid. We need a grid that is more efficient and with greater capacity to carry electricity. Should the government own it fully and manage it? Again, No! The reason often adduced for government ownership of the national grid is – Security.
In the UK, their NEPA was called the Central Electricity Generating Board and had responsibility for generation and transmission in England and Wales. In the 1990s, the generation activities were transferred to three companies and its transmission activities to the National Grid Company plc.
National Grid Company plc was first listed on the stock exchange in 1995 and today, it is privately owned and one of the FTSE100 companies in the UK. It also operates 14,000 km of electricity transmission delivering electricity and gas to Massachusetts, New York and Rhode Island in the USA and Mr. Trump has not raised any security concerns! Of course, the national grid can be owned by the private sector as long as they are not enemy aliens.
Even if the FGN wants to own the grid, does she have the money required to improve the efficiency and capacity of the grid? Will the NASS approve these sums for investment in the grid instead of their constituency projects? Will government have the presence of mind to allocate enough resources annually for the maintenance of the grid? In decision making, will political exigencies not have priority over economic considerations?
Once we have a tariff that allows efficient players to cover their cost of capital, gas to use to generate electricity and a national grid that can evacuate electricity generated, supply of power will improve significantly.
With respect to railways, the FGN should, unbundle the industry into railway infrastructure (tracks, signal and stations)
rolling stock (the trains that ply the routes).
The railway infrastructure should link Abuja to all state capitals and all the ports. The FGN, State governments and private sector businesses should own the railway infrastructure and again, the private sector businesses should own majority stake. Rolling stock should be owned 100% by the private sector. In substance, tracks and signals are like inter-city highways while the rolling stock is like having buses that ply the highways. If government is not competing with Ekene Dili Chukwu on the intercity highways, why would they want to own and manage trains?
Government should act as an independent regulator, divide the country into zones and have these private sector businesses bid for these routes. In agreeing passenger tariffs with them, the regulator will negotiate discounts for the young, the elderly and the physically challenged. Subsidies obtained in this manner do not blow big holes in government budgets.
With respect to education, there are two principal groups that we would need to focus on:
Those that have already “completed” their education
Those currently in school and new entrants
There is urgent need to re-train those who have “completed” their education embracing the following steps.
Identify the things we need to produce (e.g. food, clothing, houses, cars)
Identify the skills we require to produce these things
Train teachers
Identify how we shall use technology to scale and customize teaching
Retrain and certify
For the second group, that is those currently in school and new entrants, we need to review our curriculum, better align it to the needs of the Nation and re-train teachers to ensure they can deliver, again using technology to scale.
The government should then act as a strong independent regulator of schools ensuring compliance with standards agreed.
The challenge on the healthcare side is huge and resources are limited. However, the population is young and lifestyle changes can help reduce the amount of money the country would need to fund healthcare significantly.
The FGN should not own secondary schools. She should hand these secondary schools to eminent old boys who will act as Trustees in perpetual succession and manage these schools. Government (federal, state and local) can of course provide scholarships to indigent students who qualify to attend these institutions.
Universities in Nigeria need to overhaul their funding models. They need to be able to attract funding from users of their services, governments and philanthropists from Nigeria and above. This means that they must overhaul the way they govern their institution and ensure greater fairness, transparency and accountability.
The key areas of focus with respect to healthcare are:
Through advocacy, Nigeria can significantly reduce what is required to fund healthcare focusing of diet, exercise, safety and environment. For example, reducing salt and oil intake and taking regular exercise can improve health and productivity of the Nation. Another low hanging fruit is that improving how we drive can save numerous lives.
We need to encourage government, private sector (profit making and charities) to build and equip facilities and employ clinical and other staff who will manage these facilities.
These groups, particularly profit making institutions, will only invest if they can cover their costs of capital. A good doctor is valuable, marketable and tradable internationally. This means that he/she is valued in USD or any other international currency and not in NGN or any other weak currency. This means that what we pay him locally must be competitive internationally otherwise he/she moves!
Government revenue (federal and states) per person per annum is about =N=50,000 or USD140. This cannot be enough to provide high quality healthcare and education to all for free.
The UK’s National Health Service (NHS) has a budget of about GBP140 billion (USD196 billion) per annum. About 80% of NHS funding comes from general tax revenue and the balance comes from NHS contributions by individual taxpayers and their employers. This means that, in addition to personal income tax, most people pay about 10% of their salaries plus benefits as NHS contributions; their employers also pay a similar sum. Therefore, the UK spends about GBP2,100 (USD2,750) per person per annum on healthcare. Although free at the point of delivery, residents of the UK pay a significant amount of their earnings for healthcare.
In the US, healthcare spending is about USD10,000 per person per annum and this is funded largely through employer assisted health insurance.
Even if Nigeria, spends a paltry USD500 per person per annum on healthcare, this translates to USD100 billion per annum or NGN36 trillion per year! How do we pay for this when aggregate government revenue (all tiers of government) is about NGN10 trillion?
To fund healthcare, everyone needs to contribute. In my opinion, the most viable way to fund healthcare is through insurance. Individuals buy health insurance and government buys insurance for the poor and weak in society. In my opinion, good healthcare is a crucial need in our society and once there is capacity and willingness to pay (through a strong insurance system) service outlets will grow and quality of services will improve.
Before we discuss, how we fund Government, let us agree her purpose. What is the purpose of government?
Secure life and property
internal and external security
strong, independent judiciary that resolves disputes fairly and in a timely manner.
- Provide social services by helping the poor and weak in the society to access basic services (education, healthcare, mass transportation, food).
- Protect the value of the local currency by ensuring that the long-term rate of inflation does not exceed 3% per annum.
- Help businesses thrive by ensuring there is adequate infrastructure,
it is easy to do business,
efficient players can grow in a fairly regulated environment, and cover their costs of capital. - Help households thrive through.
employment/self-employment
protection of real incomes, savings and pension assets home ownership.
- Regulate businesses to ensure compliance with standards, promote competition and ensure fair trading.
How does the Government fund all these things if there is no free lunch anywhere? It is through taxation.
During the past five years, non-oil taxes collected by all tiers of government in Nigeria averaged 4% of national income. In Angola it was 8%, Ghana 16%, Kenya 18%, South Africa 24% and in the OECD countries 32%. The World bank says a nation cannot grow meaningfully if tax revenue is less than 15% of national income!
Why is Nigeria, generating significantly lower tax revenues than other key economies in sub-Saharan Africa? Is it the tax rates, is tax compliance or both? The principal taxes in these countries are corporation tax, personal income tax and Value Added Tax (VAT). Corporation tax rate in Kenya and Ghana is 30% and 25% respectively, in Nigeria it is 32%. the rate of VAT in Kenya and Ghana is 16% and 15% respectively, in Nigeria it is 7.5%. The top rate of personal income tax in Kenya and Ghana is 30% and 25% respectively, in Nigeria it is 24%. In Kenya, you get to the top rate when taxable income exceeds KSH564,709 (USD 5,600), in Ghana it is GHC240,000 (USD 45,300) and in Nigeria it is NGN 3.2 million (USD 8,900).
This means that with the exception of VAT, tax rates are generally same in these three countries. Why then does government collect only 4% in Nigeria compared to 16% and 18% in Ghana and Kenya respectively? In my opinion, it is largely due to poor tax compliance in Nigeria.
What if Nigeria were able to increase non-oil tax revenue to 15% of National income? This means that Nigeria will generate an additional NGN14.4 trillion (US$40 billion) in revenues every year. It also means that total Government revenue will be 20% of national income or NGN28.8 trillion (US$80 billion) per annum compared to the current figure of NGN10.4 trillion (US$28 billion).
We estimate that the obligatory spending (interest, payroll, unfunded pensions and statutory transfers) of all the three tiers of government is about NGN12 trillion. This means that, if revenue were NGN28.8 trillion, there will be free cash flow of about NGN14.8 trillion to use to fulfil the purpose of government. That is to secure life and property, help the poor and weak in society to access basic services, support young ladies to acquire skills that are valuable and marketable, partner with the private sector to build railways, repair our roads and improve electricity supply significantly.
How do we raise the level of non-oil tax revenue? First, reform the tax laws. Focus on Personal Income Tax (PIT), VAT and Companies’ Income Tax (CIT) and make tax laws simpler. Increase the top rate of PIT to at least 30%, increase the rate of VAT to 10% and reduce the rate of CIT to 20% but levy an additional tax of 20% on “Super Profits”. Super profits shall be profit in excess of a target return on equity for shareholders. In today’s terms that would be return on equity in excess of 30%. Government should also abrogate all the numerous other levies that, in any case, do not generate significant revenues.
The second and more important leg of our tax reform is for the Government to show willingness to enforce tax laws. How should Government show this willingness? I believe the Government should focus on PIT, forgive all past sins and thus look forward and not backwards. The next step is for Mr. President to make his PIT returns public annually, then make it obligatory for all those want to work for him to do the same. He should then look at all of us in the face and say “Woe betides you if you don’t comply going forward!
They should enforce by auditing a sample of individuals, if they have underpaid, ask them to pay such amounts plus a stiff penalty, if they fail impound their assets, sell and pay government. Don’t waste taxpayers money throwing anyone into jail and start feeding him.
The biggest culprits with respect to tax evasion are the wealthy 0.1% of the population (or 200,00 individuals) who ought self-assess themselves to tax but fail to do so. The focus should be on them, not businesses and those in employment who are already largely compliant.
Government (FGN and States) should create infrastructure funds into which they will pay a significant proportion of the additional revenues raised. They can then use these monies to partner with the private sector to invest in infrastructure. They will also subject these Funds to independent audits and make the annual report and accounts of these Funds public. Essentially, subject the management of these Funds to corporate governance rules that public companies observe.
Nigerians argue that they would start paying taxes when public services improve. I disagree! My counter argument is that “If you don’t buy shares in Nestle Nigeria, they’re never going to send a dividend warrant to you!” You must pay your taxes first then seek fairness, transparency and accountability in the management of your taxes. If the Government forces us to comply, we shall be more interested in what goes on in there.
Lastly, in partnering with the private sector, Government should use the Nigeria Liquefied Natural Gas limited (NLNG) model. This means that Government will be a large minority shareholder, private sector institutions that are knowledgeable in the industry will own majority and manage the operations using a company incorporated under CAMA as the vehicle for doing business.
The Government should therefore implement the NLNG model in the Oil & Gas (Upstream) industry, Railway Infrastructure and the National Grid. This will help improve transparency and accountability in these sectors.
Nigeria can do well in the midst of much lower oil revenues, but we need to make tough choices, enforce tax compliance, invest in securing life and property, subsidize only the poor and weak not everyone in town, subsidize in ways that do not blow big holes in the budget of Government, partner with the private sector in the key areas that will grow output, re-train and certify our work force, manage our population, account for taxes collected in a transparent manner. Finally, like good Nigerians, pray that the good Lord should bless our efforts.
About the Author:
Mr. Olabode Mubasheer Agusto, founder of Nigeria’s leading ratings agency Agusto & Co. Limited, has public and private leadership experience spanning over 30 years including PriceWaterhouse, Nigeria International Bank, Director of the National Pension Commission, Member of the Central Bank of Nigeria Monetary Policy Committee and Director – General of the Budget Office of the Federation. Mr. Agusto is a fellow of the Institute of Chartered Accountants of Nigeria. Bode Agusto.
