The high energy costs that Nigerians are currently facing are the consequences of inefficiency and constrained scale of operation that pervade the sector. From petroleum products to electricity, what Nigerians pay now reflects the constraints imposed by market conditions. Positive changes in these variables will improve delivery and drive down prices.
Interestingly, Dangote Petroleum Refinery has shown that prices can come down when some basic market principles prevail. Since it commenced operations last year, it has reduced the price of petrol three times, the last two being done just a few days apart. Why is the new entrant into the industry able to do this?
There will be competition in the market, but only efficient companies can compete on prices or engage in price wars. Import-dependent firms can only compete to the extent that their price differentials allow them to reduce prices in a competitive environment. Their ability to do so will depend on the global oil price, which in the coming weeks or months could experience further instability.
Microeconomic theory posits that when firms compete, marginal pricing will come into play to determine who survives and who loses. It is the firm with the lowest marginal costs that will survive in the industry while those with higher marginal costs will exit the market first.
Nigerians will witness this playout in the developing energy market in the country. Until recently, we have not had an energy market in the real sense of it. What we had was an industry that was captured by the state and a few powerful groups. Under such a market structure, efficiency was never a determinant of prices, which is why we have always had a high-cost energy sector. So, the current high costs of electricity and petroleum products are simply the consequences of the inefficiency that has prevailed in the industry over the years.
The change or reduction in prices will necessarily be incremental, long-term developments. Again, most people do not appreciate this, but that is the reality of the market. This explains why they will come in bits, not in big chunks at a time. We have seen this play out with what Dangote Refinery has done so far. Because such price reductions will track developments in the crude oil market and the company’s efficiency levels, price changes (reduction in this case) are bound to be marginal at each point.
For most consumers, each of these changes was insignificant, so they continued to buy from retailers who maintained their prices. Yet, many others switched to the few outlets where the new price was obtainable. Over time, such incremental changes will add up to significant changes. In the end, consumers will derive value from the changes, while the company will also experience relief that it can do so.
“These price reductions reaffirm our commitment to providing high-quality petrol at affordable rates, benefiting consumers across the nation. In addition, we are working collaboratively with our partners to ensure equitable reflection of this price reduction,” Dangote Refinery said in its statement announcing the latest price reduction.
Such price reductions should not be seen as mere benevolent gestures by a producer just trying to make his customers feel good. They are part of critical economic decisions. In practical terms, they are part of the 10 principles of economics that say that key decisions are usually taken at the margin. This margin is the point where a choice must be made about whether to take an action or not.
In this case, the choice to raise or lower the price per litre of petrol must be based on fundamental factors that incorporate both internal and external issues. These factors include the issue of efficiency. For prices to fall in the market, it surely implies that the cost of production per unit has fallen. Usually, this happens when a firm can raise its rate of resource conversion into products.
Dangote Refinery would not be reducing its price if these factors are not at play in its operations. Consistent price reduction shows that efficiency rate is rising, with waste products being quite low, compared with similar plants. The plant is also designed to refine many types of crude oil, as much as 27 types, according to industry sources. With this type of configuration, efficiency will be one of its strengths that will drive its price-giving power in the industry.
A temporary threat to this downward price review came last month, March, on the heels of a rumour about the end of the naira-for-crude sale arrangement. Based on that, Dangote Refinery had threatened to resort to pricing its products in dollars. That would have made sense, anyway, because if you buy in dollars, you have to price in dollars to be able to recoup your expenses.
For now, Nigerians can look forward to a new era in the oil and gas industry because this is the first time we are witnessing competition in it.
