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The effects of oil price hikes in Ghana’s economy

Fri, 18 Jul 2014 Source: Hudu, Mahama

Introduction

Crude oil is arguably the most precious natural commodity in the world, it can be a curse or blessing to nations if not properly managed, at least the ‘Dutch disease’ is still fresh in literature. The ‘black gold’ in the world is undoubtedly the largest source of energy currently.

Even though it may be common to consumers the expensive earth resource is not common the underneath of all nations. In countries where it is found its proration does not come cheap. Kuncoro, H. (April 2011,) establish that Volatility of oil price cause ‘the prices of metals, food grains and other commodities’ to go up sharply which has a high political implications, he also further indicates that fluctuations will increase a household’s income risk and a potential output loss for business and increase government subsidies. Similarly, Balaguer, J. and Ripollés, J. (February, 2012) shows that ‘short-term transmission of wholesale prices to retail prices is quite symmetric for both gasoline and diesel’. As far as oil prices affect local output, under standard considerations their effects should be surrounded by the cost share of oil in domestic production. By interpreting oil as an intermediate input in the value added production function is questionable if viewed as an imported commodity. Under considerable assumptions, imported oil enters the production function of domestic gross output, but it does not enter the production function of domestic value added. Instead they affect the domestic economy by changing domestic capital and labour inputs, Kalian, L. (December, 2009)

The Research Department of International Monetary Fund (December, 2000), indicates that the rise (instability) in oil prices will give rise in the cost of the economy, resulting increase in the relative price of energy inputs and putting pressure on profit margins. There will also be an impact on the price level and on inflation. Its magnitude will depend on the degree of monetary tightening and the extent to which consumers seek to offset the decline in their real incomes through higher wage increases and producers seeking to restore profit margins. There will be direct and indirect impact on financial markets, corporate earnings, inflation, and monetary policy. Oil price increases (instability) will affect equity and bond valuations, and currency exchange rates.

Ghana has made several attempts dating from ‘1896’ in her bid to explore oil but not enough was found for commercialization, until 2007 when significant amount was discovered at cape three points in saleable quantities, Ghana has been relying on the international market for her crude oil needs.

When Ghana National Petroleum Authority and her jubilee partners announced the discovery of oil in commercial quantities many Ghanaian received it as a sigh of relief from the international oil shocks, but this remains a nightmare because TOR has so far failed to refining oil from the jubilee fields.

According to Kuncoro, H. (April, 2011) oil price volatility has always been a global concern even before the 1973 embargo, demand and supply has been characterized with geopolitical and economic interruptions. When Iraq invaded Kurdish, the US army between 1996 and 2001 raided missile in southern Iraq the consequences of it affected the whole world. Also, as Iraq refused United Nation’s weapon inspectors into the country tension was mounted across board and the oil industry suffers some shocks. Similarly the cut down of Organization of Petroleum Exporting Countries’ (OPEC) operations within this same period contributed to plummet high oil prices, the economic recessions, the 11/2001 terrorist attack on United States of America (USA), the 2010 middle east political standup in Egypt, Libya, Tunisia, the continuous civil war in Syria and many other global wrangling are causes of oil price volatility in the industry.

Yépez-García, R. A. and Dana, J. (2012) indicates that Oil vulnerability is the value of net oil imports divided by current GDP. It is calculated from data on oil production and oil product consumption. Values are estimated by multiplying volumes by the Brent price of oil for a particular period. From a macroeconomic standpoint, the vulnerability of an oil importing country is measured by the ratio of the value of net oil imports to GDP. the higher this ratio the larger the fall in GDP that is required to offset a rise in oil prices. The impact of the oil price shock is calculated as the index of vulnerability multiplied by the percentage increase in oil prices’. Vulnerability affect the economy in two ways, firstly by affecting the supply of the economy because of oil price rise which adversely impact supply recession and secondly vulnerability also affects demand side of the economy due to lower levels of income on consumers and businesses behaviours.

EXPECTATIONS OF GHANA’S OIL FIND AND OIL PRICING

After joining the league of oil producing countries, Ghana’s economic managers faced a heavy task of whether moving the country to a blessed economy or to a cursed nation. For the ordinary Ghanaian citizen all he/she expect is some reasonable reduction of petroleum prices, industry and gross domestic product (GDP) growth, reduction in inflation and job creation, this evidence is captured in the words of the then president Kufour on BBC ‘Even without oil, we are doing so well ...with oil as a shot in the arm, we’re going to fly; … my joy is that I’ll go down in history as the President under whose watch oil was found to turn the economy of Ghana around for the better.’’’. The indigenous Ghanaian in Takoradi on whose native land oil is found share similar hopes in Agbefu’s paper ‘this has been long in coming…We are extremely excited and flattered that the oil was found in the western region, our region. With the coming of the oil, we the youth can now boast of finding white collar jobs, earning more than we earn now with fishing and petty trading. We only hope the government will consider this as a birth-right to us, and not play politics with it as usual’.

Theoretical calculation in prices is meaningless unless this reflect in pump prices. According to Adam, M. A. (November 2009) this believe is justified by the intermittent pressure by ‘civil society groups like the Committee for Joint Action (CJA) and the Alliance for Accountable Governance (AFAG) on governments’ whenever prices rises.

To meet expectations government need to influence prices through subsidies. ‘Subsidies are therefore unavoidable under some circumstances but these should be clearly defined in a subsidy policy and transparently managed. What remains challenging, however, is how to finance these subsidies’.

Consumer subsidization; the government of Ghana implemented a cross subsidization fund where petrol consumers paid more to subsidize for diesel consumers. The logic behind this was that subsidise are intended for the vulnerable or the poor, and the only way to get them benefit is to reduce diesel prices which many commercial vehicles (trotro) use. But from the researcher’s observation point and from his analysis, subsidies in this regard are skewed to the disadvantage of the poor –‘Fact is, the petroleum pricing formula used by the National Petroleum Authority is supposed to reward consumers when crude oil prices fall; and penalize them when crude oil prices rise. However, under-recoveries by the Tema Oil Refinery as a result of non-payment of subsidised bills by Government have often led to the use of the gains from falling crude oil prices to finance the under-recoveries. Thus, while petroleum prices increase with increasing crude oil prices, they do no decrease with decreasing crude oil prices. The relationship has been asymmetric, demonstrating an inconsistent application of the petroleum pricing formula’

However, the petroleum unification fund was used to reduce the burden of consumers. this worked on the basis of proximity to TOR, customers who are far away from TOR pay less at the disadvantage of those closer and the difference is use to offset any outstanding balances.

Price stabilisation is yet a policy path for government, a price stabilisation fund is usually establish and tied to a price band with a floor and a cap. In situation where prices fall below the floor, the difference is kept in the fund at other times when prices goes above the ceiling the fund is use to smoothing the price, for example the 2004 Peruvian Petroleum Price Stabilization, the Colombian Petroleum Price Stabilization Fund also Cameroon, Ethiopia and Malawi used similar methods.

THE REALITY IN GHANA’S PRICING

Pricing policy direction has been a problem to the people of Ghana and for the NPA. The prices of petroleum affect every single consumer directly or otherwise so NPA has decided to formulate the following formula for calculating petroleum prices in the country. The effectiveness of this model is determined by prevailing market condition. From the formula, crude oil prices, exchange rate, taxes or levies and margins are the factors that influence oil prices. Policy regulations and activities of government, the performances of TOR, oil marketing companies (OMC) and oil trading companies all play a major part in oil price determination.

THE FORMULAE;

‘Ex-pump Price = Ex-refinery Price + Taxes/Levies + Margins

Ex-refinery Price = CIF + Related Charges

CIF = Cost (FBO) + Insurance + Freight

Related Charges = Off-loading Cost + In-transit Losses + Inspection + L/C Cost +Financial Cost + Storage Cost + In-plant Losses + Track Loading Cost +Operating Margin’.

IMPACT OF OIL PRICE SHOCK IN GHANA’S ECONOMY

International price shocks have over the years presented some unfortunate economic challenges in Ghana by way of redirecting government resources from social intervention towards subsidies. It also at one point or the other caused shortages and panic in the system. The most recent one came in June 2014 as government of Ghana tried to take off the gap created between international prices and domestic prices, this caused some misunderstanding in the process between government and the bulk distribution companies (BDCs) and this efforts resulted in some shortage and panic buying of petrol in the local market. Another impact of oil shock is felt in 2003 as substantial percent of GDP was spent on subsidies. The table below provides details.

TABLE 3. Oil vulnerability and oil shock (2003)

COUNTRY A B C D E F G H I J

GHANA 39.0 7.0 32.0 0.8 7.62 0.044 1.4 3.0 276 93

Data source: Bacon, R., and Matter, A., The Vulnerability of African Countries to Oil Price Shocks: Major Factor and Policy Options the case of Oil Importing Countries, Energy Sector Management Assistance Program,

A: Oil and oil products consumption in 2003 in 000 barrels per day,

B: Domestic oil production in 2003 in 000 barrels per day,

C: Net imports of oil and oil products in 2003 in 000 barrels a day (oil consumption minus oil production),

D: Oil import dependence in 2003 (net oil imports / oil consumption),

E: GDP in 2003 in current US$ 7.62,

F: Estimated vulnerability to oil in 2003 (net oil imports* 365*1000* average Brent price [US$28.84] in 2003 / GDP),

G: Estimated size of shock as percentage of 2003 GDP following an average annual price increase of Brent to US$38.21(Vulnerability * 33 per cent),

H: Estimated size of shock as percentage of 2003 GDP following an average annual price increase of Brent to US$49.54(vulnerability * 72 per cent),

I: GDP per capita in 2003

J: Ratio of external debt to GDP in 2003.

From the table it is realized that 0.044 and 1.4 of Ghana’s GDP for 2003 alone was exposed to oil vulnerability and price shocks respectively by way of estimation and this is equivalent to what government spent on subsidies thereby causing some amount of pressure on government budget. Money that could have been used in other sectors like building roads, hospitals, schools and among others are used to cushion price fluctuations which has serious economic implication for the ordinary Ghanaian in the long run.

In disguise subsidise are not beneficial to the consumer because they tend to be asymmetric towards the vulnerable in the long run. 0.7% of the 2006’s Gross Domestic Product (GDP) in Ghana was spent on subsidizing oil price volatility. these Subsidies cause a big pull from government finances and eventually distort development because government sacrifice development to spend in such non-productive area which is a heavy price the poor people have to pay for in other to correct market failures,

The exchange rate effect; as indicated by the world trade organisation, higher energy prices are co-movement of higher prices for imported energy goods, and that at least some income lost from higher prices of imported energy goods are transferred from abroad to the local market and can to some extent attributed to the currency speculations. Higher energy prices reduce discretionary income as consumers have less money to spend after paying their energy bills. With perfectly inelastic energy demand the magnitude of the effect of a unit change in energy prices is bounded by the energy share in consumption. Also changing energy prices may bring about future uncertainty causing consumers to postpone irreversible purchases of consumer durables. Another facet is even when purchase decisions are reversible; consumption may fall in response to energy price shocks, as consumers may increase their precautionary motive of savings. This response may arise if consumers smooth their consumption because they perceive a greater likelihood of future unemployment and hence future income losses. Ideally, this will cause general equilibrium effects on employment and real income. In addition, the precautionary savings will also reflect greater uncertainty about the prospects of remaining gainfully employed, in which case any unexpected change in the price of energy would lower consumption. Finally, durable products which operation requires energy will tend to decline even more, as households delay or forego purchases of energy-using durables, (WTO, January 2010). Even travelling, transportation and consumption of agrarian products will reduce. Government may be force to increase taxes and levies in other to reach the equilibrium of price fluctuation.

Like any other net oil importer Ghana’s problem of oil price volatility does not seem to end soon since pricing hikes are influence by international factors. However, with good pricing policies distortions can be minimized. Other alternative sources of primary fuel should be introduced, regulatory policies should be taken seriously because it is realized that price adjustments are asymmetrical (wholesalers or retailers and even commercial vehicle owner are quick to increase oil prices and fares respectively when GNPC announces increments in oil prices but are reluctant to decrease when the same body announces reduction) thereby putting unfair pressure on the poor consumer. By far we can say that as a result of government inability to pay for under-recoveries of subsidies unfair pressure is skewed towards the poor consumer.

RECOMMENDATIONS

Following the 2007 announcement by the jubilee partners about oil find in the country there has been consistent announcement about improvement capacity on gas discoveries. This suggests that Ghana is a potential country for diversification into other energy sectors like gas. Other products like coal, natural gas, biogas, wind energy and solar are also worth considering.

Oil price hike has been over the years an unavoidable problem in Ghana’s pricing regime. Since pricing have international influence oil import countries may not obviously have total control over fluctuations, however policy makers can initiate programs and pricing schemes that will lessen the burden on consumer. The following proposal could be considered by the NPA.

Total deregulation reduces public sector dominance and develop a liberalized market that ensure adequate supply of products, this could be a suitable policy decision for the government of Ghana in the petroleum subsector because the OMC’s and the BDC’s could have full cost recovery which takes off the burden of subsidy from government. Countries such as Chile, USA, Venezuela, Japan, Mexico and Argentina are shining examples of deregulation. Considering the country’s current economic woes with unemployment and labor issues deregulation will be unjust for Ghanaians in the short time because it could worsen the ongoing economic hardships thus the high transport fares, lost of jobs, and general cost of living. Nigeria tried it and it is believe to be one of the results of the ‘Niger Delta decease’ .

Ghana has some level of experience in hedging and with the introduction of a price band the country can buy the Contango and backwardation concept to smoothing her oil prices by;

(1) expands storage capacity,

(2) Determine a price band,

(III) When prices are expected to go ‘contango’ (futures prices going higher than current spot prices) but are currently within the band then government can sign a spot contract and hedge against future prices,

(IV) When prices are expected to ‘backwardate’ (futures prices going lower than current spot prices) then use the available stock.

The advantage here is that GNPC and TOR could harvest some profit in the process which could be used to service subsidies. Secondly there will always be assurance of security of supply and thus volatility will not have much impact on local consumption

NAME; Mahama Hudu

(Center for energy research-Ghana)

Contact: 0506734457

Email; mahama_2020@yahoo.com

Columnist: Hudu, Mahama