Nigeria's fossil fuel subsidy reforms : the welfare effects on households

Understanding the distributional consequences of progressive fossil fuel subsidy reform is critical to the sustainability of reform efforts as well as progress towards more just and inclusive energy transitions. This study examines the welfare effects of fossil fuel subsidy reforms on Nigerian households, focusing on the socio-economic implications of petrol price changes caused by the removal of subsidies. Using the Quadratic Almost Ideal Demand System (QUAIDS) model, the research explores household energy consumption patterns, estimating budget, own-price, and cross-price elasticities for petrol. The study critically evaluates the welfare impacts of petrol price increases and assesses the effectiveness of government redistribution policies targeting economically vulnerable households. It considers the immediate, direct impact of price changes on household budgets (first-order effects) and adjustments households can make (second-order effects), including substitution between goods. By analysing both these effects, the research provides a holistic view of the dynamic interaction between subsidy removal and household welfare, highlighting the varied impacts across different income groups and residential settings. The study finds that the increase in petrol prices following subsidy removal disproportionately affects lower-income households. This is because the average Nigerian household has become dependent on petrol and shows an inelastic response to changes in its price. This means a petrol price hike would not significantly deter petrol consumption but would strain household budgets in the absence of available, accessible, or suitable alternatives to petrol. There is a significant variation in welfare impacts across different household income quintiles and locations, with rural and lower-income households experiencing higher welfare losses. The analysis demonstrates that targeted lump-sum transfers, particularly to bottom 40%, lower bound, and upper bound poverty line households, effectively counteract some of the welfare losses, indicating the progressive nature of these policies. The findings highlight the necessity of carefully designed redistribution policies to mitigate the adverse effects of subsidy reforms, ensuring that lower-income and rural households are adequately supported. Such policies need to consider disparate welfare impacts together with progress on the effectiveness of redistributive, revenue recycling, or palliative policies.