Imani Africa Report: How to Prevent Fuel Fraud In Africa
By Hubert Nii-Aponsah
April 21, 2016 [IMANI Africa] Attempts have been made in the past to mark or identify various fuel products in order to prevent fraud. For example, fuel marking with dyes has been in use since the 1950s but can be easily defeated using cheap and simple methods to launder out the dye. However, newer technologies using molecular markers as part of an overall fuel supply chain protection program have proven to reduce existing criminal activities and deter others. The impact of fuel fraud, how fuel marking programs operate and the results of some current African programs are presented here to support the further adoption of this technology across the continent. Saudi Arabia, for example, is estimated to lose billions of barrels of diesel to neighbouring United Arab Emirates (UAE) each year as a result of (subsidy-induced) smuggling.6 Also, Algeria lost about $1.3 billion in tax revenues to cross-border fuel smuggling in 2013 according to the Business Recorder. In Ghana, the benefits of fuel marking technology are immediate. The results include over 100% Return on Investment (ROI) and an estimated increase of about $11 million in tax excise collection per annum. The fuel marking programme has helped the government to raise more revenue from the taxed petroleum products without having to increase the tax rates. Read more below.
Refined petroleum products are an important resource in every country. Various governments impose taxes on fuel to generate revenue that finances essential public goods and services for the benefit of the citizenry. Governments also provide a boost to targeted sectors of the economy or help the needy by way of fuel subsidies.
An unintended effect is that the price differentials created by these taxes and/or subsidies produce a financial incentive for unscrupulous individuals and businesses to engage in several forms of fuel fraud. These include: smuggling, adulteration and dilution of fuels, transit fuel diversion and round-tripping as well as outright theft. Moreover, fuel fraud is not just an in-country problem but can cross borders where cheaper, inferior products are smuggled in as adulterants or subsidized fuels are smuggled out to neighbouring countries where they sell at higher prices. Smuggling of unwanted adulterants into Philippines’ fuel supply chain, for instance, has been estimated to cost the country as high as $750 million annually in tax revenue. This money could certainly have done a lot for the Philippines. This makes one wonder how much African countries are losing annually due to fuel fraud. The situation could be worse for African countries that simultaneously tax certain petroleum products and subsidize others. This is because not only is the expected tax revenue not realized but the subsidies are also wasted as they are diverted from the targeted recipients to criminals. The government loses twice when crooked businesses dilute taxed fuel with the cheaper subsidized products.
Attempts have been made in the past to mark or identify various fuel products in order to prevent fraud. For example, fuel marking with dyes has been in use since the 1950s but can be easily defeated using cheap and simple methods to launder out the dye. However, newer technologies using molecular markers as part of an overall fuel supply chain protection program have proven to reduce existing criminal activities and deter others. The impact of fuel fraud, how fuel marking programs operate and the results of some current African programs are presented here to support the further adoption of this technology across the continent.
Impact on Government Revenue
A report by the World Bank (2001) on petroleum taxation stressed that “taxes on petroleum products are a critical source of government revenue.” The report further explains, “….taxing fuel is one of the easiest ways to get revenue: collecting fuel taxes is relatively straightforward, and the consumption of fuels as a group is relatively price inelastic and income elastic, ensuring buoyant revenue as income rises and tax rates are increased”. In other words, because petroleum products cannot easily be replaced by close substitutes, taxing them is less distortionary: the decrease in demand due to the tax-inclusive price will not be that large. Additionally, as personal incomes increase, individuals are more likely to increase fuel consumption, making fuel tax revenue vital to the government.
Where fuel fraud is prevalent, a large amount of the anticipated tax revenue will not be collected. Tax evasion occurs when taxed fuels are diluted with products that have lower taxes or no taxes, such as: fuels smuggled in from other countries; subsidized petroleum products; duty-free transit fuels; stolen petroleum products; inferior products such as solvents, waste oils and others. Fuel fraud takes place in many countries, including even advanced countries in Europe. Bloomberg news reported that fuel fraud costs the EU about $4 billion annually in tax revenue. Elsewhere in Africa, Algeria lost approximately $1.3 billion to fuel fraud in 2013. These figures are indeed alarming especially for African countries that rely heavily on foreign aid to support a large percentage of their budgets annually. Failure to collect taxes due to fuel fraud could lead to unnecessary fiscal deficits and aid dependency.
The government of Ghana has for some time been riddled with a heavy debt burden despite the discovery and subsequent production of crude oil (in commercial quantities) in 2011. Driven in part by an IMF fiscal reform and credit facility, the country adopted a modern fuel- marking program, using the expected increase in revenue to close the fiscal gap. The results include over 100% Return on Investment (ROI) and an estimated increase of about $11 million in tax excise collection per annum. The fuel marking programme has helped the government to raise more revenue from the taxed petroleum products without having to increase the tax rates. The Ghana National Petroleum Agency’s (NPA) program is based on the technology and best practices of US-based Authentix, Inc.
Governments that implement fuel marking programs can generate virtually all the expected revenue to fund vital goods and services, creating a good governance environment for businesses to thrive, the economy to grow and ultimately improve the living standards of the people.
Impact on Subsidy-Targets
Another crucial issue for governments is subsidy abuse. Various governments provide subsidies to boost industries such as farming and fishing, help provide a social safety net for the needy as well as distribute the benefits of discovered abundant natural resources. A common subsidy is the provision of lower taxes or no taxes for kerosene so that poorer families can have access to affordable cooking and heating fuel. There may also be subsidies provided for marine premix fuel and off-road diesel with the overall objective of increasing economic growth.
The lower price of subsidized products provides an incentive to use it as an adulterant in more expensive or fully-taxed fuels. Subsidy abuse also occurs when subsidized fuels are smuggled out to higher-priced markets in typically the neighbouring countries to lower transportation costs. There is also the issue of round-tripping of imports notable in Nigeria. Although Nigeria exports crude oil, refined petroleum products are usually imported and subsidized. After these products are imported and the subsidy is paid, some criminals take them out of the country and bring them in again to double the subsidy. In Niger, round-tripping of exports also exists. The immediate effect is that subsidy funds are diverted from the intended beneficiaries to criminals and may well be used to finance other criminal activities.
There are several impacts of subsidy abuse. The economic growth goals for the targeted sectors are not achieved. The government also loses twice when these subsidized fuels are mixed with the fully taxed ones, losing the tax revenue and the investment in the subsidies. Increases in subsidy expenditures due to diversion could culminate in the depreciation of the country’s currency and its credit rating. Subsidy diversion is a problem for many countries. 5
Fuel marking programs can help combat subsidy abuse by marking the low- and no-tax fuels at concentrations in the low parts per billion levels and testing for the marker in the higher taxed fuel. Once marked, even when added at low quantities, the presence of the subsidized fuels can be detected using special analysers at the border or within the country catching both smuggling and adulteration of high taxed fuels. Ghana, for instance, has seen a 78% reduction in adulteration as a result of the program. Serbia also recorded a significant decline in the sales of base oils (known as diesel adulterants) by seven times. Similar fuel marking programs would enable African governments to obtain a large proportion of the fuel revenue due to them and also ensure that the subsidies reach predetermined beneficiaries.
Other relevant impacts
Apart from tax evasion and subsidy abuse due to fuel fraud, there are also other negative effects which the fuel marking programs could help address.
When fuel is adulterated with cheaper or inferior products, the quality of fuel suffers and typically does combust completely in machines or vehicles. This could lead to a quicker rate of depreciation of various machines or vehicles. This means that money which could have been used for profitable investments would be spent on maintenance instead. This could discourage Foreign Direct Investment if investors lose confidence in the profitability of their ventures due to this challenge. Fuel marking programs can reduce the rate of adulteration quite quickly, helping to ensure that citizens get value for money and removing some barriers to foreign investment.
Additionally, dilution of fuels with waste oils could have a serious detrimental impact on the environment. With greenhouse gas emission and climate change as a global concern, this effect cannot be overlooked. Fuel marking programs provide the evidence to help remove polluting adulterants from the fuel supply chain hence improving the environment. A fuel marking program would culminate in the supply and sale of more environment-friendly petroleum products by reducing adulteration and maintaining high quality.
Some Key Prerequisites of a Successful Fuel Integrity Program
There are some other essential factors to consider so that African governments can implement successful programs in their countries.
First, a government should seek out a partner with a proven track record of excellence in fuel marking programs with the state-of-the-art molecular fuel -marking technology. The partner should conduct a situational analysis to identify the problem(s) particular to the country, designing a technical and operational solution for the program that specifically addresses those problems. Often a multi-layered approach is used with a field test to screen for diversion or dilution problems. If a field test fails, further lab tests are conducted with sophisticated analysers that provide high quality evidence in support of enforcement actions or legal proceedings. To ensure that the program is meeting its objectives, the government should insist that regular procedural performance and marker inventory audits be included in the program design and costs.
Although it may appear as a good idea to give different parts of the fuel marking program to different companies in order to create competition and efficiency, this may lead to a lack of accountability. Best practice would be to partner with a company that will have the sole responsibility for the program, while potentially using local subcontractors for some operational aspects in order to create employment locally.
Second, legislation is critical to the success of the program. The government and other relevant institutions must cooperate with the partner to pass legislation and/or clear any ambiguities in existing legislation to ensure that culprits caught and arrested could be prosecuted. Without legislation and cooperation, the program cannot succeed in curbing tax evasion and subsidy abuse. Cooperation by the Government of Ghana and the NPA with Authentix yielded positive revenue results for Ghana. It is no surprise therefore that the NPA and its Chief Executive, Mr Moses Asaga, recently received two awards from the prestigious Socrates Committee of the Europe Business Assembly in Cannes, France. The NPA received the International Prize for Best Enterprise for 2015 award, while Mr Asaga was honoured with the Best Manager award for 2015.
Last but not least, legislation should be paired with strong enforcement of punitive measures. If culprits caught are not punished, the law will be seen as harmless. This does not create the strong deterrent effect necessary to reduce fuel fraud. Punishments such as fines, immediate bans and imprisonment should be meted out to culpable entities in order to ensure that the program delivers desired results. In Ghana, the deterrent effect culminated in a substantial reduction in the amount of fuel product dilution from 34% to 7% within just 6 months of the program.
Fuel fraud via tax evasion has robbed African governments of millions of US dollars in tax revenue annually. Subsidy expenditures from the remaining scarce resources also find their way to various criminals instead of intended beneficiaries such as the poor in the country.
The fuel marking programs that use modern marker technology is an innovative way of curbing these illicit activities and ensuring that individuals and firms get value for money spent on fuel. Despite calls from economists such as Nobel Laureate Joseph Stiglitz and Christine Lagarde at the recently held World Economic forum in Davos for a new measure of economic progress other than GDP growth, GDP growth still remains crucial (for the time being). African governments have for too long focused solely on capital (investment) and labour to stimulate economic growth while relatively neglecting total factor productivity typically from technological advancement and innovation. Meanwhile, studies show that total factor productivity could account for about 60% of a country’s economic growth. It is high time governments of African countries leveraged the technology used in these programs to boost economic growth and generate revenue internally rather than depend heavily on foreign aid and borrowing to finance essential public goods and services.
This paper was authored by Hubert Nii-Aponsah, IMANI Africa’s Deputy Head for the Center for Economic Governance and Political Affairs. For comments and enquiries, please email email@example.com
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