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13 months of the 4Vs: Has the Fuel Price Formula worked?

25 Jun 2019

By Madhusha Thavapalakumar At the end of one year and a month in effect, the fuel price formula is still the subject of fierce debate amongst consumers and economists. While some support the formula as the only way to replace politically driven pricing of fuel with scientific pricing, others criticise it for being a “formula” only in name, and for deviating from its purpose and over-subsidising fuel, burdening the taxpayer. Others have suggested abolishing the formula and going for alternative methods to curb losses from fuel pricing. The Sunday Morning Business decided to look back on the past year and evaluate the impact, both negative and positive, of the fuel pricing formula on the financial performance of the state-owned fuel supplier Ceylon Petroleum Corporation (CPC) and the privately owned fuel supplier, Lanka Indian Oil Corporation (Lanka IOC). Ceypetco incurs losses The cost-reflective price formula which was brought in to financially stabilise CPC resulted in the state-owned enterprise incurring losses in 2018 compared to profits a year ago. CPC is the main supplier of the national requirement of petroleum and petroleum-related products that are being imported. Its net loss widened to Rs. 104 billion compared to a profit of Rs. 3.5 billion in the previous year, despite 0.6% year-on-year (YoY) growth in litres of fuel sold in 2018. Poor financial performance resulted in over 50% YoY increase in CPC’s bank borrowing during the year. CPC borrowed Rs. 562 billion compared to Rs. 224 billion in 2017. Out of the Rs. 104 billion loss reported in 2018, a report by the Ministry of Finance attributed the amount of Rs. 82.7 billion to the depreciation of the rupee against the US dollar, which depreciated by over 19%. The rest of the loss was attributed to the on-and-off implementation of the formula. The report also reads: “The formula has not covered the full cost of the CPC, and this has adversely affected its financial position.” CPC’s petroleum sales in all the sectors it supplies to, excluding the aviation sector, witnessed losses in 2018. Profit from the aviation sector amounted to Rs. 3,841 million in 2018, an increase of 98% over 2017. In contrast, the transport sector incurred a heavy loss of Rs. 95.4 billion in 2018, with nearly 90% of CPC’s reported losses stemming from the sale of diesel and petrol at prices below its full cost. Certain sectors which had recorded profits previously had now turned into loss-making sectors, namely the power generation and industrial sectors, recording losses of Rs. 9.8 billion and Rs. 0.93 billion, respectively in 2018. According to estimates by JB Securities (Pvt.) Ltd., despite the customs duty waivers by the Government, the CPC had on average incurred a loss of Rs. 12.53 per litre on petrol and Rs. 16.91 per litre on diesel as at end-October, 2018. LIOC benefits from formula Surprisingly, in contrast to the CPC, the formula had resulted in Lanka IOC halving its previous year’s losses. Interestingly, despite the Sri Lankan rupee being the worst performing currency in the Asian region and the political disruption over the continued implementation of the formula in the fourth quarter of 2018, Lanka IOC improved its gross margins to 4.9% from 2% a year ago. Lanka IOC attributed the improvement to the price formula introduced last year, in contrast to the CPC. Lanka IOC cut down its loss by nearly 50% in the calendar year 2018, with its losses coming down to Rs. 625 million from Rs. 1.3 billion a year ago. “The implementation of the fuel pricing formula in May 2018 was a step in the right direction, ensuring that the prices reflected the global demand and supply trends, and also levelling the playing field,” Lanka IOC former Managing Director Shyam Bohra stated. However, Lanka IOC noted that the upcoming year could be challenging for them if the partial implementation of the auto fuel pricing mechanism continues, and emphasised on the full implementation of the formula. Speaking to The Sunday Morning Business in early March, Bohra expressed disappointment over the Government’s then recent fuel price revision through the fuel price formula, as revised local fuel prices were much lower than the global oil prices at the time. Bohra said that the fuel price formula had deviated from its rationale of reflecting changes in the global oil market. He added that the fuel price formula was “unscientific” as the revisions were not being undertaken according to any proper scientific method. Statement of Corporate Intent CPC signed a Statement of Corporate Intent (SCI) with the Government in 2017 to enhance its financial performance. SCI is a tripartite agreement signed among the Secretary to the Ministry of Finance, Secretary of the relevant line ministry, and the chairman of the respective state-owned enterprise (SOE) on behalf of the board of directors, with the mission of creating a platform for SOEs to operate in a commercially viable manner in order to achieve the macroeconomic objectives of the country. Accordingly, the SCI sets out the agreement between the CPC, the Ministry of Petroleum Resources Development, and Ministry of Finance in relation to CPC’s financial plans and projections for three years up to 2019. In order to improve CPC’s financial position, a pricing formula had to be introduced. Fuel price formula: A-Z In May 2018, Minister of Finance Mangala Samaraweera introduced the fuel price formula to eliminate ad hoc price revisions driven by political needs as opposed to economic needs, and to establish cost-based pricing to reduce losses suffered by the State due to low fuel prices. The formula was also one of the requirements laid out by the International Monetary Fund (IMF) under its current Extended Fund Facility (EFF) to Sri Lanka. According to the formula, the maximum retail price of fuel is an addition of the landing cost (V1), processing cost (V2), administrative cost (V3), and taxation (V4). The landing cost (V1) includes the Singapore Platts price per barrel, weighted average premium per barrel, loss due to evaporation, and exchange rate differences. Singapore Platts benchmark prices are the daily average of all trading transactions between buyers and sellers of petroleum products as assessed and summarised by the Standard and Poor’s Platts, a Singapore-based market wire service. The processing cost (V2) includes local port charges, transport cost, dealers’ margin, and also losses to dealers due to evaporation, and stockholding cost while the administrative cost (V3) includes personnel cost and other cost elements. Taxation (V4) includes customs import duty, excise duty, ports and airports development levy and Nation Building Tax (NBT). This is not the first time Sri Lanka adopted a fuel price formula. A pricing formula was adopted in 2002 and then subsequently abandoned in 2004 in view of an upcoming election by the same government which brought in the formula. However, the formula was revived again in 2007 but was scrapped two months after. Since the re-introduction in May 2018, the formula has been revised on every 10th day of the month as stipulated initially. However, there were some occasions where the Ministry of Finance delayed or missed the revision. When revising fuel prices each month, the Government does not base its monthly revisions on the global oil prices on the day prior to the revision, but instead bases it on the average of the global oil prices from the previous fuel price revision to the day prior to the upcoming revision. Revisions in 2018 Upon the introduction of the formula, fuel prices increased for the first time in almost two and a half years. Since then, domestic fuel prices had been periodically revised seven times during the year. This excludes the three reductions made by Opposition Leader Mahinda Rajapaksa in his capacity as Prime Minister and the Minister of Finance during the October political crisis. Following the first revision immediately after the formula was implemented, the price per litre of 92 octane petrol increased to Rs. 137 from Rs. 117, the price per litre of 95 octane petrol increased to Rs. 148 from Rs. 128, the price per litre of super diesel increased to Rs. 119 from Rs. 110, and the price per litre of auto diesel increased to Rs. 109 from Rs. 95. Brent prices showed an upward trend from mid-2017 till end-May 2018 when prices fell over expectations that the Organisation of the Petroleum Exporting Countries (OPEC) could wind down the output restriction deal, which was in place since the beginning of 2017. In June, the Government maintained prices without any change. During the third revision in July, prices increased further. The price of a litre of 92 octane petrol increased to Rs. 145 from Rs. 137, 95 octane petrol to Rs. 155 from Rs. 148, super diesel to Rs. 129 from Rs. 119, and auto diesel to Rs. 118 from Rs. 109. Only in the fourth revision in August did the prices of 95 octane petrol and super diesel see a slight increase. The price of a litre of 95 octane petrol increased to Rs. 157 from Rs. 155 and super diesel to Rs. 130 from Rs. 129. Supply concerns in relation to US trade sanctions on Iran resulted in an uptick in oil prices from mid-August to early-October 2018. In the fifth revision in September, fuel prices were increased even further. The price of a litre of 92 octane petrol increased to Rs. 149 from Rs. 145, 95 octane petrol to Rs. 161 from Rs. 157, super diesel to Rs. 133 from Rs. 130, and auto diesel to Rs. 123 from Rs. 118. The sixth revision occurred in October, during which the price of a litre of auto diesel remained the same while the price of a litre of 92 octane petrol increased to Rs. 155 from Rs. 149, 95 octane petrol to Rs. 169 from Rs. 161, and the per litre cost of super diesel increased to Rs. 141 from Rs. 133. Brent prices reached a peak of $ 86 on 4 October 2018, its highest level since October 2014. During the political crisis in late 2018, fuel prices were revised three times, abolishing the fuel price formula. During this period, the price of a litre of 92 octane petrol was reduced to Rs. 125 from Rs. 145, 95 octane petrol to Rs. 149 from Rs. 169, super diesel to Rs. 121 from Rs. 141, and auto diesel to Rs. 101 from Rs. 123. From November 2018, Brent prices followed a declining trend due to the build-up of global inventories and record levels of oil production from the world’s three largest producers – the US, Russia, and Saudi Arabia – along with uncertainties about future global demand growth, particularly with the slowdown of China and several advanced economies. However, following the conclusion of the crisis, despite the hike in global oil prices, local fuel prices were revised again for the seventh time based on the formula. The price of a litre of 92 octane petrol, 95 octane petrol, and super diesel were brought down by Rs. 10 while price of a litre of auto diesel was brought down by Rs. 5. Impacts of over-subsidising fuel The Government of Sri Lanka had subsidised fuel multiple times for political needs, both before and after the implementation of the fuel pricing formula. Subsidising fuel prices at times global prices are higher and not allowing them to increase to their market levels only aggravates the Government's financial burden, while also discouraging both local and inward foreign investment, including construction of new refineries for the domestic petroleum sector. According to economists, 70% of the fuel sold in Sri Lanka is consumed by the upper 30% of income earners in society and in such cases, these subsidies make the rich richer. Possible measures in addition to formula 1. Cutting down on vehicle importation A senior analyst, who wished to remain anonymous, speaking to The Sunday Morning Business earlier this year, highlighted that a record number of vehicles were brought down to Sri Lanka in 2018, even though fuel was the highest import bill of the country. According to him, amidst a depreciating currency and inadequate foreign reserves to settle the external debt pile, a country like Sri Lanka should focus on allowing the importation of fuel-efficient vehicles and discourage the importation of small vehicles as the latter are fuel inefficient, contrary to the present motor vehicle policy. 2. Need for a new refinery According to some energy expects, the losses are partly due to the inefficient operation of the refinery. The almost 50-year-old Sapugaskanda Oil Refinery processes over 50,000 barrels per day (bpd), at 50% efficiency. The complex has five oil tanks of 40,000 metric tonnes in a 165-acre land in Sapugaskanda. According to the Central Bank of Sri Lanka (CBSL), the Sapugaskanda Oil Refinery, which was temporarily shut down during June 2017, recorded an expansion in production with the completion of the renovation programme in early 2018. Accordingly, the overall output from the Sapugaskanda Oil Refinery was sufficient to meet around 30-35% of domestic demand, while the remaining demand was met through imports. However, upon proper management and refurbishment, the refinery would cater to 40% of Sri Lanka’s fuel requirement, according to experts. SriLankan Airlines Ltd. former Jet Fuel Advisor Cyril Suduwella stated that Sapugaskanda cannot use any type of oil available as there are specific crude characteristics required for the refining process and the refinery is in dire need of an upgrade. Even though purchasing fuel and storing it when global prices are low is possible, Sri Lanka lacks adequate capacities to buffer stock and therefore, the country only purchases fuel for its existing capacity. “Therefore, the Government should choose to either expand or rehabilitate the Trincomalee refinery and pass the benefits to the people,” Suduwella added, speaking to The Sunday Morning Business. Conclusion Amidst the upcoming presidential elections, the Government of Sri Lanka has to ensure transparent implementation of a fully-adhered-to fuel price formula in 2019 as this is the first full year where the price formula is effective. The Government should also pay prompt attention to building new or expanding existing storage capacities, and introduce fuel sector policies as fuel pricing is connected to the entire economy and cannot be addressed in isolation.

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