Business

How Sri Lanka really prices fuel

A Singaporean Oil Tanker transporting petroleum products

By Madhusha Thavapalakumar

You could own a vehicle or take public transport to work, but while pumping fuel or travelling in the bus, and paying extra for a litre of fuel or the bus ticket compared to what you paid the previous week, have you ever wondered how fuel prices are determined in Sri Lanka?

We Sri Lankans are convinced that local fuel prices are increased when global fuel prices increase and vice versa, despite occasional revisions to or maintenance of fuel prices solely stemming from political reasoning.

According to the famous fuel price formula introduced by the previous Government, fuel prices were supposed to be revised on the 10th of each month and a number of factors in addition to global oil prices were taken into consideration when doing so.

The main purpose of the formula was to reflect fluctuations in the global oil market, locally. Although this original purpose was more often than not served, there were times the formula ran counter to its initial purpose – when fuel prices were decided based on political reasons. Nevertheless, this formula was abandoned under the present Government. In fact, the Government that was elected in November last year is yet to announce a revision of fuel prices.

Since then however, and notably over the past three months, global oil prices reached historic lows due to reduced demand driven by the ongoing Covid-19 pandemic. In fact, at one point, global prices hit negative levels, but the Government didn’t reduce oil prices.

In February this year, when global oil prices started to plunge, Minister of Transport Services Management and Power and Energy Mahinda Amaraweera noted that the drop at that point in global oil prices was not sufficient to warrant a reduction in local oil prices; he stated that should the declining trend persist, the benefits will be passed onto the consumers. However, even though the declining trend persisted in the following weeks, President Gotabaya Rajapaksa directed the reduction of the prices of dhal and salmon, as an alternative method to pass on the benefits of global oil price reductions to consumers, so it could be felt by more people.

Nevertheless, these reduced prices prevailed only for a couple of weeks. At the end of April, the Government issued gazettes lifting the maximum retail price restrictions on these items, effectively taking away the so-called benefits of reduced global fuel oil prices felt by the people.

At a time when the benefits of a drastic drop in global oil prices hasn’t been passed onto Sri Lankans, either in the form of reduced prices for essential items or reduced local oil prices, The Sunday Morning Business decided to take a look at how fuel prices are being determined in Sri Lanka and the factors that contribute to the local pricing of fuel.

Countries we import from

Last year, Sri Lanka imported petroleum products worth about $ 3.8 billion, according to the Central Bank of Sri Lanka (CBSL). As a country which heavily depends on imports when it comes to fuel, Sri Lanka’s fuel importing markets have mainly been a number of Middle Eastern countries.

Iran’s oil market

According to research by former Treasury Secretary Dr. R.H.S. Samaratunga, Sri Lanka was importing crude oil largely from Iran and a minor portion from Saudi Arabia. However, after the US began imposing sanctions on Iran, Sri Lanka faced complications as it was majorly dependent on Iran for fuel. Following this, Sri Lanka began importing fuel from other Middle Eastern countries, especially the United Arab Emirates (UAE).

Placement of orders

According to the state-owned Ceylon Petroleum Corporation (CPC) Chairman Sumith Wijesinghe, CPC places petroleum orders for the whole year, mostly at the beginning of each year.

Long-term tender process

Speaking to The Sunday Morning Business, a former chemical engineer and Deputy Manager at the CPC noted that generally, the CPC either floats six-month or one-year tenders to procure fuel or purchase fuel in the spot market.

“If you are going for a term contract, they will float the tender and it will be for six months or one year,” the engineer noted.

After floating a tender and signing the agreement with the seller, the average of the Singapore Platts prices of that particular month would be the price at which fuel is purchased. However, if there is a price hike during the agreement period, buyers might have to pay the increased price for the fuel imported during that period.

Spot purchases

“If they are purchasing in the spot market, it will be a bit different. Anyway, it too is based on the Singapore Platts prices,” the engineer stated.

Spot purchase or spot buying is the practice of buying to meet immediate requirements, rather than for stock or to meet future demand.

Spot purchases too, according to him, will be done through a tender process, in accordance with the approved procurement guidelines of the Government of Sri Lanka. Even though the tender process is not lengthy like the aforementioned long-term method, for this process also, fuel is purchased at the average of the Singapore Platts prices of that particular month.

Sri Lanka purchases petroleum products at Singapore Platts prices. The 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 & Poor’s Platts, a Singapore-based market wire service.

When the fuel price formula was in effect, the Government at the time noted that it took the average global oil prices of the previous month in revising local fuel prices.

Journey to Sri Lanka

As the engineer noted, oil shipments imported from Middle Eastern countries reach Sri Lankan ports directly with generally no stops in between as there is no need for transit.

“If we are importing crude oil, it comes directly from the UAE. The majority of the petroleum products we are selling in the country are refined products that are mainly imported from the Singapore market and also from a few Middle Eastern countries like Fujairah in the UAE. Murban (oil) too comes directly from the UAE,” he added.

According to him, even though at times refined products are processed in China and then transported mostly to either Singapore or India, Sri Lanka usually places orders from Singapore and not from the country that processes refined products, which is again a direct shipment.

“There is no way it will go to another country and come, especially as we pay for the specific voyage. It gets loaded at the respective country’s port and comes directly to Sri Lanka,” he noted.

At the port

Once the fuel shipment reaches Sri Lankan ports, the ownership and risk of the consignments are passed onto the Sri Lankan authorities, he noted.

This is where the landed cost component comes in. Landed cost is the total cost of a commodity or a product when it lands at the port of the country importing the commodity/product.

The landed cost includes manufacturing costs of the product quoted by the supplier, all transportation costs including from factory gates till the loading port and into the vessel, Cost, Insurance, and Freight (CIF), custom duties, taxes, currency conversion, crating, and handling charges and payments. Only once these costs are cleared by the buyer is the product allowed to move.

In addition to this, in Sri Lanka, losses due to evaporation at the point of unloading are also taken into consideration when deciding on the local prices of fuel. This loss is incurred pretty much at every step right up until fuel gets pumped into a vehicle at a fuel station.

This can also be called “breathing loss” (also known as standing loss), due to the release of gasoline vapour to the ambient air as a result of the expansion and contraction of vapour inside storage tanks. The breathing loss results from changes in the temperature and pressure inside and outside the storage tank. Breathing loss occurs irrespective of changes in the liquid level inside the tank.

Gasoline storage tanks are exposed to changes in temperature, pressure, and, in the case of aboveground tanks, solar radiation. As a result, the mixture of trapped air and gasoline vapour inside the tank experience passive heating and cooling cycles. This causes expansion and contraction of the vapour mixture, resulting in the release of vapour to the surrounding environment.

Life at storage and refinery

Handling charges at the local port too have to be cleared by the buyer. After the fuel consignments have been cleared from the seller and local port charges are settled, these consignments go to different places.

These consignments are usually of two types – crude and refined. Crude oil is a naturally occurring, unrefined petroleum product composed of hydrocarbon deposits and other organic materials. A type of fossil fuel, crude oil can be refined to produce usable products such as gasoline, diesel, and various other forms of petrochemicals.

Refined petroleum products are derived from crude oils through processes such as catalytic cracking and fractional distillation. Refining is a necessary step before oil can be burned as fuel or used to create end products.

As the engineer noted, when Sri Lanka brings down crude oil, it is transferred to the Orugodawatta Tank Farm via a crude oil transfer line from a single-point buoy mooring (SPBM) located at sea, 10 km away from the Colombo Harbour.

“At Orugodawatta, they have holding tanks. From there, it will be taken to the Sapugaskanda Oil Refinery. All the crude oil that was brought in gets refined here and distributed to the filling stations,” he noted.

According to him, even though the price of a barrel of crude is lower in comparison to that of refined oil, Sri Lanka adds value to the crude oil at the Sapugaskanda Refinery, for which the country incurs a significant cost.

Meanwhile, in terms of refined oil, Sapugaskanda produces about 25-30% of the local requirement of refined fuel, while the rest is imported. The imported refined products do not need to be refined again in Sri Lanka.

In the case of imported refined products, these get transferred to two places. Either it will go to the Kerawalapitiya Tank Farm or to Ceylon Petroleum Storage Terminals Ltd. (CPSTL) where the fuel gets stored, he added.

CPSTL owns the Common User Facility (CUF) consisting of oil terminals, storage facilities, pipelines, and the bowser fleet. Crude oil too gets stored at CPSTL.

He stated that for storing at this facility, CPC has to pay CPSTL, and that these charges are passed onto the consumers in the local fuel prices. Moreover, when transferring fuel into the storage facility, another loss is incurred due to evaporation.

During these procedures, transport costs, losses due to evaporation, handling charges, dealer margin and taxes that include Customs Import Duty, Excise Duty, Port and Airport Development Levy, and Nation Building Tax, are being incurred and added; these are again passed onto the consumer.

Sapugaskanda Oil Refinery

The Sapugaskanda Refinery is the single largest oil refinery of Sri Lanka. The refinery was built by Iran under the guidance of the CPC in August 1969, initially designed to process 38,000 barrels per stream per day of Iranian Upper Zakum crude oil and Arabian light crude oil.

According to Samaratunga, the refinery at Sapugaskanda was built with the aim of processing Iranian-type crude oil and so only Iranian crude oil matched the technical specifications of the refinery, and processing other types of oils requires modern technology which the refinery lacks.

Even though Sri Lanka managed to import similar types of oil from other countries, in the opinion of University of Moratuwa Prof. Ajith De Alwis, Sri Lanka is still working on ways to procure oil from Iran without settling them in US dollars.

A barter system was proposed by the former Government where Sri Lanka exports tea to Iran which could be balanced against Sri Lanka’s pending payments on Iranian fuel imports. It is unknown whether the current Government has given up on this plan.

Not solely on oil prices

Fuel prices are based on a combination of monetary and fiscal factors even though global oil prices are a major determinant. According to the fuel price formula that was introduced by the previous Government, the maximum retail price of fuel is an addition to the landing cost, processing cost, administrative cost, and taxation.

Nevertheless, global oil prices are the biggest and most important component in deciding local fuel prices, indicating that the loss-making CPC might have profited from the ongoing situation. However, when we spoke to CPC Chairman Wijesinghe following the Covid-19 situation in Sri Lanka, he stated that orders are placed at the beginning of the year. He also reminded us that Sri Lanka does not have large storage facilities to enable the storage of imported fuel in humongous quantities when its price is low in the global oil market. He also added that since travel was heavily restricted, people did not pump fuel like they usually do, meaning that the CPC did not reap any benefits from maintaining local oil prices amidst negative global oil prices.