New players in SL’s petroleum market

Originally appeared on The Morning

By Dhananath Fernando

I remember a litre of diesel being about Rs. 16 during my school years. I took the bus to school or sometimes, a very old Toyota van. When the bus or van stopped at the filling station, I would watch with curiosity how the filling station attendant pumped fuel.

The price was handwritten on the fuel dispenser in paint and the dispenser itself was visually similar to the emoji which appears when we type ‘gas’ on our mobile phones. The price and the number of litres indicated on the fuel dispenser was a manual system, where numbers moved up like an old cricket scoreboard. Restrooms at a filling station were rare. All fuel stations were operated mainly by the State-owned Ceylon Petroleum Corporation (CPC).

Today, the atmosphere at a filling station is quite different, with more sophisticated infrastructure such as digital fuel dispensers and digital payments methods. More payment options are available and some credit card companies offer discounts for fuel. Many fuel stations have restrooms and some even have mini super markets.

Currently, the market has two players – the CPC and the Lanka IOC. A new discussion is taking place about opening our market to three additional players. If memory serves right, when Lanka IOC entered the Sri Lankan market, the Chinese Government-owned Sinopec was offered access to enter the market as well.

However, at that moment in time, it did not want entry. Even though a two-player market is not perfect, it still brought a significant upgrade to the service and quality of filling stations. In this context, how should we view the entrance of more players into the fuel market?

First, a higher number of players is better than a lower number of players, because it increases the freedom of choice for people. It also downsizes risk. If one company fails, we have the other companies supplying fuel. During the economic crisis, the Indian-owned Lanka IOC provided services when our State-run CPC failed. As such, more players and a level playing field is a prerequisite to better and constant services.

Selection of players and importance of pricing ability

More players are healthier for a market system in an ideal situation, but the regulatory barriers have to be minimal. In an industry where capital expenditure is very high and a licensing process is involved, at the very least, the selection process has to be undertaken through a transparent and competitive bidding process.

Importantly, the new players should have price flexibility. In the last agreement with the Indian Oil Corporation (IOC), one condition was that IOC needs Government approval for any price revisions.

Think of an instance where the IOC experimented with a more environmentally-friendly fuel variant with a higher price – this cannot be sold in the Sri Lankan market until permission has been obtained from the Government. When private players are given the freedom to decide the price, they can come up with better solutions.

For instance, in certain countries there is a service where fuel can be delivered to homes, similar to food delivery. This is a valuable service for boat and generator users. When a supplier delivers fuel with safety measures, it cannot be sold at the usual price. In an environment with price controls, such augmented services will not emerge.

Govt. should not engage in petroleum business

While there will be three more players entering the market, this is a solution slightly removed from the best one. The new players have been provided the licence to import fuel and store and distribute fuel at fuel stations. However, petroleum product transmission, which is a high capital intensive service, is mainly owned by the Government.

Petroleum transmission services require pipes and other capital-heavy infrastructure to load, unload, and transfer fuel from the ship to the refinery or respective storage. Ideally, all players should invest in a petroleum transmission company such as the Ceylon Petroleum Storage Terminals, because it is a shared service which requires high capital investment in foreign exchange for infrastructure development.

Keeping such an important intermediary service in one Government institute is a big risk for the entire supply chain. One interruption in the intermediary service can control the outcome of the entire fuel market. When the Government engages in business, it will not be a level playing field and no investor would like to risk their money.

Burden of CPC on the Treasury

Another reason why the fuel market and the CPC require reforms is the colossal losses incurred just by maintaining its duopoly status. For the first eight months of 2023, the losses were more than Rs. 600 billion (Figure 1). For comparison, this figure is six times the expected revenue from PAYE (Pay As You Earn) tax from all workers, including petroleum workers.

The main reason for the significant loss is the deprecation in the currency, but even with that consideration, since 2015, only a marginal profit has been made in three years. CPC’s debt to the banking sector is close to Rs. 700 billion and of that, about Rs. 561 billion is guaranteed by the Treasury (Figure 2). The CPC’s negative equity of Rs. 334 billion indicates the magnitude of losses that have accumulated over time.Geopolitics at play

We need to understand the reasons why big companies are attempting to enter the Sri Lankan market. It is not with the main objective of simply supplying fuel to the 22 million market. Most likely, it is to access the shipping routes and the Bay of Bengal market spanning from India to Bangladesh.

On the other hand, another Expression of Interest has been called for an oil refinery in Hambantota as per news reports. Accordingly, the Chinese company will have an added advantage, with both access to the Hambantota Port and now the ability to import, store, and distribute fuel.

Geopolitics at play

We need to understand the reasons why big companies are attempting to enter the Sri Lankan market. It is not with the main objective of simply supplying fuel to the 22 million market. Most likely, it is to access the shipping routes and the Bay of Bengal market spanning from India to Bangladesh. 

On the other hand, another Expression of Interest has been called for an oil refinery in Hambantota as per news reports. Accordingly, the Chinese company will have an added advantage, with both access to the Hambantota Port and now the ability to import, store, and distribute fuel. 

While geopolitics will come into play,  the fundamentals remain the same. The Government should not engage in business and more players should be allowed to enter the market. Processes have to be competitive and transparent. The outcome of this will be that consumers will win and petroleum sector workers will have higher wages. 

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Figure 1

Source: CPC Annual Reports and Ministry of Finance Annual Reports

Figure 2 

Source: Annual Reports of the Ministry of Finance and the CBSL

Golden opportunity for energy market reform

Originally appeared on The Morning.

By Dhananath Fernando

Let markets work and adjust expectations

As children, most of you might have tried the trick of obscuring the vision of a bigger object by closing one eye. I used to try this with a lamp post, by moving the finger closer to the eye while closing the other eye, thereby making the lamp post disappear. As a child, there was a thrill in making the lamp post disappear with a minute object such as my finger. 

However, in reality, we know that a lamp post or a bigger object cannot be covered with a finger, due to factors such as volume and mass. Similarly, until we ran out of petrol, Sri Lanka also pretty much thought the finger could actually cover the lamp post – the finger in this case was import controls, which we all thought was the solution for a brewing Balance of Payments crisis. 

This column has been a consistent opponent of import controls since the beginning. It has been two years since we stopped importing vehicles. Some non-essential imports (as per the definition of policymakers) such as apples and other food items have also been halted. At one point in this debacle, the Government issued licences for imports, which threatened to create a new Licence Raj. 

We went as far as to kill the forward market and once even issued a regulation mandating a 100% cash requirement to open Letters of Credit (LCs), which were then required to be opened with a 90-180-day credit period. We did so much to reduce imports for so long, so why didn’t any of these policies bring their promised results and how did we run out of money even to import fuel and life-saving medicines? After all those remedies, why have we fallen to a state where the country is in a de facto lockdown – not because of Covid but due to a fuel shortage? 

Many still haven’t understood that imports were not the problem. By contrast, having no fuel imports has become a significant problem. Of course, at a time when we as a nation have hit rock bottom, imports will come to an automatic halt due to the unavailability of foreign exchange. But import controls have certainly not helped matters and have in fact worsened the problem. If we had a solid monetary policy, if we hadn’t maintained the exchange rate at artificial levels and if we maintained stability, this problem would not have arisen. 

It is in this context that the Cabinet has granted the opportunity for any oil producing country that can bring fuel to Sri Lanka to run the fuel distribution while the Government keeps control of the operations of the Sapugaskanda Refinery. 

Surprisingly, even the strong Ceylon Petroleum Corporation (CPC) unions remain silent. Previously, CPC unions were the first to mobilise on the streets when any policymaker dared to even broach the topic of opening up investment activity to the private sector for energy and fuel. Now, private investment has entered their territory and the signals of privatisation are all there, but silence still remains. It is obvious now to these unions and to the nation at large that the State cannot operate in such competitive sectors and that attempting to do so guarantees disaster. Unfortunately, we are presently living through such a disaster. 

While allowing the private sector to operate in the energy market is a good move, expecting the fuel problem to go away simply by allowing private companies to enter the Sri Lankan market is very short-sighted. For context, the reality of the fuel market is that fuel supply can only be secured by paying in US Dollars, but sales in Sri Lanka are transacted in LKR. Even if an investor enters the market with a USD investment, if they can’t convert their LKR into USD, there will be no strong business case unless they have some other business lines which have LKR and USD interests. Whoever invests in USD should be able to convert their sales to USD; otherwise this is not a sustainable long-term solution. 

One segment that has both USD and LKR interests is exporters. They earn USD from their exports and they need LKR for their local operations. If they can get a higher profit margin through fuel sales than through a USD conversion in the banking sector and if they have adequate volumes to run a fuel business, then there is a business case for these exporters to manage a fuel distribution operation. 

Alternatively, there has to be a separate financing arm for fuel, whereby anyone who has an interest in both USD and LKR can invest with an expectation of dividends. To do that, however, fuel pricing requires flexibility. Our present environment of price controls won’t work as fuel has far too many variable cost components and competitive margins. Therefore, one solution is to open the fuel business to anyone – including local exporters – to enter distribution and not necessarily to provide the opportunity only to oil producing nations.  

Allowing anyone to import fuel is the right decision at this moment, particularly as the big companies that can afford to purchase fuel at a premium either individually or through business collaborations will do so, thereby minimising the burden on the Government. The private sector, of course, will increase efficiency as well. 

Another group that has both USD and LKR interests is our overseas workforce that provides foreign remittances. If they can get higher margins than the conversion rate offered by Sri Lankan banks, they might be willing to channel their money into the business of importing essentials. That was the logic expounded by Daniel Alphonsus in his recent article on allowing anybody to undertake fuel imports, even through open accounts. 

The expectation is that the undiyal money presently parked offshore will be channelled to essential imports as the importers can now obtain LKR by selling fuel and other goods. But again, prices have to be flexible and competition will bring the market to a stable position. Currently, the black market price of a litre of petrol is over Rs. 1,500, whereas the official price is Rs. 400. This is no secret. Alphonsus argues that the same system existed during the war in the north and east – although there was no official supply, fuel was available even in small mom-and-pop stores at a price premium, often in small glass bottles. 

Markets are strong and they will always work. Of course, they may not work as per our expectations, but the reality is that our expectations should adjust according to the markets. Since we have completely run out of options, we have a golden opportunity for reform. It is possible that we may fail, but we have little to lose and are presently not doing anything other than going around the world with a begging bowl. That too will have to be continued for now, but expecting other countries to donate their taxpayer money to Sri Lanka after so much mismanagement and loss of credibility is idealistic thinking. It is the same as our thinking when we were children – that an object would disappear if we simply didn’t see it anymore.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.