Fri | Sep 22, 2017

Understanding foreign oil and local pumps

Published:Sunday | January 31, 2016 | 1:00 AM
Golding
A section of the Petrojam oil refinery in Kingston.
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Oil prices have been falling for the past 19 months - from US$108 per barrel in June 2014 to less than US$27 a few days ago before recovering to US$35 at the time of writing, still lower than anything we have seen in more than a decade and the steepest decline ever in any 19-month period.

Most analysts predict that in the near term, the price will remain low because of the slowdown in China, the world's biggest oil importer; the easing of sanctions on Iran that will see an additional 500 million barrels per day being pumped into the market; and Saudi Arabia's dogged determination up to now not to cut production as a means of increasing prices despite the record fiscal deficit that the sharp reduction in revenues has caused them. US stockpiles of crude oil are now at an 80-year high.

The fall in oil prices is all over the news, but the typical Jamaican motorist is convinced that the full effect of this dramatic fall is not reaching him at the pump, and his anger, so often expressed on talk shows, has only been partially eclipsed by the recent bad gas saga.

Ideally, Petrojam's ex-refinery price should be a matter of arithmetic, and if the inputs and their costs were clearly identified and disclosed, that motorist might have been able to pencil it out for himself on the back of an envelope. The Jamaica Public Service Company makes a useful effort to do so in its monthly billings, identifying separately the cost of fuel and the impact of exchange rate movements as well as the tax charged. Hence, its customer disputes have mostly to do with levels of consumption rather than the computation of charges.

Petrojam does itself no favour by simply announcing a price every Wednesday with the tag line "marketing companies and retailers will add their respective margins", leaving the motorist to puzzle it out for himself. How is this price arrived at?

The vast majority of businesses set their prices on a cost-plus basis - the actual cost (direct and indirect) of producing or importing the goods plus a markup. Petrojam has steadfastly rejected this method, choosing instead to benchmark its prices on the US Gulf reference price for finished products. Its reasons are not implausible: (a) Venezuela, Mexico, Ecuador, and Trinidad and Tobago, from which we import most of our crude oil and finished products, price their products based on the US Gulf prices; (b) it provides a more stable and competitive price platform given that it covers a wide area and a huge volume of trades and its prices are determined in a transparent manner. But neither are those reasons unassailable.

 

'INDUSTRY NORM'

 

Petrojam contends that this method of pricing, known as import parity, is the 'industry norm'. It is but one of the methods used internationally. Zambia, for example, which, like Jamaica, has a small refinery but imports a substantial quantity of both crude oil and finished products, switched from cost-plus to import parity pricing in 2004, but after four years went back to the cost-plus arrangement.

One huge drawback in reference pricing is that it has no direct bearing on what Petrojam actually pays for the crude oil or even the finished products it imports. It simply takes the Gulf reference price and adds the cost it has or would have paid to land it in Jamaica, plus the Government's stipulated taxes. So, other than combing through its accounts, we have no way of knowing whether and when it is operating at a loss or reaping a windfall.

We don't know, for example, whether the marketing companies that import their own products are quite happy to go along with Petrojam's prices or whether Petrojam is having to squeeze itself because of internal inefficiencies to stay in line with the private importers. We do know that its net pretax position fluctuates wildly - from a loss of US$60 million in 2008-2009 to a profit of US$43 million in each of the following two years, then steadily declining to a loss of US$21 million in 2014-2015.

The following table illustrates the movement in the relevant indices since June 2014 relating to one litre of regular (E10-87) gasolene. To avoid distortion that would result from changes in the exchange rate, all values are stated in US dollars at the applicable rate of exchange, where necessary.

The fall in Petrojam's ex-refinery price (51%) lags behind the Gulf reference price (66%). The price reduction to the Jamaican motorist (39%) lags even further behind the average pump price in the US where it has fallen by 73% and where gasolene can now be purchased in some places for less than US$1 per gallon. What is also significant is the increased differential (from 12 to 17 US cents per litre) between the Gulf reference price and Petrojam's refinery price when January 2016 is compared to June 2014. This is puzzling because the bulk of this add-on relates to freight charges which should, in fact, be lower because of the lower cost of fuel.

The inherent complexities and public bewilderment as to how Petrojam's prices are arrived at were among the factors that led the Government in 2009 to commission Centennial Group International to carry out a performance audit of Petrojam, including its refining and terminalling operations, as well as its pricing mechanism.

Certain things were already known. The Petrojam refinery which was built by Esso in 1963 and acquired by the government in 1982 was in need of major upgrading. In its present configuration, its cost advantage in refining crude oil as against importing finished products is reported to be only around US$1 per barrel, which translates into less than one Jamaican dollar per litre at the pump. Although its rated refining capacity is 36,000 barrels per day, it does on average under 25,000 - less than half the country's total requirements. Hence, it imports vast quantities of finished products only slightly less in barrel equivalent than the crude oil it refines. It is incapable of refining the heavier crudes that could be imported at a cheaper cost or producing the full range of finished products that the market requires, much of which is imported from Trinidad and Tobago.

 

PLANNED UPGRADING

 

The planned upgrading of the refinery in conjunction with Venezuela is unlikely to come to fruition anytime soon, given the current economic realities in Venezuela that have caused it to shelve or completely abandon other refinery upgrade projects in Cuba, Nicaragua, Ecuador, and Brazil. For the foreseeable future, therefore, we will continue to refine what crude we can and import what finished products we must.

The Centennial Group made a number of recommendations relating to Petrojam's pricing arrangements. First, it suggested that we abandon the Gulf reference price and instead use Caribbean parity prices as compiled by Platts, a respected information source in energy markets. Petrojam argued, persuasively in my view, that the volume of trades in the Caribbean was too small and too heavily influenced by three dominant players (Petrotrin, Exxon and Shell) to provide a stable, transparent and reliable benchmark.

Centennial did not recommend using a cost-plus system, but neither has Petrojam provided conclusive reasons against such an arrangement, especially where the 'plus' would be subject to public scrutiny and accountability, along with a stabilisation component to even out abnormal price spikes or falls. Centennial also suggested that Petrojam's prices be determined by an independent agency such as the OUR. This would seem to be a return to regulation from which the industry has long been liberated. At any rate, no regulator would be able to cope with the market dynamics and time sensitivity that price adjustments require. This, however, must not obscure the fact of Petrojam's dominance (90 per cent) of the petroleum market and the risks that that poses for the consumers and for a commodity that is so essential to production, business and everyday living.

What I think is undeniable is the need for some kind of oversight and greater transparency on how Petrojam administers its pricing mechanism, whatever that may be - something that ought not to be left to its board of directors alone. The motorist should be enabled to better understand what goes on between his wallet and the pump.

- Bruce Golding is a former prime minister of Jamaica. Email feedback to columns@gleanerjm.com.