Lanka’s fuel price tug of war: Who really pays the price?

By Dhananath Fernando

Originally appeared on the Morning

Fuel prices and fuel price revisions have always been a political football. Statements by various politicians on the taxes imposed on fuel and the scope for reducing fuel prices have come under renewed scrutiny with the 31 October price announcements.

Adding to the confusion, a statement by the Ceylon Petroleum Corporation (CPC) Chairman – that the CPC must compensate for the losses of other players if deviating from the price formula – has sparked fresh controversy. It’s essential to unpack these issues one at a time.

According to Central Bank data, we imported approximately $ 1.5 billion in refined petroleum and $ 0.5 billion in crude oil in the first half of the year. Assuming demand and prices remain steady, total fuel imports this year will be around $ 4 billion.

About 70% of fuel is consumed by the top 30% of high-income earners in Sri Lanka who can actually afford higher fuel prices. Naturally, energy consumption rises with income, as wealthier households use personal vehicles, high-energy appliances, and consume more overall. Only 30% of the total fuel is consumed by the remaining 70% of the population, which includes fishermen, public transport users, and service providers.

Thus, if we artificially lower fuel prices through a subsidy, it effectively subsidises the wealthiest families in Sri Lanka. While a low-tax regime might be ideal, given our fiscal situation and the International Monetary Fund (IMF) programme, Government revenue must increase to about 15% of GDP. Lowering fuel taxes would thus provide tax relief to the wealthiest 30% of households and incentivise excessive fuel consumption.

Imperative to adhere to fuel formula

Instead of being swayed by popular demands to reduce fuel prices, especially with rising tensions in the Middle East, the Government should first review its balance sheet to ensure adequate revenue with minimal market distortions to achieve debt sustainability.

If the Government aims to lower fuel prices for the public transport and fisheries sectors, the best approach would be a direct cash transfer rather than lowering all fuel prices, which would mitigate the impact of high fuel prices on essential goods and services.

It is imperative that we stick with the fuel formula and strengthen it if necessary. Unfortunately, there is limited information regarding the recent controversy over agreements between fuel suppliers on price revisions. If, as the Chairman claims, there is a clause to compensate private players for losses, this would be unreasonable if true.

In the absence of the full report, the only available information is a post on X from the former Minister of Power and Energy, who claims the CPC only pays the difference when the Government provides a subsidy or other mechanism to deviate from the price formula. In fairness to private players, if only the CPC receives a fuel subsidy, it creates an unlevel playing field, as petrol and diesel would be cheaper at CPC stations than at private ones.

Although the subsidy benefits consumers, it primarily benefits the wealthiest 30%, and rising demand could drastically increase the total subsidy cost for the Government. Therefore, a fuel subsidy is not advisable, as it essentially transfers Treasury funds to the wealthiest households in Sri Lanka.

Another issue has arisen: one supplier has reportedly requested about Rs. 82 million as compensation for deviations from the fuel price formula. It is difficult to assess this claim fully, as the original documents are not publicly available, but if true, it raises questions about whether recent price revisions adhered to the formula.

In particular, price adjustments before and after the elections require examination. Data on whether the September and October price revisions complied with the formula has also not been published; making this information available would reduce information asymmetry, essential for a functioning market economy.

Providing consumers with the best price

A further question is whether only a Government-owned CPC can reduce prices, and why prices are not decreasing with private players like Lanka IOC, Sinopec, RM Parks, and United Petroleum in the market.

The answer is not straightforward. The CPC is already heavily in debt, with high financing costs that must be covered. Moreover, prior to the latest revision, Sinopec’s diesel prices were actually lower than others, illustrating how competition can bring prices down.

However, prices depend on global crude and refined oil rates, and sometimes on the efficiency of refineries. When a price formula is in place in a small market, players often charge similar prices, but more competitors could introduce value propositions, including price variations based on global fluctuations.

For example, Lanka IOC offered an environmentally friendly fuel at a higher price, while Sinopec sold diesel at a lower price. To remain competitive, each player must offer something unique, which may not always be a lower price but can include quality or convenience.

The final point is that the new administration has requested a flat dealer margin instead of a percentage tied to global fuel prices, which is a positive move. Dealer costs are mainly influenced by inflation rather than global prices. The purpose of the price formula is to account for both variable and fixed costs to prevent losses and provide consumers with the best price.

In a market system, the consumer is at the centre. To prioritise consumer needs, we must ensure multiple players and transparency in pricing to minimise information asymmetry. Publishing the final fuel price revision calculations for the past two months and the full price revision agreement with private players would be a constructive first step.

Why Sri Lankans fear development

Originally appeared on The Morning

By Dhananath Fernando

The three types of fears we endure as a country

Fear is a universal emotion and we have all come across three major types of fear in our lives. The fear of failure is the most common one that often paralyses us and prevents us from taking action. The fear of success is a lesser-known fear that keeps us from achieving our goals. Finally, the fear of judgement causes us to fear being evaluated by others.

Unfortunately, in Sri Lanka, the fear of reform has encroached upon all three of these personal fears. In public policy, there are currently three primary fears:

Fear of reforming State-Owned Enterprises

It is no secret that Sri Lanka’s State-Owned Enterprises (SOEs) have been one of the main reasons for the country’s economic crisis. Everyone agrees that SOEs need to be reformed, but there are different opinions on how to do it. Some believe that the losses are mainly due to corruption of politicians and political influence against reforming SOEs. Others believe that with capable management, SOEs can become profitable.

However, in my opinion, the absence of competent people to run State institutions and corruption are both symptoms of the absence of a market system.

In a market system, the focus is on making profits and minimising corruption. However, it doesn’t mean everything is perfect; rather, it is geared to minimise corruption and maximise profits. Therefore, opening up the market can help solve this issue.

One key fear that is brought forward is the risk of high prices when the markets are opened. However, based on our experience, prices decrease with the opening of markets and the allowing of more competition.

For instance, Sri Lanka’s telecommunications prices are some of the lowest in the region and the entry of Lanka IOC into the fuel market did not increase prices. On the other hand, the Ceylon Petroleum Corporation (CPC) incurred losses and it had to pass these on to taxpayers. Its losses of Rs. 632 billion over eight months in 2022 will have to be borne by the people of Sri Lanka through the contribution of about Rs. 28,000 per person.

It is evident that the absence of a market system is one reason for the profits not being sustainable, so we always drift back to where we started. The losses of the CPC for the first eight months of 2022 are greater than the allocation for both health and education together, which is about Rs. 550 billion.

Such high losses are indicative that all loss-making institutes, including the CPC, SriLankan Airlines, and the Ceylon Electricity Board (CEB), should be restructured to reduce the burden on the Treasury and thereby the taxpayer.

The focus is not only on prices but also on the quality and accessibility of the service. In the past, during fuel shortages, people paid Rs. 1,000 per litre on the black market. Therefore, simply claiming that the Government can provide fuel at a lower price is not very logical. We need a Sri Lanka where people can afford and decide what they want to use rather than the Government deciding what we should do. This is the Sri Lanka we envision.

Regulation is crucial and the Government needs to create a regulatory framework to ensure a level playing field. The current Public Utilities Commission Act has provisions, but we need to move towards a competition commission to ensure fair competition.

Fear of competition

The second fear among Sri Lankans is the fear of competition. We consider competition as one person winning and the other person losing. However, it is a formula where both sides can win. The fear of competition mainly arises in global trade and we often wish to block our competition by imposing high tariffs. However, this has been detrimental to Sri Lankans and to our businesses and we need to move past this fear.

It is also important to remember that competition is the key to maximising consumer welfare. Competition brings in choice to the market and leads to competitive prices. Simultaneously, it incentivises firms to optimise their processes and functions – the key to remaining competitive and profitable. Therefore, competition should be thought of as a win-win scenario where firms are incentivised to optimise their operations and grow while consumers enjoy maximised welfare.

3. Fear of imagining a prosperous Sri Lanka

It is understandable to have concerns and fears about the transition to a more prosperous Sri Lanka, especially when it involves a shift away from a State-dependent model. However, it is important to recognise that a prosperous Sri Lanka can bring many benefits and opportunities for its citizens.

A prosperous Sri Lanka can create jobs and provide opportunities for entrepreneurship and innovation. It can also attract foreign investment and contribute to the growth of the economy. With a thriving economy, the Government will have more resources to invest in areas such as education, healthcare, and infrastructure, which can lead to an overall improvement in the quality of life for its citizens.

It is also important to acknowledge the role of the private sector in providing essential services and goods, as well as contributing to the growth of the economy. While the Government has a role to play in ensuring the safety and wellbeing of its citizens, it is often the private sector that drives innovation and progress.

As Helen Keller once said, avoiding danger does not necessarily lead to safety in the long run. It is important to face our fears and embrace change, even if it is uncomfortable at first. With the right mindset and a willingness to adapt, a prosperous Sri Lanka can be within reach.

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.

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