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.

The economics behind the fuel crisis

Originally appeared on The Morning.

By Dhananath Fernando

I recently overheard a conversation while taking public transport. The bus I was commuting in was moving at a snail’s pace across Dehiwala as people had blocked the road to show their displeasure over fuel shortages. The fuel queue was long, spanning over a few kilometres, consisting of mostly three-wheelers. The conversation started when a lady seated at the back lost her patience as some three-wheeler drivers tried to block the road. 

“Three-wheelers are a curse on our country,” she said. “Look how long the queue is and how undisciplined these tuk drivers are. They consume a lot of fuel and they just sit and waste their time browsing the internet on their phones while they are in the queue. All these drivers are a part of our labour force and they are part of the problem behind this fuel crisis. We should ban three-wheelers and develop public transport. The Sri Lanka Transport Board should field as many buses as possible. Why can’t they employ more trains at this time?” She had initiated the conversation with a gentleman seated next to her, who was also highlighting some solutions. 

Her opinion would be mirrored by many Sri Lankans if they were asked about the reasons behind the fuel crisis and economic crisis. While we all understand that it is the foreign exchange or USD shortage which led to this fuel crisis, the productive use of our limited fuel stocks has been in discussion for many months. People are now worried that once the latest fuel shipment is exhausted, Sri Lanka will completely run out of fuel as we are scraping the bottom of the barrel of the Indian credit line. 

We all have to admit that fuel has become an extremely scarce resource given the shortage of USD. Another side to the problem is that fuel importation and distribution is mainly done by the Ceylon Petroleum Corporation (CPC) and Lanka IOC (LIOC). Both these companies do not generate USD revenue. 

If we allow anyone to import fuel, then the exporters who have US Dollars will import fuel mainly for their usage for export output. The garment and rubber industries will import fuel on their own with their own US Dollars to run their generators and plants and pay the tax. 

It is far more convenient, efficient, and productive for them to depend on their own supply chains than depend on the inefficient CPC. When there are industries that can afford fuel imports at their own cost, there will be more fuel for common people through CPC and LIOC with the little forex and credit lines they secure. 

Daniel Alponsus has explained this in his recent blog in detail (1), where he further suggested removing price controls on fuel and allowing an open market account for fuel imports so the informal forex will automatically move towards essentials such as fuel while remittances will start flowing.

Before we come to the conclusion that three-wheelers are the problem (as per the conversation I overheard on my journey), we have to first ask why there are so many three-wheelers on the roads. The simple fact of the matter is that they are very efficient – they are lightweight, their fuel economy is about 30 km/litre, and they can transport one to three passengers per trip. By comparison, the fuel efficiency of a personal vehicle – depending on the weight and engine displacement – would on average be approximately one-third of the fuel efficiency of a three-wheeler. 

Secondly, three-wheelers are the main form of last-mile transport. They provide flexibility in labour markets, contributing to their popularity. The final and most significant reason for the large number of three-wheelers is the lack of sufficient public transport – both in terms of quantity and quality. If there was an option for anyone to become a service provider of public transport, most three-wheeler drivers would have become public transport drivers. 

At present, just because you have a bus doesn’t mean that you can field it on the road due to the route permit system. In many cases, the selling price of a route permit is a few times higher than the value of the bus even after a massive excise duty, sometimes above 100%, being imposed on the vehicle. 

Our policies have therefore discouraged many entrepreneurs from entering the market for public transport. In addition, we have strict price controls on bus fares, which limit the ability of service providers to differentiate their services at different price levels. 

For example, a young executive may be willing to leave his vehicle at home and shift to public transport if there is a transport service that provides internet service and a breakfast package. The executive can work while commuting and he can save on his breakfast preparation time at home. However, with the current controlled prices and route permit system, such niches with higher quality of service (and higher prices) cannot be fulfilled. 

So the main reason for the higher number of three-wheelers and more fuel combinations is the absence of market forces in the public transportation sector. The fuel crisis has been exacerbated by bad public policy in relation to public transport. This has compelled us to use 60% of our fuel imports, which is the highest single commodity type import in our import basket. 

The only encouragement provided for public transport was the bus lane priority system – now even that has unfortunately been abandoned. If we want to incentivise the buses for their fuel, another option is to subsidise their fuel based on mileage. This means the bus operators would buy fuel at the same price as a normal customer at the pump but they will obtain a subsidy based on mileage to avoid any leakages (i.e. resale of fuel on the secondary market at a premium) and provide incentive for drivers and consumers. 

Poor data availability and the lack of information systems acts as a bottleneck for such initiatives. However, if private mobile based services like PickMe or Uber can track mileage and location, there cannot be a reason why the same mechanism cannot be implemented for public transport.  

In the midst of rising fuel prices, Germany reduced public transport fares to encourage more people to commute through public transport. This is so that the fuel consumption of using individual vehicles would be lower. Unfortunately, Sri Lanka did otherwise. Our policymakers did not understand the economics and optics of the problem. Until we understand the dynamics of the situation, we will all simply listen to and believe conversations about three-wheelers being the issue without really understanding the fundamental problem.  

References:

1. https://danielalphonsus.substack.com/p/solving-sri-lankas-fuel-crisis?s=w

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.

Living the same economic year 73 times

Originally appeared on The Morning

By Dhananath Fernando

Both the Government and the Opposition are in agreement that Sri Lanka’s ailing economy is at peril. A few weeks ago, the Minister of Energy admitted that buying fuel has become a challenging task with import payments only being settled after nine months. These same sentiments were echoed by the former Prime Minister when he was recently sworn in as a Member of Parliament. However, the diagnosis of the problem at hand and building an action plan to address it is continuing at a snail’s pace.

The problem has reached a level where letters of credit (LCs) are opened on a rationed basis and some importers have claimed that private banks do not facilitate foreign currency for their imports. On the other hand, forex dealers have been barred from quoting above Rs. 200 for the dollar.

This will simply create more forex shortages as people who have USD now would not sell it to the Government as it does not reflect the market value. Instead, people may consider parking money outside or keep it in USD terms considering the devaluation of the Sri Lankan rupee in real terms. Owing to the Central Bank regulation, even though the USD rate is less than Rs. 200, in the open market the rates are much higher.

Shortages in foreign exchange is not a recent phenomenon. The Minister of Trade mentioned at Parliament that the current foreign exchange crisis is the worst ever in history. However, our solution for the problem so far has been “not proposing any solution”.

We are doing the same thing over and over again and expecting different results. If we rewind back to 16 June 2020, the President criticised the Central Bank for not extending their support and not utilising the tools to revive the economy.

In February this year, the State Minister of Finance mentioned that the fears of debt sustainability have no grounds as we expect $ 32 billion of inflows and total International Sovereign Bonds (ISBs). He went on to say that the country’s outstanding debt is only about 16% and annual debt servicing of $ 4 billion is manageable compared to $ 32 billion of inflows.

Depending on the same figures, the President in November last year assured debt sustainability after a credit rating downgrade by Fitch.

However, the forex crisis pops up again and the frequency of the problem is getting higher. Earlier imports were controlled and then exporters were requested to convert 25% of their earnings on an immediate basis. However, regardless of strict measures and stringent regulations being imposed, the results have been the same or are getting worse.

Now even the members of the ruling party have started to admit the forex challenge at hand.

Earlier, the Leader of the House said answering a question posted by a journalist that the Government has enough money to take up mega development projects. However, last week, the Minister of Trade and the Minister of Energy were open about how difficult the situation is.

It is an indication that things are getting challenging. On the flip side, it’s a positive indication. At least, everyone is getting to realise the gravity of the problem in the first place. Until recently, there was denial of the fact that there is even a crisis to begin with. A Citi Bank report in December last year was titled “Denial is not a strategy”. This shows that even our international stakeholders were aware that we as a country have been denying the problem rather than providing a solution.

According to the current Government, the previous Government is mainly responsible for the economic crisis at hand as growth numbers were low and the debt numbers were high at the point of the transition. According to the main Opposition, this Government’s tax cut programme introduced in December 2019 and poor Covid management are the main reasons for where we are now. In politics that is how things are. It is always someone else that is responsible for the problem.

The common belief is that bad politics is leading to bad economics as the politicians lack understanding of economic policy and the inherent corruption. While there is some truth to it, often bad economics leads to bad politics.

It is unavoidable that bad economics fuel political storms. If we look at the defeat of the previous Government, it was too led by bad economics. Policies by the two Heads of State were in two different directions. The very first interim budget was stretching the government balance sheet beyond our capacity with massive pay increases for government employees. A proper economic plan was absent and by the time the V2025 policy formulation was done which was poorly implemented, it was too late to come back to a growth trajectory. The Cabinet Committee on Economic Management (CCEM) was dissolved and a National Economic Council (NEC) was appointed and later even the NEC was dissolved. The same policy contradiction on the top led to a constitutional crisis and a vacuum in national security ended up in a terrorist attack that could have been prevented. The Easter attacks were a big negative shock to our entire economy.

As a result of this sequence of events, the then ruling party, United National Party (UNP), was divided into two and the then Prime Minister had to experience a historic defeat in the last general election, which was just 10 months ago with a roaring two-thirds majority for the current ruling party.

It seems back-to-back economic decisions by the current administration are repeating the same mistake of the previous administration and another political crisis spiral is brewing.

Growing import bans, not implementing a proper economic reform agenda, and inward-looking policies of self-sufficiency combined with Modern Monetary Theory (MMT) has created instability in the entire financial system leading to a historic balance of payment crisis. Politically, it has opened a window for the same Prime Minister who was defeated just 10 months ago and has challenged the Government on economic and Covid management. So we are back again on the vicious cycle of bad economics leading to bad politics. The irony is that bad economics not only leads to bad politics but also has a serious negative effect on the quality of life and poverty of all Sri Lankans. Unfortunately, we as a nation have become victims of this vicious cycle. Robin Sharma popularly said: “Don’t spend the same year 75 times and call it a life.” There is no doubt that here in Sri Lanka, we have been doing exactly that for the past 73 years since Independence.

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.

Rich man plays, poor man pays

Originally appeared on The Morning

By Dhananath Fernando

How we end up footing the bill for Government price controls

Purchasing alcohol was an expensive endeavour back in college. I remember the total alcohol bill being shared equally amongst those who drink and those who don’t. Sri Lanka’s fuel pricing mechanism is quite similar to this. The subsidised prices are a blessing for direct users of fuel who can afford it. The majority, who are secondary users, end up paying for the subsidy indirectly. Sri Lanka’s fuel problem is quite complex. If we are to overcome this issue it is vital that policymakers understand the concept of “markets” and “prices”. 

It is important that Sri Lanka integrates with global markets and continues to allow fuel imports. This costs the Government approximately about $ 3.5 billion per annum. Global fuel prices fluctuate based on market conditions, and it is crucial to understand why prices fluctuate and the indicators of these fluctuations. Some oil deposits in the world are located such that their extraction process is relatively easy and less costly. Some others are very costly to extract. The Middle East and the OPEC (Organisation of the Petroleum Exporting Countries) are reputed for their oil reserves, whereas the extraction of oil is comparatively more costly in areas like Alberta, Canada. Global oil prices are determined based on this ability of countries to supply to the global market. Political, economic, and climatic developments, and changes in these countries have a direct impact on global oil prices.

So what does the “price” increase communicate? It communicates to the consumer the scarcity of that particular resource within the particular time frame. So increases in global oil “prices” is an indication to consumers that fuel is becoming a scarce resource, and we have to use it optimally. It is also an indication to producers that they can earn more by producing more. This narrows down to the basics of supply and demand. Price is an indicator of scarcity. The “market economy” is not complicated, it is merely allowing the “price system” to work. This allows prices to indicate what should be done. Price is not just a number or a sum a consumer pays. Final retail prices are an accumulation of labour costs, material costs, scarcity, externalities, and factors of production. This is fundamentally why we must not intervene in the market price mechanism.

Sri Lanka has always ignored market principles. The island nation has been trying to artificially keep fuel prices constant despite the continuous fluctuations of global prices. We have failed to understand that such fabricated interventions to either inflate or deflate prices will only result in ceasing to keep up with global indications on whether the resource is scarce or not.

Sri Lanka’s fiscal discipline and stability has always been connected to fuel and the Ceylon Petroleum Corporation (CPC). As a result of fuel price changes, there are significant knock-on effects on all utilities, including electricity and water. CPC provides fuel at a lower price to the Ceylon Electricity Board (CEB), which is one of the main sources for electricity generation. As a result, the pricing of electricity is also now not indicative of scarcity. The CPC, which buys fuel at higher prices and sells it lower, now owes significant debts to most of the state banks. 

The debt incurred is in US dollar terms. A delay in payment or a default may adversely affect the entire financial system. The heavy impact this would have on the banking sector will consequently impact the Central Bank of Sri Lanka (CBSL). It is no secret that the CBSL bails out the CPC and CEB through Treasury Bills, or by printing money. Therefore it is clear that by intervening, we have successfully exposed the entire financial system to deep peril.

The current Minister of Energy said the banks have informed the  CPC Chairman that they do not have foreign currency to pay for fuel imports. This was informed to the Secretary of the Treasury, who then summoned all the heads of banks, who collectively assured the payments for fuel imports. He further stated that the CBSL said it cannot offer any reserves, given the country’s economic woes. It is perplexing to say that the problem is really this severe. It is clear that intervention in the price system has caused a massive domino effect beyond comprehension. 

According to a World Bank report, the biggest beneficiary of subsidised fuel prices are the highest echelons of society. “The non-poor are the largest consumers of fuel and electricity (the top 30% of society consumes 70% of fuel. This is well ahead of direct and indirect consumption of fuel by the bottom 40% through public transport). The administered fuel prices are an effective subsidy to the non-poor funded indirectly by fiscal resources,” stated the World Bank in its Development Update for Sri Lanka in November 2017.

I see no difference in this fuel pricing phenomenon and how the final alcohol bill was shared amongst those who drink and those who don’t in my college days. The poor are bearing the burden of fuel subsidies so the rich can buy fuel for much cheaper. The weighed-down poor only consume fuel in the form of transport, electricity, and other secondary forms. We have to understand that the losses of the CPC have to be paid by someone. Currently, that someone is constituted by both the rich and the poor. 

One important aspect is that the Government also collects revenue through the consumption of fuel. Changes made to the duty waiver have caused enormous losses to the Government. Giving cash subsidies to the poorest section of society could have been a much better strategy than tampering with duty waivers and underpricing fuel, ignoring market signals.

According to the calculations shown in Figure 1, the recent price changes do not reflect market prices of diesel, as illustrated in Figure 2.

What is the solution?

The first solution lies in addressing the problem. As of now, Sri Lanka’s fuel prices fail to indicate scarcity, hampering the independent function of market prices. One way of doing this is by setting up a transparent mechanism and changing the prices to reflect market prices. It may be a price formula or a process where transparency is assured. 

Such a step will incentivise better resource allocation. Consumers will be able to shift between alternative choices and manage their decisions based on price signals. The previous administration introduced a pricing formula that was very poorly administered. The method of calculation was not properly communicated. 

I recall a time when elections were approaching, with a simultaneous spike in global oil prices underway. However, Sri Lanka’s oil prices remained the same. The same was seen when global prices reduced during the first lockdown, and the local consumer was deprived of the deflation. 

One common misperception on this strategy was voiced politically as: “Why do we need a Government if the prices are going to change according to the world market prices?” Simply because we are now experiencing the consequences of such control by the Government. As The Morning reported, the fuel fund has a negative Rs. 26 billion and there are many discrepancies over the numbers in numerous reports. 

Another common misperception is that based on the price changes of fuel, we are going to allow bus fares and other connected prices to change daily. It may be daily changes or it can be changes over a month or a quarter, and there are so many ways we can structure it based on market forces. We have all forgotten that we deal with so many daily price fluctuations. Vegetable prices, Gold prices, stock market prices, and even the prices we pay as interest for Treasury Bills and Bonds change everyday. Price changes for a reason: they communicate the market conditions, which is the ultimate objective of “price”, and allowing the markets to work. 

It is true that this price hike has an impact on the poor. The Government can consider direct cash transfers. The cost of cash transfers will be lower than the losses we collectively incur from the CPC, CEB, and other fuel-dependent state institutions. The current price hike is just another temporary solution; it does not fix the problem. 

Increasing the share collected by everyone at my university party does not change the unfair division of the cost. Likewise, a price increase without setting up a market system and price signals to operate won’t solve Sri Lanka’s fuel and economic crisis.Purchasing alcohol was an expensive endeavour back in college. I remember the total alcohol bill being shared equally amongst those who drink and those who don’t. Sri Lanka’s fuel pricing mechanism is quite similar to this. The subsidised prices are a blessing for direct users of fuel who can afford it. The majority, who are secondary users, end up paying for the subsidy indirectly. Sri Lanka’s fuel problem is quite complex. If we are to overcome this issue it is vital that policymakers understand the concept of “markets” and “prices”. 

It is important that Sri Lanka integrates with global markets and continues to allow fuel imports. This costs the Government approximately about $ 3.5 billion per annum. Global fuel prices fluctuate based on market conditions, and it is crucial to understand why prices fluctuate and the indicators of these fluctuations. Some oil deposits in the world are located such that their extraction process is relatively easy and less costly. Some others are very costly to extract. The Middle East and the OPEC (Organisation of the Petroleum Exporting Countries) are reputed for their oil reserves, whereas the extraction of oil is comparatively more costly in areas like Alberta, Canada. Global oil prices are determined based on this ability of countries to supply to the global market. Political, economic, and climatic developments, and changes in these countries have a direct impact on global oil prices.

So what does the “price” increase communicate? It communicates to the consumer the scarcity of that particular resource within the particular time frame. So increases in global oil “prices” is an indication to consumers that fuel is becoming a scarce resource, and we have to use it optimally. It is also an indication to producers that they can earn more by producing more. This narrows down to the basics of supply and demand. Price is an indicator of scarcity. The “market economy” is not complicated, it is merely allowing the “price system” to work. This allows prices to indicate what should be done. Price is not just a number or a sum a consumer pays. Final retail prices are an accumulation of labour costs, material costs, scarcity, externalities, and factors of production. This is fundamentally why we must not intervene in the market price mechanism.

Sri Lanka has always ignored market principles. The island nation has been trying to artificially keep fuel prices constant despite the continuous fluctuations of global prices. We have failed to understand that such fabricated interventions to either inflate or deflate prices will only result in ceasing to keep up with global indications on whether the resource is scarce or not.

Sri Lanka’s fiscal discipline and stability has always been connected to fuel and the Ceylon Petroleum Corporation (CPC). As a result of fuel price changes, there are significant knock-on effects on all utilities, including electricity and water. CPC provides fuel at a lower price to the Ceylon Electricity Board (CEB), which is one of the main sources for electricity generation. As a result, the pricing of electricity is also now not indicative of scarcity. The CPC, which buys fuel at higher prices and sells it lower, now owes significant debts to most of the state banks. 

The debt incurred is in US dollar terms. A delay in payment or a default may adversely affect the entire financial system. The heavy impact this would have on the banking sector will consequently impact the Central Bank of Sri Lanka (CBSL). It is no secret that the CBSL bails out the CPC and CEB through Treasury Bills, or by printing money. Therefore it is clear that by intervening, we have successfully exposed the entire financial system to deep peril.

The current Minister of Energy said the banks have informed the  CPC Chairman that they do not have foreign currency to pay for fuel imports. This was informed to the Secretary of the Treasury, who then summoned all the heads of banks, who collectively assured the payments for fuel imports. He further stated that the CBSL said it cannot offer any reserves, given the country’s economic woes. It is perplexing to say that the problem is really this severe. It is clear that intervention in the price system has caused a massive domino effect beyond comprehension. 

According to a World Bank report, the biggest beneficiary of subsidised fuel prices are the highest echelons of society. “The non-poor are the largest consumers of fuel and electricity (the top 30% of society consumes 70% of fuel. This is well ahead of direct and indirect consumption of fuel by the bottom 40% through public transport). The administered fuel prices are an effective subsidy to the non-poor funded indirectly by fiscal resources,” stated the World Bank in its Development Update for Sri Lanka in November 2017.

I see no difference in this fuel pricing phenomenon and how the final alcohol bill was shared amongst those who drink and those who don’t in my college days. The poor are bearing the burden of fuel subsidies so the rich can buy fuel for much cheaper. The weighed-down poor only consume fuel in the form of transport, electricity, and other secondary forms. We have to understand that the losses of the CPC have to be paid by someone. Currently, that someone is constituted by both the rich and the poor. 

One important aspect is that the Government also collects revenue through the consumption of fuel. Changes made to the duty waiver have caused enormous losses to the Government. Giving cash subsidies to the poorest section of society could have been a much better strategy than tampering with duty waivers and underpricing fuel, ignoring market signals.

According to the calculations shown in Figure 1, the recent price changes do not reflect market prices of diesel, as illustrated in Figure 2.

What is the solution?

The first solution lies in addressing the problem. As of now, Sri Lanka’s fuel prices fail to indicate scarcity, hampering the independent function of market prices. One way of doing this is by setting up a transparent mechanism and changing the prices to reflect market prices. It may be a price formula or a process where transparency is assured. 

Such a step will incentivise better resource allocation. Consumers will be able to shift between alternative choices and manage their decisions based on price signals. The previous administration introduced a pricing formula that was very poorly administered. The method of calculation was not properly communicated. 

I recall a time when elections were approaching, with a simultaneous spike in global oil prices underway. However, Sri Lanka’s oil prices remained the same. The same was seen when global prices reduced during the first lockdown, and the local consumer was deprived of the deflation. 

One common misperception on this strategy was voiced politically as: “Why do we need a Government if the prices are going to change according to the world market prices?” Simply because we are now experiencing the consequences of such control by the Government. As The Morning reported, the fuel fund has a negative Rs. 26 billion and there are many discrepancies over the numbers in numerous reports. 

Another common misperception is that based on the price changes of fuel, we are going to allow bus fares and other connected prices to change daily. It may be daily changes or it can be changes over a month or a quarter, and there are so many ways we can structure it based on market forces. We have all forgotten that we deal with so many daily price fluctuations. Vegetable prices, Gold prices, stock market prices, and even the prices we pay as interest for Treasury Bills and Bonds change everyday. Price changes for a reason: they communicate the market conditions, which is the ultimate objective of “price”, and allowing the markets to work. 

It is true that this price hike has an impact on the poor. The Government can consider direct cash transfers. The cost of cash transfers will be lower than the losses we collectively incur from the CPC, CEB, and other fuel-dependent state institutions. The current price hike is just another temporary solution; it does not fix the problem. 

Increasing the share collected by everyone at my university party does not change the unfair division of the cost. Likewise, a price increase without setting up a market system and price signals to operate won’t solve Sri Lanka’s fuel and economic crisis.Purchasing alcohol was an expensive endeavour back in college. I remember the total alcohol bill being shared equally amongst those who drink and those who don’t. Sri Lanka’s fuel pricing mechanism is quite similar to this. The subsidised prices are a blessing for direct users of fuel who can afford it. The majority, who are secondary users, end up paying for the subsidy indirectly. Sri Lanka’s fuel problem is quite complex. If we are to overcome this issue it is vital that policymakers understand the concept of “markets” and “prices”. 

It is important that Sri Lanka integrates with global markets and continues to allow fuel imports. This costs the Government approximately about $ 3.5 billion per annum. Global fuel prices fluctuate based on market conditions, and it is crucial to understand why prices fluctuate and the indicators of these fluctuations. Some oil deposits in the world are located such that their extraction process is relatively easy and less costly. Some others are very costly to extract. The Middle East and the OPEC (Organisation of the Petroleum Exporting Countries) are reputed for their oil reserves, whereas the extraction of oil is comparatively more costly in areas like Alberta, Canada. Global oil prices are determined based on this ability of countries to supply to the global market. Political, economic, and climatic developments, and changes in these countries have a direct impact on global oil prices.

So what does the “price” increase communicate? It communicates to the consumer the scarcity of that particular resource within the particular time frame. So increases in global oil “prices” is an indication to consumers that fuel is becoming a scarce resource, and we have to use it optimally. It is also an indication to producers that they can earn more by producing more. This narrows down to the basics of supply and demand. Price is an indicator of scarcity. The “market economy” is not complicated, it is merely allowing the “price system” to work. This allows prices to indicate what should be done. Price is not just a number or a sum a consumer pays. Final retail prices are an accumulation of labour costs, material costs, scarcity, externalities, and factors of production. This is fundamentally why we must not intervene in the market price mechanism.

Sri Lanka has always ignored market principles. The island nation has been trying to artificially keep fuel prices constant despite the continuous fluctuations of global prices. We have failed to understand that such fabricated interventions to either inflate or deflate prices will only result in ceasing to keep up with global indications on whether the resource is scarce or not.

Sri Lanka’s fiscal discipline and stability has always been connected to fuel and the Ceylon Petroleum Corporation (CPC). As a result of fuel price changes, there are significant knock-on effects on all utilities, including electricity and water. CPC provides fuel at a lower price to the Ceylon Electricity Board (CEB), which is one of the main sources for electricity generation. As a result, the pricing of electricity is also now not indicative of scarcity. The CPC, which buys fuel at higher prices and sells it lower, now owes significant debts to most of the state banks. 

The debt incurred is in US dollar terms. A delay in payment or a default may adversely affect the entire financial system. The heavy impact this would have on the banking sector will consequently impact the Central Bank of Sri Lanka (CBSL). It is no secret that the CBSL bails out the CPC and CEB through Treasury Bills, or by printing money. Therefore it is clear that by intervening, we have successfully exposed the entire financial system to deep peril.

The current Minister of Energy said the banks have informed the  CPC Chairman that they do not have foreign currency to pay for fuel imports. This was informed to the Secretary of the Treasury, who then summoned all the heads of banks, who collectively assured the payments for fuel imports. He further stated that the CBSL said it cannot offer any reserves, given the country’s economic woes. It is perplexing to say that the problem is really this severe. It is clear that intervention in the price system has caused a massive domino effect beyond comprehension. 

According to a World Bank report, the biggest beneficiary of subsidised fuel prices are the highest echelons of society. “The non-poor are the largest consumers of fuel and electricity (the top 30% of society consumes 70% of fuel. This is well ahead of direct and indirect consumption of fuel by the bottom 40% through public transport). The administered fuel prices are an effective subsidy to the non-poor funded indirectly by fiscal resources,” stated the World Bank in its Development Update for Sri Lanka in November 2017.

I see no difference in this fuel pricing phenomenon and how the final alcohol bill was shared amongst those who drink and those who don’t in my college days. The poor are bearing the burden of fuel subsidies so the rich can buy fuel for much cheaper. The weighed-down poor only consume fuel in the form of transport, electricity, and other secondary forms. We have to understand that the losses of the CPC have to be paid by someone. Currently, that someone is constituted by both the rich and the poor. 

One important aspect is that the Government also collects revenue through the consumption of fuel. Changes made to the duty waiver have caused enormous losses to the Government. Giving cash subsidies to the poorest section of society could have been a much better strategy than tampering with duty waivers and underpricing fuel, ignoring market signals.

According to the calculations shown in Figure 1, the recent price changes do not reflect market prices of diesel, as illustrated in Figure 2.

What is the solution?

The first solution lies in addressing the problem. As of now, Sri Lanka’s fuel prices fail to indicate scarcity, hampering the independent function of market prices. One way of doing this is by setting up a transparent mechanism and changing the prices to reflect market prices. It may be a price formula or a process where transparency is assured. 

Such a step will incentivise better resource allocation. Consumers will be able to shift between alternative choices and manage their decisions based on price signals. The previous administration introduced a pricing formula that was very poorly administered. The method of calculation was not properly communicated. 

I recall a time when elections were approaching, with a simultaneous spike in global oil prices underway. However, Sri Lanka’s oil prices remained the same. The same was seen when global prices reduced during the first lockdown, and the local consumer was deprived of the deflation. 

One common misperception on this strategy was voiced politically as: “Why do we need a Government if the prices are going to change according to the world market prices?” Simply because we are now experiencing the consequences of such control by the Government. As The Morning reported, the fuel fund has a negative Rs. 26 billion and there are many discrepancies over the numbers in numerous reports. 

Another common misperception is that based on the price changes of fuel, we are going to allow bus fares and other connected prices to change daily. It may be daily changes or it can be changes over a month or a quarter, and there are so many ways we can structure it based on market forces. We have all forgotten that we deal with so many daily price fluctuations. Vegetable prices, Gold prices, stock market prices, and even the prices we pay as interest for Treasury Bills and Bonds change everyday. Price changes for a reason: they communicate the market conditions, which is the ultimate objective of “price”, and allowing the markets to work. 

It is true that this price hike has an impact on the poor. The Government can consider direct cash transfers. The cost of cash transfers will be lower than the losses we collectively incur from the CPC, CEB, and other fuel-dependent state institutions. The current price hike is just another temporary solution; it does not fix the problem. 

Increasing the share collected by everyone at my university party does not change the unfair division of the cost. Likewise, a price increase without setting up a market system and price signals to operate won’t solve Sri Lanka’s fuel and economic crisis.

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.