Fuelling reform

Originally appeared on The Morning

By Dhananath Fernando

Fuel shortages have become abundant. The implications of these shortages need no lengthy explanations. They will affect all of us: from a multinational company to the average man on the street, every action we take in life will be disturbed. The electrical grid is already experiencing multi-hour, island-wide blackouts and the situation could escalate to include water supply and many other utilities, for which the knock-on effect will be very severe. 

There were serious discussions in Parliament about the possibility of revising fuel prices. In fact, the CBSL Governor himself has requested that prices be increased. When fuel prices are increased, it may (to an extent) reduce the demand for fuel. But fuel is such an essential commodity that even when prices are increased, the drop in demand may be low. But when fuel prices are increased, people will have to spend more money on fuel and related products, hence there will be less money being spent on non-fuel imports. As the non-fuel imports come down, the balance of payments will come closer to equilibrium, reducing the extent of that crisis. Ultimately, that’s the fundamental feature of a market system.

Fuel price revisions have never been popular in Sri Lanka, as historically, revisions have always led to price increases. When the former Finance Minister late Mangala Samaraweera announced the price formula along with his team including the present Finance Ministry Secretary Dr. S.R. Attygalle, many people did not see the fuel pricing formula positively. 

In my opinion, the optics and launching the formula were also quite bad in the context of a political economy. The formula was introduced at a time when global crude oil prices were increasing, so many people thought the price formula was just an attempt – or an excuse – to increase the price rather than the proper market mechanism. At launch the officials were laughing and it was launched as V1+V2+V3 = V4 and it was captured in the media and popular rhetoric that policymakers were having fun by increasing the burden on poor people. So while the decision to implement the formula was appropriate, the marketing and getting the public on board with market-based pricing could have been better. Later on, with elections getting closer, adherence to the price formula was not maintained. But market-based pricing of fuel is definitely a need for the ailing Sri Lankan economy. 

It is crystal clear that we are unable to sell fuel at lower prices than the cost of production and distribution without incurring heavy losses and debts. The Ceylon Petroleum Corporation (CPC) makes a loss of Rs. 46.80 per for every litre of diesel even after receiving a duty waiver of Rs. 25. For petrol following a duty waiver of Rs. 45 the CPC makes a loss of about Rs. 18. 37. 

After the fuel shortage became prevalent, the common excuse trotted out by policymakers is that they don’t have dollars to buy fuel. In my view, this is misleading. While it is true that we do not have dollars to buy fuel at the soft-peg rate of approximately Rs. 200 per USD, we may have USD to buy fuel at the market rate of about Rs. 250-260 per dollar. Interestingly, we do not need the assistance of the International Monetary Fund (IMF) to make these little changes with a big impact. Increasing domestic fuel prices may reduce the losses of CPC, but it will not solve the underlying problems causing shortages. Currently our Government makes two main losses on every litre of petrol or diesel: first, it suffers an operational loss on subsidised fuel and secondly, it suffers an exchange rate loss.

While the main reason for the current crisis is shortage of USD, it should be noted that the energy market dynamics are also very weak. It’s a duopoly market with over 80% share for the State-owned CPC, one of the biggest loss-making State-owned enterprises in the nation. As per sales for 2020 of diesel, because of the duty waiver alone, the Government is losing out on about Rs. 30 billion in revenue for petrol and about Rs. 98 billion for diesel. 

It is simply not worth making such losses, making life inconvenient for consumers while also losing political capital at the same time. There is no winner when the State tries to keep fuel prices low. Claiming that our prices are low doesn’t really matter when we have no fuel available at all! So although it is not a popular decision, the right and rational decision is to determine the price based on market forces. Also, the entry barriers have to be reduced or eliminated to allow other players to enter the market. Singapore, a smaller country with a population less than a quarter of Sri Lanka’s, has more fuel and energy suppliers, ensuring price and supply stability.

Rather than merely providing excuses as to why we do not have USD to buy fuel, the Government can identify the price at which it can make the USD available for our fuel imports. Long-term reforms are the only solution for this problem. Emerging from our economic strife is determined by when we start our reforms programme. It’s better for everyone that we start sooner than later. 

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.