Our (Sri Lankans') immunity to global oil shocks!

Everyone is now talking about global oil prices as it recently hit a new bottom (below USD30/barrel). A look at the global oil market (if you are trying to understand the market), will direct you to different things, such that; we hear about Brent, WTI, etc., Commodity markets/exchanges (NYMEX, ICE, etc), instruments like Spot, Futures, etc. (if you want to study these things, log on to this please). Anyway, my aim in this post is not to look at global oil markets but to give you an account on how the Sri Lankan markets work in the face of the global dynamics.

Structure and economic importance

The Ministry of Petroleum Resources Development acts as the policy making and chief accounting body for four entities; Ceylon Petroleum Corporation, Ceylon Petroleum Storage Terminals Pvt Ltd, Petroleum Resources Development Secretariat and Polipto Lanka Pvt Ltd. Sri Lanka’s annual fuel bill is c. USD 4.5 billion. (this includes both Crude Oil and Refined Products imports). To give you some context, this is about 25% of country’s total import bill and approx. 50% of the export bill. However, due to recent sharp drop in oil prices import bill has almost halved as of November 2015 and its share as a percent of total imports has dropped to 14%. (Note: Crude oil imports & Crude oil (CIF value LKR mn) for 2015 are for the 1H15, total USD value from Jan - Oct period) 

Government’s revenue from taxes on petroleum is as depicted in the below table: (it actually does not represent a major part of it’s revenue as it is claimed to be in the media and in political circles).

Sri Lanka petroleum market

Sri Lankan petroleum market is a regulated duopoly. Ceylon Petroleum Corporation (CPC) and Lanka IOC PLC (a subsidiary of Indian Oil Corporation Ltd) are the two players in this market. Apart from fuel importation and distribution in Sri Lanka these two players are also involved in the lubricants business, bunkering. Bituman and other services. (in which the competition is very different and that discussion I will reserve for another post, as my focus here is to talk about fuels).

CPC is engaged in import of Crude as well as refined products while LIOC sources refined, bulk fuel, from international markets. CPC actually imports three types of crude, namely; Light Crude Oil (has not been imported since 2014), Murban Crude Oil and Oman Export Blend. LIOC is said to possess 18% market share in the domestic fuel retail market (as per their latest published Annual Report. However, the overall market share, looking at sales quantum, is about 13%).    

CPC is struggling with some structural problems as pointed out in the Annual Report.

“..Murban crude oil which gives a better yield, helping to increase the refinery margin. The Murban crude oil is only produced by Abudabi National Oil Company in Abu Dhabi and hence has a very limited supply with only 10% of the production coming to the open market in Asia. However, there is speculation that this 10% will also likely to be further reduced with the recent commissioning of a new refinery owned by ADNOC in UAE. This might have a negative impact on the procurement of Murban crude oil by CPC in future and hence will need to explore for alternative crude oils compatible with the current refinery configuration”.

Sri Lanka faced this similar problem when the US imposed sanctions on Iran as CPC’s refinery is, understandably, best suited to refine Iranian Crude.

Further the Annual Report points that “Making the situation worst, the CEB demand for fuel oil has drastically reduced with the commissioning of Norachcholai Coal Power Plant compelling CPC to look for alternative avenues to market the excess fuel oil produced at refinery. With a highly unstable demand for thermal power generation coupled with a very low demand for the local industry, the refinery is facing problems of disposing around 1,400 Metric Tons of excess fuel oil per day”. As a result, they have had to sell/export the excess at very low prices.   

The Duopoly

As I mentioned, the Retail Fuel business in Sri Lanka is a regulated duopoly. The government run CPC accounts for c.85 - 87% of the market while the balance is shared by LIOC. The table below shows the financial performance of both entities. (Please note that LIOC is a March Company while CPC is a December company. However, 2014 figures are from Jan-Dec 2014 for both and 2015 figures are for Jan – Sept 2015 for both companies, for comparison purposes. Also note that figures are in LKR millions).

To get a better understanding it is essential to look at the performance ratios which are produced below. (Keep in mind that two years of data analysis may be not enough to get a better picture).  

To get an understanding about the financial positions of the two entities I have reproduced their Balance Sheets (as at CYE14 and Sept 2015). The accompanying ratio analysis shows a comparison of them. Capital structure of CPC is not helping at all, as per the analysis.   

Operationally, CPC is understandably employing around 5,800 staff (equivalent to 50% of the staff of all the State Owned Industrial Enterprises. Statistic from Central Bank of Sri Lanka). However, LIOC only employs around 174 staff members as per there disclosures in the CSE. This converts to Revenue per Staff figure of LKR 290.65 million for LIOC and LKR 48.96 million for the counterpart, CPC. 

Similarly, CPC runs 1193 Fuel Stations island-wide. LIOC, on the other hand, operates 179 Fuel Stations.

In terms of sales, local sales of refined products are about 4.4 million metric tons. (table for total local sales and CPC sales). LIOC sells c.0.5 million MT (555,918 MT in 2014 FYE, 584,436 MT in 2015 FYE).

Finally, I’d like to come to the most interesting bit, the retail fuel prices in the local market. The chart below gives the CPC’s crude import prices over last several years. (LIOC does not import crude). As per the CBSL’s most recent Economic Weekly publication the 2015 December import price was USD41.21 per barrel. (this is not directly comparable to world market price due to many reasons. But its trajectory is not substantially different from the global movements).

Now look at the local market retail prices of different versions of fuel used by people. In the political arena, different numbers are thrown by different people but without any basis (but just with the intention of attaining political mileage out of it. Once, I can remember, one of the current government’s ministers, during the campaign, mentioned that CPC is taxed unnecessarily to fund the activities of former regime’s family). So, it is our duty to do our own research to see what is actually happening.

Why not reduce local fuel prices?

The above is a common question every one raised in the recent past, as they know the global market has collapsed. (no one ask the opposite of this question when the global market climbs up). But, that’s human nature.

The government has reported that they can’t give any further reductions as they have got to deal with a bad fiscal situation plus and they want to make up for the losses they made while prices were high.(essentially the people have had to pay for the state sector inefficiency). Inefficiencies are partly due to CPC’s financial situation and its inability to invest in its infrastructure and technology. (one reason being fuel was sold at subsidized prices when global prices were very high). On the other hand, even though the price of oil in USD terms dropped significantly, the LKR has also depreciated significantly over last year or so. Hence, the LKR value of the imports have not dropped in a similar passion.

Hence, Sri Lankan companies/individuals can’t be expected to be benefitted even if the oil prices are at historic lows in the world markets. However, may be we are being benefitted from the reduced import bill such that we might have avoided a greater crisis due to BoP problems had our import bill remained at USD4 billion levels.  

Will you be willing to take the risk of changing oil price. (Nowadays, quickly and rapidly changing). Of course, you answer will be most likely be a ‘yes’. In this scenario, we should be prepared to accept higher prices if world prices increase. (that may sound little harsh, isn't it).  If this wa the case, you will save in down markets and can probably be using those savings for wealth generation. Conversely, in an up market, you may see your savings affected badly. (If the up market prevails for a prolonged period it may affect you severely). But, we may be better at managing our own finances better than the governement does with all its political interferences.  

Bottomline

Retail fuel prices become one of the main topics of discussion in and around election times and most often oil prices are reduced soon after a government is elected. (happend even after the most recent election!). As goverement gets older, it is highly unlikely that they reduce oil prices. (it has not happened that way before, may be once or twice only). In contrast, tendency to increase retail prices in the face of increasing global fuel market is very highly likely, irrespective of elections. Hence, in a declining fuel market, LIOC and CPC stand to make huge profits and vice versa.

Since our market fuel prices are government decided we don’t tend to see the same variation in prices that we see in the global markets. (on a very constant and regular interval, at the extreme case on a daily basis). We are worried now as the world prices are at historical lows. But, commodity prices are very volatile and we never know when would they reverse and start increasing. (then we will be surely happy the price in the local market is fixed, well until the GoSL increase it). However, due to this mechanism we are immune to global shocks (at least in the short run) as the government partially hedge us against shocks with their regulated price.