Talking business

Last week we saw shortages of petrol at pumps across the country.  Here is some background.

Pumps ran short of fuel when three refineries had to be shut down for maintenance. The shutdowns created an interruption in the regular supply of product, a disturbance that traveled rapidly down the petroleum supply chain all the way to the pumps. The very short “transmission time” - from outage to closure - had one simple reason: not enough storage capacity. So the crucial question thrown up by the pump closures is this: why is there such limited storage capacity in our petroleum supply chain?

The short answer to that question is that nobody can figure out who should pay to build and maintain this storage capacity. But why can’t anyone figure this out? This is where the answer gets a lot longer.

As the pump closures showed us, the question of smooth and continuous supply of petroleum product is not one that can be left to purely commercial considerations. There is a powerful public interest at stake which needs to be clarified and safeguarded. After all, we’re not talking about an interruption in the supply of chewing gum or hairspray. Vehicular fuels are vital necessities, and an interruption in their supplies can shut down ambulances and police cars, trucks and buses. The public has a vital interest in seeing to it that the petroleum supply chain is organised in a way to minimise disruptions.

Petroleum storages are key to absorbing disturbances in the supply chain; they act like synapses that absorb the shock of an interruption long enough for supplies to resume. But reserves carry a tremendous cost. Aside from the physical infrastructure, the amount of money that needs to be invested in buying and holding the hundreds of thousands of tons of oil required to build a meaningful reserve is enough to put off any private entrepreneur.

Every executive from the oil industry will tell you that the main obstacle to making this investment in a storage system is the circular debt, and will gladly talk at length about all the liquidity problems that the circular debt creates for his business. But there’s more to the story.

It was almost exactly two years ago that the Bhagwandas Commission on Oil and Gas Price Mechanism told us a simple story of greed and avarice that shook the oil industry to its foundations.

The story went something like this. In 2002 the government introduced a new Protective Tariff Formula, or “deemed duty” to be paid to the refiners at the rate of 10% of the selling price of their product. In return the refiners agreed to not disburse more than 50 percent of their profits as dividends to the shareholders, but to retain these earnings and use them to invest in upgradation of their plant. OMCs, likewise, were offered a fixed return of 3.5 per cent of the selling price of their product as “dealer margin,” in return for a legally binding commitment that they will invest in maintaining a storage capacity sufficient to tide over 21 days of a supply interruption.

The Bhagwandas report then tells the story of how the oil industry basically took the money and ran.  Between 2001 and 2007, it shows how the profits of the oil industry spiked spectacularly, by up to 3,500 per cent in one case, but the investments required in plant upgradation and storage capacity were slow to materialise. Not only that, the rising price of oil meant more government revenue through sales taxes, customs duty and the petroleum development levy, all of which grew by many orders of magnitude.

A win-win situation was created between government and big business. Both got what they wanted from the spiralling price of oil from 2002. Neither had an incentive to upset the apple cart by demanding that some of this windfall money be diverted to control the price of fuel at the pump, or to invest in a venture that would do nothing to enhance shareholder value.

The price of this alliance has been paid by the public, the only party without a voice in this transaction.  And the bill has come to the public in two installments: first time at the pump when you fuel up. And the second time in the line as you wait to fuel up, because your petroleum supply chain has no synaptic protections for you, leaving it brittle and vulnerable to the slightest disruption.

the writer is Editor Business and Economic policy for Express News and Express 24/7

Published in The Express Tribune, June 13^th, 2011.