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10% reduction in petroleum prices: “Too little” or “too late”?

  • SOURCE: | qwesa2big
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    On the eve of the New Year, 2015, the National Petroleum Authority (NPA) announced a reduction in ex-pump prices of petroleum products by 10% across board. This was not without drama. Most of the headlines that followed the announcement pointed to price reduction under duress.

    A number of civil society organizations and political parties put pressure on NPA to reduce the prices due to reasons such as the oil price crush and relative stability in the value of the local Ghanaian currency.

    Some of the organizations threatened public demonstrations against NPA and the Government; a situation that was expected considering that petro-politics is a feature of petroleum pricing in most parts of the world.

    The oil price crush emerged in mid-June 2014 and by December same year, Brent crude oil price losses were estimated at 45% over the period. Over the same period, the Ghanaian local currency held its value against major international currencies.

    These factors are major determinants of petroleum product pricing in Ghana. In line with the Automatic Adjustment Pricing Formula (AAPF), which is applied by NPA, consumers of products expected reduction in ex-pump prices. However, since the introduction of the formula, movements in crude oil prices have been asymmetrical with movements in ex-pump prices of products, reflecting inconsistent application of the formula.

    Some have also attributed the inconsistent application of the pricing formula to political interference, leading to debt accumulation from under-recoveries, and its consequences on price distortions.

    Thus, in periods of high crude oil prices, interference in the application of the pricing formula prevents the pricing authority from fully passing-through higher crude oil prices to consumers. This creates the temptation to withhold over-recoveries during periods of lower crude oil prices to finance debts from under-recoveries.

    As expected, NPA’s refusal to adjust ex-pump prices appropriately as crude oil prices fell continuously in the second half of 2014 was based on its decision to use the over-recoveries to defray debts from under-recoveries. Whether this was justifiable or not had implications for the integrity of the AAPF.

    Fact is public confidence in the pricing regime for petroleum products are an important requirement to ensuring an efficient downstream petroleum industry. Inconsistent application of the formula undermines public acceptance of product pricing when market fundamentals require upward adjustments.

    This is why politicians are compelled to interfere in the pricing process by either suspending the pricing formula or failing to finance promised subsidies. This practice no doubt has been too costly for the country, and the NPA’s dilemma to reduce ex-pump prices or not over the last four (4) months clearly demonstrates this effect.

    Consumer frustration must be well managed or it gets translated into anger and socio-political tensions. It was therefore not surprising that public frustrations and the threats of public demonstrations in the face of regulatory arrogance eventually forced NPA to understand the “animal language”.

    The NPA no doubt has been badly bruised as a regulator and has somehow lost its status as a principled arbiter between the market and the consumer. Some have even described the price reduction by 10% as “Too little” or “Too late”.

    Is the price reduction “too little” or “too late”?

    Most of the market fundamentals that determine petroleum product pricing did not support the refusal or “arrogance” of the NPA to effect downward adjustments in prices, including the major factors – crude oil prices and Free on Board (f.o.b) prices of refined products.

    First, the fall in crude oil prices by 45% from mid-June to end of 2014 sent the biggest signal to the market to respond appropriately. The latest response by the NPA with a 10% price reduction does not appear to reflect the overall cumulative effect of a 45% loss in crude prices. It must be stated however that the 10% price reduction is consistent with month-on-month losses in Brent Crude oil price, which has averaged 10% since October 2014.

    Thus clearly, NPA only considered monthly price movement, which tended to erode the cumulative price windfall due consumers since the beginning of the oil price crush. This anomaly has been caused by the failure of the authority to adjust ex-pump prices from August to December 2014 although the evidence of the oil price crush was already pronounced.

    The decision to apply the windfalls to defray debts from under-recoveries could also not constitute a sound one; and this has been addressed in subsequent sections in this paper.

    Second, Free on Board (F.o.b) prices of petroleum products which are prices quoted on a daily basis by export orientated refining centers, have seen appropriate reductions around the World including the North West Europe where most of Ghana’s petroleum products are sourced from. F.o.b prices reflect supply and demand balances for petroleum products.

    Thus, the fall in F.o.b prices have resulted from higher product supply than demand especially since August 2014. This has affected refinery margins adversely in spite of the growth in refinery capacity. Margins are further expected to fall considering that new refinery capacity expected in early 2015 would add about 1.4 mmbbl/day of capacity, which could lead to idle capacity if demand for products does not pick up soon.

    F.o.b prices promise to remain low as a result of this. NPA’s refusal to reduce ex-pump prices since August 2014 on account of falling f.o.b prices of petroleum products could therefore not be justified.

    Third, freight rates have increased over the period and reached a 6-year high in December 2014. Freight charge is the cost of transporting refined petroleum products from export refining centers to Ghana’s ports, and are based on freight rates published by London Tanker Brokers Panel on 1 January each year.

    However, the rates are adjusted on a monthly basis in line with the so-called Average Freight Rate Assessment (AFRA), which is a function of risks, and supply and demand of ships transporting refined petroleum products internationally. This is the only factor, which has favoured NPA’s decision. However, compared with the other major factors, the overall effect pointed to a significant reduction in fuel prices.

    Based on the variables above, it is safe to argue that a 10% reduction in ex-pump price is “too little” considering the overall effect of market conditions over the last 6-month period. The reduction appeared realistic if it was based on month-on-month changes in crude oil prices.

    However, considering that market conditions signaled an imminent collapse of the market since August 2014, the NPA’s announced price reduction can appropriately be described as “Too late” and reflects bad faith in the operations of a regulator, which should provide an enabling environment for sustaining the confidence of all players and consumers.

    Marriage of Convenience – NPA and BDCs

    The NPA has explained that it accumulated debts of more than GHS400 million from under-recoveries by Bulk Distribution Companies (BDCs) in the past. As a result of the delay in reducing ex-pump prices, it has been able to defray about GHS200 million of these debts. Good reason isn’t it? And as expected, the BDCs through its advocacy mouthpiece have been very supportive of the arguments by NPA.

    This marriage of convenience is not by accident. Recently, the BDCs were at war with NPA and the Government, which led to the re-enactment of long queues of the 1980s at our petro-stations. During the stalemate, the BDCs argued for removal of subsidies and upward adjustment of petroleum prices citing market conditions. Today, with a reverse in market conditions, they are arguing against downward price adjustments. What a skewed logic!

    The apparent inconsistency in the position of the BDCs illustrates the fact that they are pure capitalist who are concerned more about their business interests and profitability; but are ready to ignore the political economy environment in which their businesses thrive.

    The BDCs should realize by now that nobody is against their right to recover their debts from NPA/Government. Nobody is against their penchant for profiteering, but the fact that this can become exploitative clearly reduces the value of their arguments. Unfortunately, the NPA was set up to check exploitative pricing and protect market credibility, an objective it has rather defeated.

    Also, the exchange losses and as well as subsidies from price differential which led to accumulated debts to the BDCs constituted a premium to the economy for government’s poor management of the local currency at the time the under-recoveries occurred.

    Why the NPA would resort to the use of price windfalls to defray the debts instead of turning to Government remains answered. Therefore, recovering accumulated debts from price windfalls is not only exploitative but also bad economics inflicted on consumers by NPA and its collaborating BDCs.

    It is further saddening why NPA decided to use all the over-recoveries to defray debts to BDCs. This is not done. This is bad strategy. NPA would have won the public confidence for future upward price adjustments if it applied between 50% to 60% of the over-recoveries to the debts and gave the rest to consumers through ex-pump price reduction even if marginal.

    My candid opinion is that the BDCs should rather be on the side of the public because Government cannot be trusted to allow future higher crude oil prices to be passed on to consumers if public protestations are loud; and this could have serious implications for the operations of BDCs.

    Thus, it is better for the BDCs to argue for the consistent application of the AAPF rather than holding on to its current ill-fated marriage of convenience, which cannot stand the test of time.

    Effects on the downstream petroleum industry

    The recent developments may tend to deepen negative outlook for the downstream petroleum industry. The actions and inactions of NPA and Government in particular will bring two serious effects:

    On one hand, there will continue to be consumer loss of confidence in the AAPF, a situation that makes political interference a permanent feature of the pricing regime for petroleum products.

    On the other hand and flowing from the first effect, there will continue to be inefficient pricing of petroleum products as a consequence of unfunded subsidies, accumulating debts from under-recoveries and waiting to clear the debts with over-recoveries if there are any at any time.

    Two main proposals

    1. We must be bold and consistent with the application of the AAPF. If we cannot, the cost of administered pricing will be catastrophic for the country’s fiscal outlook and socio-economic development.
    2. We must do away with foreign exchange induced subsidies. Alternatively, Government should budget for the size of the subsidy it can finance and be transparent about it. Foreign exchange losses can also be addressed by using forward prices (That is spot price in US Dollar terms plus or minus foreign exchange premium).

    These proposals are not new. Lack of political will has been the challenge. The earlier we confront these challenges the better for the future of the downstream petroleum industry in which consumers will benefit from efficient pricing, windfalls and reliable supply of petroleum products.


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