THE CASE FOR OIL REGULATION: FREE MARKET DOES NOT ALWAYS YIELD LOWER PRICES

THE CASE FOR

OIL REGULATION:

FREE MARKET DOES NOT

ALWAYS YIELD LOWER PRICES

To: “ Energy Secretary Angelo Reyes”

Sent: Mon, January 25, 2010 10:03:59 AM
Subject: 1st Follow Up: THE CASE FOR OIL REGULATION: FREE MARKET
DOES NOT ALWAYS YIELD LOWER PRICES

This is to respectfully reiterate the recommended RETURN to OIL REGULATION--on the ground that doing so is feasible (as was done for years in the past), and that doing so is the option most beneficial to the nation, as propounded in the herein forwarded position paper (ANNEX A).

May I be favored with the courtesy of your reply regarding your STAND on the recommended return to OIL REGULATION?


MARCELO L. TECSON
A Concerned Citizen

San Miguel, Bulacan
January 25, 2010


Copy Distribution Through Separate Emails:
Office of the President;
Select Executive Branch government officials;
Majority of Senators and Congressmen;
Commission on Audit officials;
Members of Philippine Economic Society;
Select members of media and academe,
professional & think-tank organizations,
civil society groups, concerned citizens....



========================================



----- Forwarded Message ----
From: Marcelo Tecson
To: “Pres. Gloria M. Arroyo” ;
“Sec. Angelo Reyes” info@doe.gov.ph;
vp@ovp.gov.ph; erermita@op.gov.ph; ops_edp@ops.gov.ph; mteves@dof.gov.ph; absantos@neda.gov.ph;... nmonsada@doe.gov.ph; mobillo@doe.gov.ph; senator_enrile@senate.gov.ph; congress_nogie@yahoo.com; boy_nograles@yahoo.com; etc….
Sent: Tue, November 24, 2009 8:11:06 PM
Subject: --Fwd: THE CASE FOR OIL REGULATION: FREE MARKET DOES NOT ALWAYS YIELD LOWER PRICES



THE CASE FOR RETURN
TO OIL REGULATION:
FREE MARKET DOES NOT
ALWAYS YIELD LOWER PRICES



For: Concerned GOVERNMENT OFFICIALS and CITIZENS


With the Department of Energy (DOE) unable to erase the doubts of the public on suspected oil industry overpricing, the issue of oil regulation vs. deregulation has cropped up anew. As culled from the annexed position paper, some of the salient points of the issue are as follows:


1. It is DOE’s job to monitor and keep the public informed of the actual result of oil industry deregulation, that is, whether or not it actually lowered oil product selling prices as touted by its proponents. As the cost-recovery portion (of sales) being used to pay oil company costs and expenses cannot be object of downward price adjustments, by selling prices we actually mean the sales portion that is left with the oil companies after paying their costs and expenses out of their sales proceeds. In other words, we refer to their profit MARGIN on sales. It is DOE’s duty to disclose to the public the movement of PESO MARGIN PER LITER of oil products as of the following points--shortly before the advent of oil deregulation in 1998, to serve as base number; as of 2005 when a government-commissioned independent review committee affirmed the propriety of deregulation, to establish the validity of the committee’s conclusion; in 2008 during the height of crude oil prices at roughly $150 per barrel, to prove that oil companies did not take advantage of the situation through overpricing; and as of today, to see how present oil industry PESO MARGIN PER LITER compares with the base number, or the margin shortly before implementation of deregulation in 1998--which will concretely show the existing impact of deregulation on selling prices.


2. DOE is against regulation on the ground that it will entail subsidy from taxpayers. This is simply not correct because it improperly presupposes that the Oil Price Stabilization Fund (OPSF) will be mismanaged once again as was done sometime after EDSA I. For as long as the OPSF is properly managed, it will not entail subsidy, as it in fact did not entail subsidy from its inception in 1979 up to 1986 and sometime thereafter.


3. Based on the front-page news story of the Philippine Daily Inquirer on August 22, 2005, it appears that, instead of bringing down selling prices, deregulation actually raised the oil industry profit margin on oil products. As reported by the Independent Review Committee in June 2005, in the case of gasoline, the P2.67 per liter margin (23% of P11.62 per liter pump price) under the past regulated regime rose to P5.00 per liter (16% of P31.18 per liter pump price) under deregulation, or a whopping increase of P2.33 per liter.


4. Deregulation or free market will not always yield lower prices. More than a dozen oil companies sharing an annual oil market of 12 BILLION liters may not be happy with the above P2.67 margin per liter of product, the probable reason why they raised it to P5.00 per liter by 2005 or earlier. However, if the same annual sales volume is enjoyed by just one or two or three oil companies in a regulated environment, they may be satisfied enough to stay in business even if the margin is fixed and reduced to just say P2.50 per liter—the apparent condition during the regulated regime prior to 1998. At that time, what the big three oil companies lacked from their relatively LOW MARGIN per liter, they made up for through HIGH SALES VOLUME.


5. Those who successfully worked for oil deregulation in 1998 might have erred in not considering the then peculiarities in the oil industry, which made deregulation an apparent failure in the lowering of oil product prices, as explained in detail in the position paper.


6. Oil regulation which employed OPSF as an implementation tool was instituted for years without entailing taxpayers’ subsidy. It was done when PNOC senior vice president Antonio V. del Rosario was Undersecretary of Energy, and when Petron Corporation vice president Orlando L. Galang was Director of the then Bureau of Energy Utilization, which had jurisdiction over the oil industry. Definitely, there are other Filipinos at present who can operate likewise the OPSF without requiring taxpayers' subsidy, therefore there is no need to hesitate in going back to regulation.


The herein position paper (ANNEX A) which recommends return to oil industry regulation is submitted for consideration of concerned government officials and citizens.


MARCELO L. TECSON
A Concerned Citizen

martecson@yahoo.com,
martecson@gmail.com,
San Miguel Bulacan
10-26-09, 11-06-09, 11-23-09



===========================




ANNEX A


THE CASE FOR RETURN
TO OIL REGULATION:
FREE MARKET DOES NOT
ALWAYS YIELD LOWER PRICES


INTRODUCTION:
OIL INDUSTRY DEREGULATION
PROVOKED HIGHER—NOT LOWER—PRICES
BECAUSE OF PECULIARITIES IN THE OIL INDUSTRY


Economic solutions should be condition-oriented, meaning, principles of economics learned from the academe cannot be applied uniformly and consistently to contrasting economic situations that developed one at a time over the years. The solutions must adapt to the prevailing economic conditions. Accordingly, my herein comments and conclusions are based on peculiar oil industry conditions that rendered oil deregulation unsuitable in the economy. Economists and other experts concerned might have overlooked these conditions when they steadfastly advocated and affirmed oil deregulation in the past.

Regulation of business maybe bad, but lack of regulation can be worse because if unbridled, free market operates much like the law of the jungle, where the strongest and most ferocious lion reigns supreme over weak and defenseless animals. In the same fashion, under untrammeled free market, powerful and oligopolistic companies acting in concert--or in cartel under the direction and guidance of their industry associations--may hold captive customers in the palms of their hands.

Free market satisfactorily works in numerous relatively low-capital small and medium enterprises, where collusion is impractical because anybody with some means can join the competition once high selling prices make the business too profitable, so that an automatic price-control mechanism operates, as in the case of hardware stores which we see everywhere, or in mineral-water supply where growing competition has brought prices significantly down. This is not necessarily true, however, in capital-intensive oligopolistic industries controlled by just a few sellers, like the oil industry where not just anybody can put up an oil company even if business is made too good by high prices--therefore there is no automatic price-control system under which new competition from the ranks of onlookers (lured by potential high profits from high prices) will emerge to unwittingly dampen profiteering prices. This condition, plus some peculiarities or unique characteristics of the local oil industry, rendered deregulation incapable of producing the desired result—lower petroleum product prices.

On the contrary, oil industry deregulation spawned higher prices, as explained in this paper, presented for the information and consideration of concerned government officials and citizens.




I. TO BE TRULY PRO FREE MARKET
MEANS INTERVENING IN THE MARKET
WHENEVER THERE ARE MANIPULATIONS
AND EXCESSES BY MISBEHAVING
ECONOMIC PLAYERS

Under government regulation, price control may render unprofitable the production and marketing of goods, thereby discouraging production and causing short supply in the market, to the detriment of the buying public. Therefore, free-market adherents, including non-performing economic managers afraid to disturb the market lest they be blamed for any disastrous results, want to let market forces—or sellers and buyers by themselves—come up with the right prices enough to maintain supply and demand for products.

However, if regulation of business is bad, lack of regulation is not necessarily good either. Economic players—sellers and buyers, creditor-banks and entrepreneur-borrowers, employers and workers, etc.—have conflicting interests, hence the government cannot abdicate its powers, do nothing, and simply “delegate” to one party like sellers the protection of the other party. Usually united, powerful, oligopolistic, or cartelized sellers may take advantage of weak and unorganized buyers--through overpricing and profiteering.

Therefore, to be truly pro free market does not always mean doing nothing, leaving everything to market forces, and letting the price seek its own level, that happens only in textbooks--it cannot happen in a captive or cartelized market. In the real world, there can be price manipulation, cartel, hoarding, intentional cutback in production, and other unfair practices that vitiate free market. Under any of these economic-sabotage conditions that hamper the free operation of the economic law of supply and demand, the government has to intervene to preserve, not destroy, free market. [Marcelo L. Tecson, Sr., Puzzlers: Economic Sting, ( Makati City : Raiders of the Lost Gold Publication, 2005), pp.12-13, 141, 227]




II. OIL DEREGULATION VS. REGULATION—
WHICH OPTION PRODUCES THE
DESIRED MARKET?


To begin with, what kind of market do we want? The choice between deregulation and re-regulation should depend on the kind of oil market we need and want. In this case, I suppose we need a market that provides reliable or stable supply of quality petroleum products at the cheapest or most advantageous prices to the buying public.


1. On the Provision of Stable Supply—
There Was No Threat of Supply Cut-Off
in Defiance of Regulation for as Long as
Profit Margins Were Allowed and Cost
Increases Were Recovered During Past
Regulated Regime

It is assumed under the dominant--though currently criticized because of the present global economic meltdown--free market economic ideology that lack of price regulation, or deregulation, is conducive to the provision of stable oil supply. The question then is whether the alternative option, regulation, can provide the same stability in supply. Stated differently, will price regulation discourage continuing oil supply in the market?

In the more than two decades I worked in the energy sector, the most part of which was spent in the oil industry, except for one instance provoked by prolonged delay in approval of oil industry price-increase petition before martial law, I am not aware of any threat of supply cut-off that was provoked by price regulation. The oil companies had accepted for years the then scheme of having them earn a specified peso margin per liter of product under government-approved selling prices. Thereafter, to take care of subsequent crude oil price increases, the selling prices were adjusted upwards on a purely cost-recovery basis. That way, the prevailing margin per liter of product is indefinitely maintained.

How did the unwritten fixed-margin arrangement become acceptable to the oil industry?

The oil companies did not complain for as long as they could raise prices even on cost-recovery basis only. This situation stemmed from the need by multinational oil companies with integrated global operations to maintain regular crude oil sales outlets worldwide—rather than rely on selling to the erratic spot market—so that even if they made just marginal profits out of their Philippine refining and marketing operations, it was still economical for them. Moreover, with limited number of competitors in the local market, they compensated through HIGH sales volume their LOW incremental margin.



2. On Affording the Public the Cheapest
or Most Advantageous Prices—
Deregulation Promoted Higher Peso
Margin per Liter of Oil Products


a. It seems the present oil industry deregulation has promoted practically doubled peso margin per liter in the oil industry as far back as 2005 or earlier, and nobody from the public knows how much it has gone up further as of today—thanks but no thanks to the Department of Energy that appears clueless on the matter.

Paradoxically, deregulation, instituted in 1998, instead of promoting reduced profit margin in the oil industry as a result of competition from new and independent players, practically doubled the regulated margin by 2005 or perhaps even earlier. Worse, by 2009, it seems the Department of Energy (DOE) cannot even say how much the existing margin is.

In the case of gasoline, as reported in the August 22, 2005 front-page news story by the Philippine Daily Inquirer, which used data presented by the government-commissioned Independent Review Committee in June 2005, the P2.67 per liter margin (23% of P11.62 per liter pump price) under the past regulated regime rose to P5.00 per liter (16% of P31.18 per liter pump price) under deregulation, or a whopping increase of P2.33 per liter. Thus, while PERCENT MARGIN on SALES dropped from 23% under regulation to just 16% under deregulation, it actually translated to almost doubled PESO MARGIN per LITER owing to the drastic rise in SELLING PRICE. (The witting or unwitting message of the news item was that there was a lowering of prices because profit margin on sales dropped significantly from 23% to 16%, but it was oblivious to the fact that the lower 16% margin is now applied to a much bigger base amount of P31.18 selling price per liter, thereby yielding a much higher P5.00-margin per liter.)

Please note that way back in the 1970's when annual national oil consumption was smaller, ONE CENTAVO average industry price increase per liter meant ONE HUNDRED MILLION PESOS (P100 million) annual increase in sales to the oil industry. As updated, based on our present national fuel consumption of 12 BILLION liters per year (Conrado R. Banal III, "Keep off the gas," Philippine Daily Inquirer, September 17, 2009, page B6), the ONE CENTAVO per liter average price increase would rise to ONE HUNDRED TWENTY MILLION PESOS (P120 million) annual sales increment to oil companies.

If ONE CENTAVO price increase per liter is substantial in terms of absolute amount, how much more if it is in PESOS, as in the case of the P5.00 per liter margin in gasoline sales way back 2005 or earlier. If the average margin for all products is, say, P3.00 per liter, based on 12 billion liters of annual sales, the oil industry will earn some THIRTY SIX BILLION PESOS (P36 billion) in annual net income. If there is a government oil company like Petron Corporation in the past that has say 40% market share, then roughly P14 billion of industry net income would go back to the Filipino people as owners of the government oil corporation.

On the other hand, if the oil industry does not generate this absolute amount of net income, parent-company-to-subsidiary transfer pricing of oil imports beyond international prices used in local product pricing, as well as other possible causes—like failure to attain break-even point on the part of new oil players, or error in calculation of peso margin per liter--may explain the situation.

It goes without saying that the people have to know the very crucial oil industry peso margin per liter, the determinant of possible oil industry overpricing.

So, how much is the average per liter margin today? Will DOE officials please ascertain this critical information--which may make or break deregulation--and tell the people through media?

The newspaper also reported that “Oil firms earn billions of pesos amid crisis.” (Philippine Daily Inquirer, August 30, 2005). This suggests that what the old oil companies lost to the new market players in terms of market share or sales volume, they recovered from the public through increase in selling prices in excess of actual cost increases—which price increases are similarly enjoyed by the new players—an everybody-happy solution for all of them.



b. Past oil industry regulation operated through setting fixed peso margin per liter of oil products and allowing price increases on cost recovery basis only—a scheme accepted by oil companies from inception of regulation in the 1970’s up to its abolition in 1998--and there is no showing that present oil deregulation produced lower peso margin per liter compared to that under past regulation; on the contrary, as just shown, it appeared that the peso MARGIN per liter practically DOUBLED way back in 2005, the year an independent review committee affirmed the supposed need for continued deregulation on the basis of alleged lowering of oil product prices.


Past oil industry regulation did not mean fixing of selling prices at certain levels regardless of subsequent increase in oil importation costs—which could have driven away oil industry players if it were so. Instead, it set selling prices that yielded the authorized fixed peso margin per liter of products to the oil companies, then adjusted the selling prices upwards or downwards whenever there were subsequent cost increases or decreases that would disturb the targeted peso margin per liter. In this manner, the oil companies were assured of return for their capital and efforts, while the spending public was protected from unwarranted overpricing and profiteering.

Under the past regulated regime, the big three oil companies had the entire market for themselves. This explains why they could afford to accept relatively low margin per liter of product. What they lacked through LOW MARGIN, they made up for through HIGH SALES VOLUME. Consequently, small independent players could not compete with them at the time as the small players, given their low sales volume, could not live with low margin

In the first place, how did the fixed peso margin per liter of oil products originate as tool in the regulation of selling prices?

Shortly before the creation of the Oil Industry Commission (now Energy Regulatory Commission) in the early 1970’s, I saw the practice of maintaining existing profit levels and raising selling prices just enough to recover crude oil cost increases done by oil companies themselves. Thereafter, when the foreign parent oil companies tried to raise their margin on crude oil sales to their local subsidiaries by way of “hardening of prices” or increase in inter-company pricing—it was too late for them. The increased inter-company billings were not allowed as price-increase item by the already created Oil Industry Commission. This scheme of allowing a fixed margin per liter was refined later and perpetuated throughout the regulation regime through a conscious determination of what was the appropriate peso margin per liter, then maintaining it under all subsequent selling price adjustments.

Government regulators used the allowed peso margin per liter as an easy way of projecting the annual net income of oil companies. If peso margin per liter of products, market shares, and sales volumes were known, then a calculation of estimated ANNUALIZED OIL COMPANY NET INCOME can be readily made. The making of such approximation in the oil industry is quite feasible because three cost accounts alone that are readily determinable accurately--cost of imported oil, direct labor, and taxes--already constitute roughly 90 percent of total cost, so if we estimate the remaining 10 percent on a very conservative or high basis, our calculations would be substantially correct.



C. To ascertain the propriety of price increases regularly implemented by oil companies, the Department of Energy has to tell the people the historical peso margin per liter of oil products shortly before start of deregulation in 1998, as of 2005 when the independent review committee affirmed the supposed wisdom of the present oil deregulation, as of 2008 when crude oil prices rocketed to roughly $150 per barrel, and as of 2009 under current prices.


At present, the Department of Energy is not being asked to regulate selling prices because it has no such power under the Oil Deregulation Law. However, under the monitoring requirement of this law, it is expected to answer the question as to how the peso margin per liter of oil products behaved after the advent of oil deregulation in 1998, so the people will know whether deregulation has indeed been beneficial to them by way of lowering of prices, as professed by the independent review committee that evaluated deregulation in 2005.

The independent review committee concluded that deregulation brought about lower prices. By prices, it meant SELLING PRICES PER LITER of oil products. The selling prices consist of two components—COST RECOVERY and MARGIN. The cost-recovery component refers to part of sales used to pay the cost of goods sold: oil importation costs, taxes, and refining and marketing expenses. Margin refers to the remainder of selling prices that inures to the oil companies as profits.

We don't have to quibble over the selling price component used to compensate the oil companies for their costs because, in reality, this portion does not remain with them--it goes to the payees of their costs. For as long as necessary and incurred on an arms-length basis, their costs would be the same whether they are under regulated or deregulated regime.

What we should scrutinize then is the selling price component that goes to the oil companies--the PESO MARGIN PER LITER. Oil deregulation would have been beneficial, it would have LOWERED indeed the oil industry SELLING PRICES--if there is a DROP in the component subject to possible reduction as a function of competition under deregulation--the PESO MARGIN PER LITER of products.

Now, what are the facts? After deregulation, did the oil company PESO MARGIN PER LITER in fact DROP from its level before deregulation in 1998 to lower levels as of 2005, 2008, and 2010?

Any defense of oil industry deregulation is not right for as long as the above question is evaded and not correctly answered.



3. Regulation Has Built-in Disincentive
to Oil Smuggling, Thereby Avoiding Smuggling
and its Concomitant Problems of Reduced
Tax Collection and Ballooning Budget Deficit
Under Deregulation

Rampant oil smuggling, to become feasible, has to hurdle two obstacles: first, market for the smuggled oil, and, second, evasion of apprehension by the AFP (navy, coast guard) and PNP.

Under the past oil regulation, the oil market was controlled by the big three oil companies, which could live with LOW MARGIN owing to their HIGH SALES VOLUME. With their prospective LOW SALES VOLUME, independent players could not enter the oil market because they could not survive under the then prevailing LOW MARGIN for the industry. With the market in the firm hands of the three oil majors, it was, therefore, difficult to find regular market for significant volumes of smuggled oil. Smugglers could not regularly sell in noticeable volumes to service station dealers because it would be in violation of the latter's dealership contracts with the big three oil companies to buy from other sources. Smugglers could not also sell regularly to major direct consumers because the latter have standing purchase contracts with the big three. Any disruption in purchase pattern can be readily noticed, with smuggling as cause easily discovered and reported to authorities. Consequently, with the first hurdle alone difficult to overcome, the system had built-in DISINCENTIVE to OIL SMUGGLING and the smugglers themselves would not attempt to do it.

Under oil deregulation, it is easy to hide smuggled oil because there are many independent players. The authorities could wittingly or unwittingly fail to pin down actual cases of smuggling because there are many legitimate oil importations by the independents, and smuggled oil can be injected and assimilated into the system. Therefore, the SMUGGLERS could pass the first hurdle--market. They have to contend only with the second HURDLE, the military and the police. As can be observed, our law enforcers have not been effective in curbing smuggling.



4. Under Deregulation, Whenever there is
Oil Cost Increase, Prices are Raised Even
Before Exhaustion of Low-Cost Inventory;
However, Whenever there is Oil Cost Decrease,
Prices are Reduced After Exhaustion of
High-Cost Inventory—a Practice Suggestive
of Cartel, not Free Market Competition

Under deregulation, to recover cost increase in oil importations, the oil industry raises oil prices even before its low-cost inventory is exhausted. In the process, it overcharges its customers on low-cost inventory sold at higher prices intended for subsequent high-cost oil purchases.

In a reverse situation, whenever there is drop in purchase costs of imported oil, the oil industry exhausts first its high-cost inventory before implementing price reduction. Thus, the oil industry has something to gain and nothing to lose—at the expense of the people.

In comparison, under regulation, the government allows price increase after the estimated exhaustion of low-cost inventory. Usually, the combined inventory of crude oil and petroleum products was equivalent then to about 45-day sales volume. This meant that unlike the present prompt raising of deregulated prices whenever there is price increase in oil imports, under the past oil regulation, price increase would be allowed only after 45 days when the low-cost inventory is deemed exhausted.

The very low oil inventory of new economic players without refining facilities is precisely one of the disadvantages of the present deregulated system. During volatility of international prices, they may raise their local prices, but it is possible that before they get their replenishment stock, the international prices have gone down, and yet they have already unduly raised their prices even if it will turn out later that they will not actually incur increased cost because of the subsequent drop in international prices.

However, the WORST EFFECT of very low oil industry crude oil and product inventory will be felt as and when there is war or international political upheaval and there arises a disruption in oil supply to us. Within a very short period of less than a month, the country will run out of needed oil supply—which will bring the entire economy to a halt. This is not the case in other countries conscious of this contingency and have prepared for it.



5. In Competent Hands, the Implementation Tool
of Oil Regulation--Oil Price Stabilization Fund
(OPSF)--Will Not Entail Subsidy, as was Already
Done for Years Before EDSA I


a. The rationale for OPSF

It seems there is a misconception about OPSF as implementation tool of oil industry regulation. It will not be used to shoulder any needed price increases that have to be borne by the buying public. All necessary increases in pump prices of petroleum products will still be instituted as is the case right now under deregulation, hence regulation will not result in any subsidy by taxpayers. The main difference is that, under regulation, after allowing the oil industry a pre-determined peso margin per liter of products, subsequent price increases will be on cost recovery basis only.

Oil companies do not start to suffer cost increases at the same exact time. For example, one oil company’s first shipment of imported oil at newly increased purchase price has already arrived while those for other oil companies will arrive some weeks later. In this case, the particular oil company will need to raise its prices ahead of the other companies, but it cannot do so because its products will not sell if the other companies have not yet raised their prices. It cannot stop selling its oil products either while waiting for industry-wide price increase, because it will disrupt its regular oil supply to its traditional customers, with dire consequences.

On the other hand, as their high-priced importations will arrive later and are not yet in the market, the other oil companies could not yet raise their prices without being accused of overpricing and profiteering. Under the circumstances, to do justice to the particular oil company without being unfair to the buying public through premature industry-wide price increase, the OPSF can be used to reimburse the particular company for its cost increase already incurred—a case of addressing phased or uneven but material industry cost increases in needed precision and tailor-made fashion.

To generate cash balance for OPSF, a separate oil-company price increase earmarked for this purpose has to be authorized by the Energy Regulatory Commission. Whenever the motoring and consuming public buy oil products, their purchase prices will include the OPSF levy. Oil companies will receive the OPSF impost as part of their daily sales collection from customers. On a monthly basis, they will remit the collected OPSF impost to the Land Bank trust account designated for the purpose. As can be seen, part of the public which does not buy oil products will not contribute to the OPSF, therefore it will not entail subsidy from the non-buying public provided the OPSF is properly managed and does not develop any deficit.

Proper OPSF management includes the government’s prompt authorization of industry-wide price increase once all the oil companies have received oil imports at newly increased costs, then started selling the same in the market--which will result in oil companies getting their cost recovery from the newly increased selling prices, no longer from the OPSF, thereby stopping avoidable further claims from the OPSF. However, the OPSF impost on oil product sales will continue even if claims from it will temporarily stop, resulting in continuing build-up of the fund until it is used again in the next round of oil import cost increases.

The problem of one oil company receiving and selling high-priced oil imports ahead of other oil companies will be encountered alternately by all of them, hence it is a potential common problem to them. We can assume that oil industry members have tackled this problem in their industry meetings under the auspices of the Petroleum Institute of Philippines (PIP), or whatever its new name is. In most probability, their agreed upon solution is premature industry-wide price increase. This maybe discerned from their sometimes weekly price adjustments, as well as their waiting for further price developments abroad, which suggests that any price increase abroad is followed by corresponding prompt price increase in the Philippines, something needed by purely marketing oil companies with minimal product inventory and without any crude oil inventory, because they do not have oil refining facilities in the Philippines.



b. As was done for years in the past before the OPSF became discredited in the hands of new government officials--who unwittingly converted the Fund into a subsidy scheme for populist reasons--the OPSF can be successfully operated without entailing subsidy from the general public

The usual OBJECTION to oil-industry REGULATION is that it will entail SUBSIDY from the general public through its implementation tool, the OPSF. The subsidy will arise if owing to delay in price increase, oil industry cost recovery will continue to be sourced from the OPSF, which will then suffer a DEFICIT, with the deficit being satisfied through replenishment from TAXES paid for by taxpayers, many of whom do not buy oil products. The net result—the non-buying public (like the super-poor without cars), which pays value added tax through its purchases of non-oil products but do not buy gasoline, will subsidize the buying public (like the super rich with Mercedes Benzes and BMW’s). Economists and other experts who look at things this way will certainly object to OPSF, and because OPSF is part of oil regulation, they will likewise object to regulation.

The objection is unwarranted, for it is premised on the automatic assumption that the government will mismanage once again the OPSF as was the case some years after EDSA I. The mismanagement was in the form of prolonged delay in oil price increases due to populist reasons. The delay caused MULTI-BILLION-PESO OPSF deficit. This monumental error need not be repeated in re-regulation. All that has to be done is to institute prompt price increases as warranted. These prompt price increases will even be SLOWER than the present FAST price-increase initiative by the oil industry, which immediately raises product prices even if the existing low-cost inventory is not yet exhausted.

The OPSF scheme started in mid-1979. As of mid-1984, total fund utilization amounted to more than ELEVEN BILLION PESOS (P11 BILLION). By December 31, 1985, as shown in a printed report submitted to Malacanang, it had a cash balance of P1.4 BILLION, temporarily invested in Treasury bills while still unused. By December 1986, some P600 MILLION OPSF collection was invested likewise in Treasury bills. Thus, for seven and a half (7 ½) long years of operation as of end 1986, the OPSF generally functioned smoothly and did not entail any subsidy from the non-buying public.

Therefore, it is not right to say that the OPSF cannot be operated without accompanying subsidy from taxpayers. It was done for years in the past when then PNOC Senior Vice President Antonio V. del Rosario was Undersecretary of Energy, when Petron Corporation Vice President Orlando L. Galang was Director of the Bureau of Energy Utilization, and when I was in the Finance and Management Service of the now Department of Energy, where I had to oversee the processing (especially documentation and checking of calculations) of the cited more than ELEVEN-BILLION-PESO oil company reimbursement claims from the OPSF. Please note that at our own initiative and request, which was granted by the Commission on Audit (COA) as an exception to the then already existing practically 100% withdrawal of COA pre-audit, all OPSF reimbursements were pre-audited by COA.



6. Under Regulation, Price Increases and
OPSF Reimbursements Were Based on
Cheapest International Prices at which
the Imported Crude Oil Could be Purchased

In the regulated set up, the oil companies could not as a matter of right invoke price increases based on their documented purchase prices of imported crude oil. Even if their actual purchase costs were higher, the government-authorized price increases and OPSF reimbursements were limited to the allowable ceiling or benchmark prices--the most advantageous posted prices for crude oil offered for sale in the international market. This safety net protected the buying public against any attempted upward manipulation in crude oil prices. It also constrained the oil companies to procure crude oil from the cheapest sources, or make their prices competitive with the cheapest prices.



7. There is Nothing Wrong in Government
Intervening in Monopolies, Oligopolies,
and Strategic Industries Providing Public
Services or Sensitive Products, like the
Oil Industry Where any Significant Price
Increase Triggers Inflation

Logically, for as long as a profit- and service-oriented government corporation is efficiently managed and profitable, it is better owned by 92 million benefiting Filipinos than by a few thousand benefiting generally well-off private stockholders—a basic application of the democratic fundamental philosophy of achieving the greatest good for the greatest number. However, some economists (as well as other experts for that matter) beholden to free market cannot see it that way. They make no distinction between profitable and losing government corporations. For short-term gain out of the proceeds of privatization, they cannot see the crucial long-term role of government corporations in public-service and sensitive industries, where the government should maintain presence as safety net in the protection of free market and public interests. Thus, Petron Corporation, as well as other government corporations, were privatized because it seemed some of our economists in public and private sectors hate to see the 92 million Filipinos--the true owners of government corporations--given preferential treatment (in the enjoyment of profits from these corporations) over a few thousand private stockholders, who could not care less about the public being overcharged for their products, for as long as the MARKET CAN BEAR their exorbitant selling prices.

Chinese government officials, the administrators of the world’s giant economy—reported to be with the biggest dollar reserves—see things differently and more logically. Instead of entrusting key industries totally in the hands of private stockholders, they have GOVERNMENT corporations HANDLING their growing EXPORTS. For instance, when PNOC imported Shengli crude oil from China years ago, it had to transact with a Chinese government corporation.

This is not to say that no government corporation should be privatized. What I am saying is that while the government has abandoned its presence in the oil industry through privatization of the government-owned Petron Corporation, the government should not totally abdicate the protection of the buying public through 100% deregulation of the oil industry. As it is a very complex and sensitive industry—price increases in its products provoke inflation—the government should at the very least ensure that oil products are priced fairly and equitably.



8. Under Present Deregulation,
Captive-Market Pricing Can be Done
Even in an Urban Center, Which was
Never Done in Past Regulated Regime

Under existing deregulation, supposed “market forces” have produced CAPTIVE-MARKET PRICING—not free-market pricing—of oil products in Cebu, the nation’s populous and vote-rich Queen City in the south, and not even its representatives in Congress could do something about it. Under regulation, there was no such exploitative captive-market pricing over NO-CHOICE customers, especially in Cebu which is not a far-flung area. In the past, the local oil majors prepared WHOLESALE POSTED PRICES (WPP’s) for different locations nationwide, with price variations accounted for mainly by differences in transshipment cost.

The propounded captive-market pricing in Cebu is presented in an email I received. The selected quotes from the article of an apparently aggrieved Cebuano is shown below. For the puzzling overprice, the article exhausted all possible reasons, none of which sensibly justified the higher price of up to P8.00 per liter solely in Cebu. By process of elimination, arbitrary captive-market pricing remains as the possible culprit. If so, is this not a case of misbehaving economic players in a vitiated free market that calls for government intervention?

From: cepolitics
To: CePol@yahoogroups.com
Sent: Tuesday, September 29, 2009 10:57:07 AM
Subject: Don't take Cebuanos for fools


AS IT APPEARS
By Lorenzo Paradiang Jr.
(The Freeman)
Updated September 29, 2009 12:00 AM

Selected Quotes from the Article:

“It's a stinging pain of adding insult to injury, as in putting salt to the wound, that the "Big 3" oil firms--Shell, Petron, and Caltex-Chevron--are recklessly taking Cebuanos for fools.

“Long have the Cebuano oil consumers been unreasonably slapped with a P5.00 to P8.00per liter higher pump price compared to any other elsewhere nationwide…. The over-abused excuse is the recycled so-called "market forces", or a bigger term "economic fundamentals", or "things uncontrollable", or the "law of supply and demand" factor.

“Starting with alleged "competition" factor as causing the pump price discrepancy.… If there's competition among the petroleum suppliers, then the end-result would have been similar low prices in Cebu as in Manila and elsewhere in the country. Given the oil suppliers nationwide are the same--even including small/medium stakeholders--does it mean that they have agreed to gang up on Cebu, while being competitive in other local markets? Or, if stiff competition dictates the Manila cheaper pump price, what about in Mindanao and elsewhere, except Cebu?

“Another weak excuse for the overprice in Cebu, is a vague hint of the peso-dollar exchange rate fluctuations. Again, how does such facet affect only the Cebu pump prices as much steeper than anywhere else? Whether the peso-dollar exchange fluctuation is exclusively applied at source of importation, or continues along in transit up to distribution, then the question again is: Why single out Cebu as lone victim to shoulder the much greater burden?Remember that the price difference is P5.00 to P8.00 per liter, not per barrel, or per ton.

“Then there's the oft-cited "high cost of production" exponent which mainly goes, most likely, with the refining of crude oil, as well as its incremental overheads. Safely assuming that the refined products (were) shipped from the same refinery plants in the capital region in Luzon to the Visayas and Mindanao, why must Cebu stand out like a sore thumb to get slapped with the lion's share of the high cost of production?

“The most plausible basis for the price discrepancy could be the cost of transshipment of refined oil from the common refinery to distribution points. But then, again, this factor is unavailing because how come that the oil retail cost in (farther) Mindanao is cheaper than that of (nearer) Cebu, given the comparative transshipment variance in distance from the same source or refinery?
“In recap, Rep. Raul del Mar's suggestion is logical that the cost of oil per liter in Manilaplus transshipment cost ought to be the pump price in Cebu, not more.

“Meantime, DOE Secretary Angelo Reyes appears still hedging on what steps to take… as if biding his time for the controversy to die down on its own….”




9. Past Regulation Ensured that High Transfer Pricing
Was Not Passed on to the Consuming Public

In the past, under regulation, the government addressed the problem of high crude oil transfer pricing between foreign parent oil companies and their local subsidiaries--by creating the Philippine National Oil Company in November 1973 and acquiring two local oil companies that now jointly exist as Petron Corporation. Thereafter, PNOC bought crude oil direct from oil exporting countries, principally Saudi Arabia, so the problem of unfair transfer pricing was avoided.

In the case of other oil companies, their selling prices were made competitive to that of Petron, so their high transfer pricing was also nullified. However, such high transfer pricingmay have persisted to this day to show low net income in the financial statements of their local oil subsidiaries--which might have misled those looking at their financial statements into believing that deregulation has indeed pared down oil industry profits.

Unfortunately, with the advent of globalization and deregulation, Petron Corporation was privatized-- thereby sacrificing for short-term gains the need for the government's permanent presence as CATALYST in the inflation-sensitive oil industry.

Today, high transfer pricing may not count in the setting of selling prices, but it may still have a role in the showing of low net income for multinational oil-company subsidiaries. As for the possible low net income of new marketing oil companies without refineries, that may be more due to their failure to go way above break-even sales volume, not because of low selling prices.



10. Considering the Advent of the Era of Crude
Oil at $100 per Barrel, We Have to Take Another
Look at Oil Industry Deregulation vs. Regulation--
Because Oil Product Prices Have Gone so High
that the Public Cannot Afford Even the Slightest
Overpricing by Oil Companies.


Oil industry regulation was implemented in the past for years with sustained LOW MARGIN PER LITER, together with rationalized wholesale posted prices that were fair to CEBU customers and others. I cannot see why it cannot be done today. Some of the highest government officials responsible for the implementation are still around and can give insights on the matter.

The simple test of the advantage or disadvantage of oil deregulation is on its impact on the PESO MARGIN PER LITER of oil products. We should not begrudge the oil companies if they raise prices to recover actual cost increases of imported oil. However, if under prevailing distressed conditions of our economy, their price increase constituted increase in their INCOME over what they used to earn under the past regulated regime, then we have to take a fresh look at oil industry deregulation under present distressed economic conditions.

So, the question now is, what was the oil industry PESO MARGIN PER LITER shortly before the onset of oil deregulation in 1998, what was it as of mid 2005 when the independent review committee affirmed deregulation, and what is it TODAY? We have to know first the answer to this question before continuing to meekly accept that deregulation actually resulted in lower prices.



III. DISSENT TO THE INDEPENDENT REVIEW
COMMITTEE'S AFFIRMATION OF OIL
DEREGULATION IN JUNE 2005:

REGULATION OF PROFIT RATES—NOT SELLING
PRICES PER SE--IS A METHOD ENSHRINED IN
OUR LAWS AND FOLLOWED UNDER ECONOMIC
CONDITIONS THAT DO NOT EXACTLY LEND TO
DEREGULATION OR UNBRIDLED FREE MARKET,
AS IN THE CASE OF FRANCHISE-HOLDER UTILITY
MONOPOLIES AND PUBLIC SERVICE PROVIDERS


In its June 2005 Report on the Downstream Oil Industry Deregulation Act of 1998 (RA No. 8479), the government-commissioned Independent Review Committee, which included experts in accounting and economics, presented two possible ways of reducing oil product prices:

(1) Ask oil companies to reduce prices.

(2) Provide subsidy.

As the Committee correctly concluded, the two options are not feasible. If, as a matter of policy, selling prices are fixed at arbitrary levels under which oil companies would incur losses without any prospect of making profits in the future, they would certainly close shop.

On the other hand, if the reduction in selling prices would be made up for by taxpayers’ subsidy in order to entice oil companies to stay, it is also not feasible because the government does not have the needed subsidy fund. On the contrary, it is faced right now by more than P200-BILLION budget deficit. Moreover, such subsidy scheme is not right. It makes even poor people who pay taxes through 12% VAT on product purchases--but do not consume oil products--shoulder the cost of gasoline and diesel used by rich car and sports-utility-vehicle owners.


1. The Independent Review Committee Did Not Err
in its Two Price-Reduction Options; Unfortunately,
its OPTIONS Were INCOMPLETE

Please note, however, that the options presented by the Committee were incomplete. It did not include a third option already followed during the past regulated regime for roughly TWO DECADES, implemented smoothly from the early 1970’s up to the time the OPSF was subsidy-free shortly before the outbreak of the first Gulf War in August 1990. The feasible third option: reined in selling prices (meaning, devoid of overcharging) through government authorized fixed PESO MARGIN per LITER of OIL PRODUCTS.

Oil industry regulation through allowing a predetermined PESO MARGIN per liter of products is the recommended feasible option because it addresses the OBJECTIONS against the two options cited by the Independent Review Committee in June 2005. It does not arbitrarily FIX the SELLING PRICES at amounts that may cause the oil industry to suffer losses. On the contrary, it automatically allows PROFITS to oil companies at targeted reasonable range depending on prevailing economic conditions. It also does not entail taxpayers’ SUBSIDY, just prompt PRICE ADJUSTMENTS on COST RECOVERY basis only—after allowing margin on sales to oil companies and exhausting their low-cost inventory.


2. There are Existing Price/Rate Regulation Models
to Go by in Oil Industry Regulation, and These
Do Not Involve Setting of Prices/Rates at Fixed
Immovable Levels Regardless of Consequences
(Gain or Loss) to Economic Players

Regulating product selling prices or public service rates does not mean setting prices/rates at fixed immovable levels--regardless of whether the product suppliers or service providers gain or lose in the process. There are available models that have been generally accepted by all concerned—the spending public, industry players, government regulators, and multilateral financial institutions--depending on the amounts at which the prices/rates are set. The most notable local models are as follows:

a. Regulated Maynilad and Manila Water rates, which are allowed to rise for the recovery of legitimate cost increases.

b. Regulated Meralco electric power rates and Transco distribution rates, similarly authorized to rise for the payment of valid cost increases.

c. Regulated telecommunication rates and expressway/skyway toll rates, set at
amounts designed to attain targated rates of return, then adjusted as necessary.

d. Regulated public transport fares, given rate increases whenever there are substantial diesel cost increases to be recovered.

e. Bank spreads or margins, indirectly fixed by Bangko Sentral ng Pilipinas (BSP) during economic turbulences, in order to contain high interest rates.


The last model may not be of public knowledge and has to be explained.

Following are actual cases of how BSP officials, in coordination with banking industry leaders, indirectly set a fixed range of bank spreads or margins for 40 or so operating commercial banks—analogous to fixing peso margin per liter of products to oil companies—as means of stimulating low interest rates, in lieu of simply setting a ceiling or fixing bank lending rates at low levels:

First, at the height of the Asian meltdown during first quarter 1998 (when traders and other borrowers in Mindanao staged militant protests against the then prevailing very high interest rates of almost 40 percent), to calm down the protesting borrowers and avoid possible bank runs, the Bankers Association of the Philippines (BAP) itself came up with a published association members’ “gentlemen’s agreement”—a clear case of cartel--voluntarily limitingbank spreads, or margin, on bank lending from 3 percent to 8 percent over 91-day Treasury bill rates. (References: Deogracias N. Vistan, “Bringing down banks’ lending rates: The rationale of the BAP’s concerted efforts, The Philippine Star, February 20, 1998, page 25; Deogracias N. Vistan, “An Important Message from the Bankers Association of the Philippines,” Philippine Daily Inquirer, March 11, 1998, page B6.)

Second, in reaction to my letter issued personally to BSP officials during the public hearing on high interest rates on April 17, 1998 at the BSP office--in which letter I recommended BSP’s granting of concessionary measures to banks conditioned upon their actual lowering of interest rates--“Bangko Sentral Governor Gabriel Singson has agreed to cut the reserve requirement on bank deposits by two percentage points to 8 percent from the existing 10 percent to enable banks to further bring down their lending rates…. Approval will be conditional on the BAP (Bankers Association of the Philippines) agreeing to lower the member-banks’ lending rates from the present (spread of) 2-7 (percent)… to 1.5 to 6 (percent)…. BAP had accepted Singson’s condition…. The governor made it very clear… that he would only consider reducing the intermediation cost if… banks would reduce the range of their lending rates. Otherwise, the move would only benefit the banks, not their borrowing customers.” (Doris C. Dumlao, “Bank reserves cut to 8%,” Philippine Daily Inquirer, May 21, 1998, p. B1).

Third, during the fury of the Asian crisis in last quarter 1997 and first quarter 1998, BSP found all sorts of reasons not to regulate interest rates and pinned so much hope and reliance on its moral suasion over banks, as reflected on the July 27, 1998 report of the BSP Committee on Interest Rates. The fact, however, that Philippine banks charged the highest and way out-of-line interest rates and bank spreads in the region meant that BSP’s moral suasion was powerless against banks. However, this was not the case when a brand-new new Governor, Mr. Rafael Buenaventura, took over the reins of BSP. At that time, the following news item appeared in a local daily: “The Monetary Board, the policy-making body of… Bangko Sentral ng Pilipinas… is drawing up sanctions against banks violating the 1.5 percent to 6 percent spread on lending rates (the same 1.5 percent to 6 percent bank spread set by BSP Governor Gabriel Singson in May 1998, as shown in the second case above) over the prevailing yield of the benchmark 91-day Treasury Bills…. BSP… disclosed (that) the (monetary) authorities are looking at withholding approval of bank branch application of those summarily charging interest rates beyond the agreed spread.” (Fil Sionil, “MB prepares sanction on spread rule violation,” Manila Bulletin, September 6, 1999, p. B-1). What happened thereafter? “Reacting to threats that the Bangko Sentral will come down hard on banks that will sharply increase their lending rates, most banks left their rates unchanged or even lowered them, according to the Bangko Sentral’s industry survey…. The decline came despite the rise in Treasury bill yields across the board last Monday.” (R. G. Falgui, “Loan rates dip despite hike in yields of T-bills,”Business World, September 9, 1999, p. 13). Thus, under a new Governor, BSP suddenly found its bearings and successfully reined in bank spreads as means of stabilizing or lowering interest rates.

In sum, the recommended oil industry regulation, which uses the mechanism fixed PESO MARGIN per LITER of oil products in preventing profiteering selling prices, is not an outlandish idea. It is just another form of already existing profit-rate regulation, applied in this case to inflation-inducer petroleum products and designed to yield targeted profits or return to industry players. It is in lieu of blindly fixing selling prices without regard to resulting gain or loss to industry members. Moreover, while it fixes peso margin per liter, it does not control sales volume, hence it encourages competition in the increasing of market share towards greater absolute amount of incremental income, thereby inducing each market player to reduce, not raise, selling prices to the extent it can.




IV. CONCLUSION: THE BEST THAT WE DO NOT
HAVE TODAY UNDER DEREGULATION, WE
HAD IN THE PAST UNDER REGULATION,
SO WHY NOT RE-REGULATE? IF THE
GOVERNMENT ACTUALLY IMPLEMENTED
REGULATION FOR YEARS BEFORE EDSA I
WITHOUT SUBSIDY IN OPSF, WHY CAN’T
IT DO THE SAME TODAY?


The best that Filipinos wish—but do not have--under the present regime of deregulation, they already had in the past under oil regulation. Under the old regulated regime, after allowing oil companies a much lower peso margin per liter, they were authorized to raise their selling prices on cost recovery basis only. Moreover, they could charge the new rates from the date the industry low-cost inventory is deemed exhausted, not earlier. Equally important, there was no threat in the stability of supply that might be ascribed to price regulation.
In economics, deregulated or free market is the catalyst for sustained product supply at competitive prices. Incredibly, as stated, we already enjoyed this situation under the past oil-industry regulation before the OPSF was transformed into a subsidy scheme some years after EDSA I, or during the first Gulf War in 1990-1991 when crude oil prices rose dramatically without corresponding prompt adjustments in authorized local oil product prices, thereby leaving OPSF the burden of shouldering the necessary stiff price increases.

Knowing how the multi-billion-peso OPSF subsidy arose in the past, are our energy officials so incapable that they do not know how to avoid its fallacious repetition--which is why they always assume that it will be repeated, which is why they always pose its repetition as objection to re-regulation?

If not, what more do we want? What deal or option can we find better than a doable and properly implemented oil regulation?

We already had the best in the past, yet our executive and legislative government officials (including those who fallaciously converted the OPSF into a subsidy scheme due to populist reasons) did not know it. They opted for deregulation on the expectation that new market players would bring about lower prices. Indeed, we initially enjoyed lower prices from the new players, but after gaining their share of the market, they raised their prices to the same levels as those of the old oil companies. This is not surprising because in the oil industry,three non-controllable costs alone—cost of imported oil, direct labor, and taxes—constitute roughly 90 percent of total cost even before crude oil prices soared in 2008 to unprecedented heights, in the process giving new and smaller players very little elbow room for reducing prices and margins.

The reason is that unlike in other industries where economic players compete in both thePRODUCTION and MARKETING of goods at the cheapest cost and prices—in the local oil industry, the economic players compete in the MARKETING phase only. They do not compete in the production or extraction from the ground of the oil products that they obtain through purchase from exporters abroad, so they procure their traded products at essentially uniform costs without much room for competition in the procurement process. Add Philippine taxes to cost of imported oil and the resulting total amount comprises at least 85% of total cost of goods sold, as we computed way back in the 1970’s when crude oil price was at way less than $30 per barrel.


The foregoing peculiarities in the local oil industry—which free-market apostles and pro-deregulation economists may have overlooked all this time—means that competition under deregulation instituted in 1998 cannot actually promote significant lowering of oil prices, because of the following:

First, there was NO prior HIGH MARGIN under past regulation
from which the price reduction under present deregulation
could be sourced, and

Second, the arena for price competition in the local oil industry
is very limited: in the MARKETING aspect only, which may
just be about 10% or a little more of cost of goods sold,
instead of in both production and marketing.


To illustrate, in the power industry which has substantially varying costs of electricity produced from hydro, geothermal, coal-fired, bunker-oil-fired, and diesel-fired power plants, price competition lies mainly in the PRODUCTION aspect—which is not the case in the local oil industry.

On the contrary, as what can be observed, deregulation will promote high prices because with the sharing and division of the existing fixed market pie over the greatly increased number of economic players, and with resulting REDUCED or LOW PER CAPITA SALES VOLUME for each of them, there will be compelling desire for everybody to RAISE PESO MARGIN PER LITER to generate the absolute amount of net income satisfactory to each of them. With present HIGH MARGIN, the three oil majors are compensated for part of their market shares eaten up by the new market players, while the new players with still LOW SALES VOLUME are appeased by the significantly raised margin per liter—a win-win solution for all of them at the expense of the buying public.

It is time the government do justice to the Filipino people by giving them under regulation what the oil industry has deprived them under deregulation—proven fair, transparent, and most advantageous oil product prices.
Accordingly, return to oil regulation is hereby respectfully recommended, for consideration by concerned government officials and citizens.

MARCELO L. TECSON
A Concerned Citizen


martecson@yahoo.com,
martecson@gmail.com,
San Miguel, Bulacan
9-30-09, 10-26-09, 11-06-09, 11-23-09, 1-24-10, 1-27-10