Fuel price study

Strategic Perspective
René B. Azurin

Posted on October 25, 2012

BEFORE I left Manila last month for an extended holiday, I had to take part in publicly presenting the results of a six-month study into the “reasonableness” of local gasoline and diesel prices. This was not a particularly pleasant experience. Outside the University of the Philippines’ School of Economics (where the presentation was held), groups known to subscribe to a fixed set of ideas not consistent with the findings of the study predictably staged a loud (though small) demonstration and, inside the hall, their spokesmen used the open forum to criticize the study and even cast aspersions on the motivations of the members of what was called the Independent Oil Price Review Committee, or IOPRC.

The IOPRC study produced four major conclusions. From correlation and regression analyses, one of these was, “Local pump prices are more responsive to world oil prices now than at any period since regulation... (and) This holds whether one looks at the time it takes for local pump prices to respond to changes in world prices or the amount of variation in local pump prices explained by changes in world oil prices.” Essentially, this means that local gasoline and diesel prices simply track international prices of these fuels.

A second major conclusion, drawn from applying what is called a “gravity model,” was that regional pump price differences can be explained partly by distance and the efficiency of the logistical infrastructure, since these affect transport and handling costs, and partly by the intensity of competition in the specific area, that is to say, “greater competition results in lower price”. Basically, this implies that government should increase efficiency “by investing in the necessary infrastructure” and that it should take steps to promote more competition as this “is essential to keep prices relatively low and fair.” Prices tend to be high in areas where the mayor (or some other high public official) owns the only gas station in town.

Third, no evidence was found of the kind of “overpricing” claimed by some consumer groups and by certain senators. To reach this conclusion, the IOPRC developed, through a detailed analysis of all the cost factors involved in the production, importation, marketing, and distribution of oil products, a predictive “Pump Price Model” that would allow the estimation of retail pump prices for gasoline and diesel, given specific values for particular variables like crude oil price, foreign currency exchange rate, and various tax rates.

Finally, using a “project finance model” to calculate the actual internal rates of return of oil companies during pre- and post-deregulation periods, it was concluded that “the oil companies’ profits are reasonable” compared to the returns of companies in other industries like telecommunications, mining, and electric power, and the returns on government securities. It was also found that oil companies’ post-deregulation returns were far lower than pre-deregulation returns.

Reacting to these conclusions, a visibly furious member of a transport group recited the usual litany of criticisms of the “dambuhalang” (monstrous) oil companies, like exploitative pricing and excessive profiteering. Having played his role, this fellow stomped out of the hall without waiting for a response, possibly because he did not feel prepared to engage in an intellectual discussion on these issues.

Anyway, my response -- to this fellow’s friends -- was to point out that what they were actually complaining about was high global oil prices and they were wrongly assuming that the IOPRC study was meant to determine whether those were “reasonable” or not. In fact, what the IOPRC study only aimed to do was to establish whether local producers and sellers of fuel oil products set “reasonable” or “fair” prices in the light of prevailing global oil prices. In other words, the IOPRC took global oil price levels as a given, not as a study variable. Price-setting in international oil product markets is actually way beyond the mandate of the IOPRC, not to mention its limitations in time and resources. Furthermore, an academic study has to have a clearly delineated proposition that can be established with the tools and data available.

Much more reasonably, someone in the audience asked if the IOPRC study considered the multinational oil companies’ “transfer pricing” practices in determining if local prices were “exploitative” and profits “excessive.” What the question implies is that oil companies, being vertically integrated firms (from oil exploration to oil production to refining to transport to marketing to distribution), can arbitrarily set the “transfer price” from one stage to the next in order to adjust the level of profits at each stage and so allocate the bulk of their profits to wherever locality the tax consequences will be most favorable. The honest answer to the question is “no” and the simple reason for that is that to be able to say anything about this subject would require looking into the books of companies not operating in this country, something not quite possible.

Doubtless, multinational oil companies practice various forms of transfer pricing to allow them to minimize their overall taxes and maximize their global profits. To be realistic, however, the intra-company transfer pricing practices of global companies whose affiliates and subsidiaries are incorporated all over the planet are not something a country like the Philippines, which accounts for about 0.3% of global oil purchases, can do anything about. Even the US, the world’s largest buyer of oil, has hardly any say in this matter.

One of the IOPRC’s recommendations is to establish an automatic fare adjustment mechanism that would allow jeepney, bus, and taxi operators to immediately adjust their fares at the beginning of each month in response to changes in the average price levels of gasoline and diesel during the previous month. Very strangely, the head of a transport union with a pending application for a fare hike and threatening to stage a nationwide strike if this petition was not granted strongly objected to this proposal. That makes no sense unless his true aim is to continue justifying the existence of the union and keep its members contributing union dues.

The IOPRC was created by a Department of Energy circular dated March 1, 2012 in response to a public clamor for an independent investigation into price and profit levels of local oil product producers and sellers. The members were constituted from nominees proposed by various sectors of society and they received no compensation whatsoever.