Does the local oil refinery deserve tax incentives?

When the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Bill was passed in the Senate in November 2020, a bicameral conference committee (bicam) was convened, supposedly to iron out differences between the Senate and House versions of the bill.

But after two months of stealthy discussions, CREATE came out of the bicam with completely new provisions which did not exist in either of the Senate nor the House bills. By the time the public got wind of these insertions, both houses of Congress ratified the bill, bypassing any opportunity for public debate.

One particularly controversial insertion is Section 295 paragraph G, a provision exempting local petroleum refineries from paying taxes and duties on crude oil imports. Another provision in Section 296 inserts crude oil refining in the Strategic Investment Priority Plan (SIPP), which outlines the activities qualified to receive incentives.

The secrecy surrounding the bicam proceedings begs the question — what or who prompted these questionable insertions?

Ultimately, the insertion of tax breaks for crude oil refiners can be linked to the precarious state of the last remaining oil refinery in the Philippines, the Petron refinery in Limay, Bataan. The refinery temporarily shut down in January due to weak refining margins. In late 2020, Petron publicly appealed to the government for tax exemptions, warning that the refinery would shut down otherwise.

In a memorandum sent to President Rodrigo Duterte on Feb. 6, House Ways and Means Chair Representative Joey Salceda justified the insertion of tax exemptions for local refineries in CREATE. He argued that the current tax regime disadvantages domestic refiners, imposing higher costs and administrative burdens on the industry as compared to those who import finished petroleum products. Thus, he said that the CREATE provisions on crude oil are simply leveling the playing field by only taxing refined petroleum products after they are removed from the refinery, similar to international practice.

His main argument was that domestic refining is more economically beneficial than importing finished petroleum products, and that closure of the refinery would lead to import dependency. Losing the Petron refinery, he said, would expose the country to a national security threat, as the Philippines does not yet have a strategic petroleum reserve (SPR) managed by the state in case of a national emergency.

Without first considering the merits of the provisions, the manner by which these were included in the final version of the bill is highly questionable. CREATE is not merely a revision of the tax law, but a structural reform that significantly impacts our country’s industrial policy. This is why, for example, the bill only broadly defines what investments may be considered to be strategic and then outlines the process by which any one of these industries may be included in our national plan later on.

Whichever industries our government may deem as strategic must first be scrutinized. Policy makers may identify and propose certain industries to be prioritized, but these must always undergo public debate and discussion, with participation from as many stakeholders as possible.

One underlying principle of CREATE is that fiscal incentives are made transparent and economically justifiable. Last minute insertions made by politicians result not only in an opaque policy process, but in misguided and inferior policies as well.

Perhaps the reason why these insertions were not included in either version of the two chambers of Congress is that these would not have held up under public scrutiny.

The existing fiscal environment is an easy scapegoat to blame for a refinery’s distress or closure, but the hard truth is that local refineries simply cannot “compete with larger integrated end-to-end refineries with petrochemical complexes,” as Finance Secretary Carlos Dominguez III has articulated.

The Philippines has neither the comparative advantage nor the economies of scale to be competitive in oil refining. The maximum productivity of Shell’s recently-closed refinery was around 110,000 barrels per day (bpd) and Petron’s is at 180,000 bpd. In comparison, Singapore’s refineries produce 500,000 to 700,000 bpd; South Korea’s 700,000 to 800,000 bpd; and India’s 1.3 million bpd.

Further, the real constraint faced by local oil refineries is the Department of Energy’s inventory requirement, not the tax regime. To illustrate, the input value-added tax (VAT) of an oil refinery is lower than that of the importer of refined products. The main constraint of the domestic oil refinery is the requirement of an inventory of 60 days’ worth of product, while an importer of refined petroleum needs to maintain an inventory of only 14 days. (In reality, the inventory for the local oil refiners is around 40 to 45 days.) This is not only a larger cost factor than existing taxes, but also renders oil refineries more vulnerable to price squeezes.

However, a larger inventory cuts both ways. Oil, being a commodity, is subject to price volatility. Unfortunately, at a time of reduced demand and oversupply resulting in lower prices, a large inventory translates into higher costs. On the other hand, when oil prices shoot up, a large inventory results in a windfall for the local oil refinery. Petron wants to have its cake and eat it, too.

The reality is that our local refineries are not economically viable. To repeat what Finance Secretary Dominguez said, crude oil refining in the country is uncompetitive, and hence does not deserve tax incentives.

These misguided insertions for Petron will not make its refinery more efficient or scalable, nor are they likely to keep the refinery open in the long run anyway. In fact, due to our archipelagic geography, it is often much cheaper to import petroleum from Singapore to Mindanao, than it is to ship it from Manila to Mindanao. Our irrational fascination with self-sufficiency often comes at the great expense of forgoing sustainability.

Globalization has led to greater integration and interdependence among economies, making it less worthwhile to try to produce everything ourselves at all costs. Especially for oil, as everyone desires a drastic reduction of the carbon footprint, our country must wean itself away from fossil fuel.

Framing this as an issue of national security is a tired argument. Like it or not, oil is almost absolutely scarce in the Philippines.  Even Petron imports its crude oil. The Philippines imports 99% of its crude oil. In this light, the argument of national security by way of protecting Petron flies in the face of reality.

Keeping our remaining oil refinery is more an emotional reaction than it is a sound economic policy. The general consuming public would actually be better off importing cheaper refined petroleum products.

Besides, we must think long-term and realize that the world is moving away from oil — as it should. Demand for petroleum was significantly weakened due to the COVID-19-induced lockdowns in 2020. But even beyond short-term demand shocks, an increasing number of countries are committing to lower their carbon footprint and shift towards renewable energy.

New Zealand, for example, is pushing for renewables so strongly, that it has disincentivized domestic oil production and refining — rendering it practically completely dependent on imports for any of its oil needs. NZ’s sole oil refinery, which produces 135,000 bpd, is already being converted into an import terminal. This kind of decisive policy is what is needed to encourage the development of alternative energy sources, pushing the country ahead of the curve.

Providing tax breaks for oil refining may benefit one company’s bottom line in the very short term, but it is a futile policy which ultimately contradicts the country’s strategic investment priorities.

AJ Montesa is an economic policy analyst and Pia Rodrigo is the communications officer of Action for Economic Reforms.