CPC plays while the consumer pays - Sri Lanka Guardian

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Sunday, November 30, 2008

CPC plays while the consumer pays


"An independently and professionally managed CPC with a price formula in place, will reduce costs, reduce wastage and above all the banks will back it up with good credit terms and thereby benefit the consumer."

by Daham Wimalasena


(November 30, Colombo, Sri Lanka Guardian) Everyone is clamouring for a drastic reduction of fuel price in this country, consequent to the dramatic drop in crude prices world wide. The current price is about US$ 58 per bbl. Every country has positively responded with substantial price reductions except Sri Lanka. Let us examine as to why the Sri Lankan government which always claimed that domestic prices will go up and down with World Market prices is now reluctant or unable to bring down prices to substantially low levels as was prevalent last year.

For the last four years CPC has done nothing to reduce prices other than to indulge in hedging which, in my opinion, is nothing but speculative gambling, as there is nobody competent at CPC to handle such risks. The initial success of the hedging operation was publicized and celebrated by both the Minister and the Chairman, with massive 'cut-out' cheques being presented by the banks to the CPC as one would see like the the end of a cricket match, with the winners carrying away cheque cut-outs. Last two months with hedging causing massive losses to the CPC, we have not seen such scenes between the Bank and the CPC - as the massive payouts by the CPC to the banks are now done in high secrecy!!

Hedging is not a long term solution to volatile oil prices unless there is a fully fledged Risk Management Department at CPC, who do tracking daily prices of the various terminal markets.

The answer lies in refinery expansion; expediting exploration activities; rigid cost control; financial discipline of the highest order, and adhering to a reasonable and consistent pricing formula. Hedging operation of the CPC was ill-conceived, as it was managed by a 2-member team who claimed to be experts, just because they roamed the world for two years. The hedging itself was for a long period of one year. Hedges at best are for a few cargoes over two or three months period and certainly not for one year!! Who hedges for one year in a product which is unpredictable and volatile? The end result of this bungling gamble gone wrong, is that CPC has to pay out as much as Rs. 40 billion to the banks whereas this Rs. 40 billion should have rightfully benefited the consumer instead of contributing to the profits of foreign banks involved in hedging.

CPC and the Ministry must take the blame for this extraordinarily expensive fiasco. To put the blame on the Cabinet of Ministers and other institutions such as the Central Bank is totally wrong. It was the CPC and the Minister's recommendations that the Cabinet approved. This irresponsible action of the Ministry and the CPC is comparable to an equally irresponsible cabinet paper presented by the CPC and Ministry recommending an Iranian Refinery proposal which was inflated by over Rs. 1 billion. Today we have a chairman who claims hopefully that crude oil price will reach US$ 120 per bbl by end of the year - merely to save his skin! Sri Lanka can do without such experts. Hedging has placed CPC on the edge of disaster and destruction.

Financial indiscipline at the CPC is another reason why consumers do not benefit from low crude oil prices. CPC customers like the CEB, Railway, RDA, Mihin Air, Armed Services, Maga Neguma have to pay as much as Rs. 80,000,000 for fuel supplied. Why CPC allowed such credit and why it was allowed to go up to such dizzy levels is the million dollar question and is due to nothing but lethargy and incompetence. All the defaulted customers are funded by the Central Government Budget and the Treasury transfers money on a regular basis as per the Budget. It is the duty of the CPC to collect their dues in time. This massive debt is temporarily overcome by the CPC by borrowing from the banks at a high interest rate averaging 20% +. This is a massive and unnecessary cost is recovered by the CPC from the consumers by including it, in their costs when fixing fuel prices.

Over-dependence on Iran for our crude oil requirements is another major reason for the local consumer not benefiting from low fuel prices world wide. The CPC now buys over 90% of its crude oil from Iran because it has given extended credit terms (7-month credit). While Iranian crude oil is not the cheapest in the market, Iranians impose a massive premium as much as US$ 2 per bbl on their sale price when the normal premium about as US$ 0.50 cts per bbl. So the benefit given to CPC on credit terms is taken away by the high premium imposed at the time of delivery. Apart from the negative financial implications of Iranian crude sale terms, buying almost all our crude oil requirements from Iran has certain strategic implications in case of armed conflict or sanctions against that country. As you know, even now Iran is subject to certain UN sanctions due to its nuclear ambitions. It is most undesirable that we should rely almost solely on Iran for our crude oil when there is a doubt even price wise. In the past we relied on Iran for about 2/3rd of our needs and we should reverse the current adverse trends quickly. More so because it is Iran which is in the forefront of OPEC nations calling for production cut levels and thus for higher crude prices!! CPC has put all its eggs in the very basket that is vigorously advocating higher crude prices!!.

It is a well known fact that Iran's economy is as badly managed as ours in Sri Lanka. Even imported fruits are subsidized. Gasoline queues are common despite Iran being one of the biggest exporters of crude oil in the world. To expect Iran to help us in our time of need is ridiculous. Their entire economy is dependent on high oil prices and when it dips below US$ 68 a bbl, their economy is in negative territory. Over reliance on Iran is almost as dangerous as over reliance on hedging.

CPC also appears heading for liquidation when one considers its outstanding financial commitments. To Iran, CPC owes Rs. 110 billion; to finished product suppliers - Rs. 50 billion; to commercial banks including hedging -losses Rs. 40 billion; while significant loans have been also taken from EXIM Bank, AAB and India, payments are also due to the Treasury on account of PAL, custom duties etc. Making a grand total of over Rs. 200 billion. All these commitments and loans need to be repaired, but has the CPC the ability to do so? They can only meet these commitments if they keep retail prices artificially high, depriving the consumer the benefit of low fuel prices found elsewhere in the world.

Whatever price reductions the CPC offers, it will never reflect the true position. CPC prices will have to include costs of inefficiency, financial indiscipline and other acts of omission and commission.

If the CPC is to survive and the consumer is to benefit, a reasonable price formula enforced independently, is a necessity. Politics should have no place. If the government wants a political price, then it should be backed by a subsidy from the Treasury.

An independently and professionally managed CPC with a price formula in place, will reduce costs, reduce wastage and above all the banks will back it up with good credit terms and thereby benefit the consumer.

In today's context, our local retail prices should be in the range of Rs. 50 - 60 per litre and nothing more. The question then is who is taking whom for a ride?

The writer, former Chairman - CPC
- Sri Lanka Guardian

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