Monday, February 13, 2012

Pilipinas Forum 25: On Oilex and Proposed State Monopoly in Oil Trading

These are the exchanges more than 11 years ago and the official position paper that we issued on the proposed National Oil Exchange Commission, a government monopoly corporation on oil trading. As usual, get your favorite snacks and drinks, this is 31 pages long. Enjoy.
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Pilipinas Forum


On Oilex and Government Monopoly of Oil Trading

August-September 2001 2000

Dear Noy,

Initially, Cong. Garcia said the OilEx was patterned after the California eletric system, only latter did he start saying that it was patterned after the PEPEX...

and you see noy, it's more than just the bureaucratic inefficiency it will breed, it's also about the INAPPLICABILITY of the proposal...

1. The oil industry does not operate on a GRID system

Independent suppliers of electricity in the State of California or any of its contiguous states could supply electricity anytime and in various quantities (as long as their capacity permits) as transmission of their product throughout the state by the press of a button, such that bidding may take place on a hourly basis and that delivery of the product after bids is ensured.

Unlike an electric grid system, however, where electricity may easily be transmitted instantaneously anywhere within the grid, oil comes from different sources around the world and would take months and before it reaches our shores. The bigger oil tankers have a maximum rated speed of 16 to 18 knots, such that a tanker leaving Venezuela could take three months to reach our shores. Also, it should be noted that California buys its electricity not only from the lowest bidder, but buys only a majority of its supply for a given time from the lowest bidder. It is interesting to note that California still buys from the other bidders on a pro-rated basis, depending upon their proximity to the lowest bid. This is one reason why California was able to stabilize and even bring down the prices of electricity in their area because price competition between the participating bidders were intensified thereby resulting to lower prices.

In the case of the NOEC, it bids out its oil requirements monthly, and this is a totally different, if not, a precarious situation because what will the NOEC exactly do? Anticipate demand monthly? There is no clear mechanism how the NOEC or the DOE will do this and the prospect of fuel shortages occurring isn’t too remote.

The idea that the price of our supply may go to the lowest bidder will not be guaranteed because the NOEC will only have a day to approve the bids. What would happen if a day after bidding the prices of world crude oil immediately goes down? Prices in the world market change daily, even hourly, and fluctuates widely (ANNEX 1b). Still, the best price stabilizer is the presence of competition which has continually checked domestic oil prices despite increasing crude and product prices in the international market.

Also, the measure’s plan to tap the spot market (this is where the government will ideally get the cheapest price) also poses a number of problems, specifically on the cost and time of delivery and the quality of the commodity ordered. For all we know, we might end up spending more processing poor quality Chinese crude! Take into consideration that soon enough power generation plants will be requiring “sweet crude,” or the best quality crude, to conform to air emission standards under the Clean Air Act.

2. Suppliers of crude oil are located in different areas of the world

The Philippines comprises less than ½-percent of the world’s crude oil consumption and it is difficult to presume that we precede others in the sellers’ order of preference. We should always remember that we’re at the bottom of the hierarchy of importance as far as the distribution of crude oil supplies is concerned. The demand for crude oil is highly volatile, though cyclical, such that during the month of October, Europe tries to buy all the oil it can get its hands on, and that US demands for the product traditionally rises in the months of March and April. So how sure are we that we can get a steady supply from the world during these months. It is said that during the Gulf War, the Big 3 have to literally beg to crude oil suppliers the world over to supply them with the commodity. Should the Philippines bid out its crude oil requirements to the world on a monthly basis, wouldn’t it be hard to guarantee that supplies would reach the country on time save when Singapore, who is the closest exporter of crude oil to the Philippines, win out the bid every time.

3. The supply of world oil, as the bill admits, is cartelized.

One irony in the proposed measure is that while it recognizes that a monopoly/ oligopoly/ cartel in world oil supply exists, it fails to subscribe to the fact that the problem of rising oil prices in the country is not a domestic issue, but an international one. If Rep. Garcia vehemently protests against the cartelization of the world supply of crude oil then establishing a NOEC is NOT THE SOLUTION because prices in a cartelized environment will always remain the same. If Rep. Garcia is dead serious about government intervention to augment the problem then maybe it would just be more practical, and less expensive, if government would just implement another subsidy program to deter any oil price hike. But is this not going a step back back?

So what lowest bidder are we then talking about? We should remember that it’s a seller’s market out there, and that OPEC and non-OPEC countries shall and will always sell its product to those who can pay more, like Japan, the US, and the EU. And if we think that the prices of crude oil from non-OPEC countries is cheaper then we should think again. Their prices have historically been the same! What oil producing economy in its right mind would sell its crude oil at a price lower than the OPEC’s when the demand for the product have always been continually high (remember that oil is price inelastic, in the long term, at least)?

To say that what worked with power industry in California will work for the oil industry in the Philippines is downright oversimplification of the problem and of the solution. We cannot get away that easily. Electricity, given that there is a critical amount of power suppliers could be available anytime, anywhere. But, oil, sad to say, could only be available from a limited few (about 40 suppliers the world over) and that the delivery of the said commodity is subject to so many variables (i.e. weather disturbances, political instability, or any other acts of God).

hope this adds to the discussion...

- Poch
Bermudez

Hey Poch,

This is interesting. Actually I'm not so familiar about the nitty-gritty of the debate about this oil exchange of Cong. Tet Garcia. My disagreement with the proposal is basically on its economic theory and principle: it's again back to regulation. Government regulation accdg. to theory and experience, will always result to inefficiency (& corruption) if the subject of regulation is not a "public good", if there is no "market failure", and no "externalities" involved. Thus, if these things are not present, government should NEVER come in to intervene or regulate.

Thus, unlike the provision of national defense or traffic lights, where no private businesses will dare produce and expect to make profit, oil retailing is a purely private good where private businesses – in competition with one another - will provide and make profit in the process.

- Nonoy Oplas

Conflicts arising from fiercely parochial causes (e.g. nationalist/ethnic movements, sector strikes, etc.) have probably resulted to more deaths, economic losses and deprivation than any other events in recent history. My views on the recent transport strike and the OilEx issue:

First, deregulation, not transport strikes, would be a more effective and more lasting oil price-reduction measure. If you want to bust the Big 3 market dominance, you have to facilitate the entry of more players to the industry. The fact that the oil industry in our country performs importation, refining, storage and distribution operations, without the huge costs of extraction (and exploration, for some), makes it a fairly 'contestable industry'. And this is already evidenced by the presence of other oil companies in the market. The more players, the more profits are suppressed, as companies try to undercut each other's prices to increase their market shares (in a perfectly competitive industry, which exists only in textbooks, profits are zero in the long run). In countries with highly competitive energy industries, a liter of petrol can
sometimes be cheaper than a liter of bottled water. Petrol prices rise and fall in a day or two following changes in global prices. OPEC is still powerful but it no longer wields the same power it used to. Other countries have explored their own energy sources, have learned to develop more energy-efficient technology, and have become more efficient users themselves following the two global oil crises.

Second, government should shy away from regulating both the supply and price of oil as well as fare rates. If transport organizations and unions are free to set their fare rates, strikes would be minimized and commuters would have a range of choices. As commuters flock to jeepneys and buses that charge lower fares, others operators would have to cut their fares to gain commuters back. Price-cutting would settle to a fairly lower level of fares. Regulatory power over supply and prices should be limited to emergency circumstances like war and extreme shortages in supply. The Government already spent billions just to stabilize oil prices during the OPSF regime. Which could have been used for more basic social services. And you thought you did not pay for that as a taxpayer. In the actions of the different parties to this conflict, various interests were considered but the consumer's. At si Mang Driver ay si Mang Consumer din. I don't want government to be dictating my political choices (martial law, national ID, etc.), so why should I want it to dictate my economic decisions, as well? This is not the way towards a 'civil society'.

Third, creating another government regulatory agency or for government to again own an oil company is not the answer. The controversy involving former Petron employees getting priority over the purchase of shares when the company was privatized showed how government power over business entities can be abused. If you set up any government company, inefficiency is more likely than not to creep in. How can you get the best managers when they can earn more in the private sector? And once created, you know how politicians just find it difficult to abolish agencies/corporations.

Just look at why the Soviet economy collapsed and why the Chinese economy continues to prosper. Because as one economist puts it, "the Soviets followed the 'Harvard Model' while the Chinese adopted the 'Chicago Model'.

Which "has made all the difference".

- LuzAbogadi-Rose

Even if, hypothetically, corrupt government officials would not abuse the OilEx, the logic behind OilEx itself is suspect.

Going back to my earlier statement that the OilEx was patterned after the deregulated California electric system, as Cong. Garcia earlier claimed it was, I would like to emphasize that the system has not worked perfectly well with California (refer to a NY Times article on Aug. 3 or 6)

The OilEx is way too costly. Consider this: government is supposed to expropriate the oil storage facilities in the country. To give us an idea of how much we are talking about here, Pilipinas Shell spent some EIGHT HUNDRED MILLION PESOS in refurbishing its oil depot in Pandacan. How much will government be spending to either lease or own these facilities?

This is just one point. There are so many other concerns which require serious consideration, and more importantly, some really serious study. I really don't think the proponents of the bill have carefully studied the full implications of the proposal.

Honestly, I think the whole proposal is just one of those "in aid of re-election" gimmicks (note that Sens. Drilon and Enrile (author!?!) have even publicly declared their support for the bill).

(I even received reports that Cong. Tet Garcia has built oil storage facilities somwhere, ready for expropriation. BTW, has anybody thought about the integrity and practicability of Cong. Garcia's proposal even after Cong. Garcia's involvement in the Batngas Napthalene Cracker Plant incident???)

BOTTOMLINE: It is worth (and fun) talking about how government will corrupt the OilEx should it be put into law, but it is also worth looking at the logic behind the proposal, which I personally think is FLAWED in so many ways.

- Poch Bermudez

Hello friends,

I'm seriously considering that we launch a signature campaign to OPPOSE this Oil Exchange bill of Cong. Garcia. News yesterday said his bill has already passed the Comm. on Govt. Enterprises, and is now pending before the Comm. on Appropriation. Why? Because his proposal will require an appropriation of P17 BILLION! You know how big this amount is? Recently, govt. privatized its remaining 30% share with the PNB (so that bank is fully privatized now, but govt. still has 2 100%-owned banks, LBP and DBP). With such sale, govt. will get only about P7 billion. In addition, P17 billion is larger than the COMBINED budget of DSWD, DTI, DOT, NEDA, and several other small departments next year. And Cong. Garcia and other gullible Congressmen think this is a small amount just to accomodate another layer of govt. bureaucracy and regulators?

So, I will urge you to study that proposal. You have read some of the postings here in the forum regarding the subject. Consider them together with your other readings. Note also how the new players (there are at least 61 of them now) and potential competitors of the "big 3" look at the Garcia bill. What I know is that almost all of them are against another set of govt. regulation. If you are convinced of the faults of the proposal (framework, analysis, implementability, transparency, etc.), I will urge  you to sign that petition. We shall give them to the House and Senate leadership because ultimately they are the ones who will decide on this bill.

Note though, that among the supporters of the Garcia bill are those running for Senate elections next year: Sen. Enrile, Drilon, and Speaker Villar! Upps, teka, Senate Pres. and House Speaker ang mga supporters ng bill ah. Di kaya malamang papasa ito? Whatever, e di kalampagin natin sila.

- Nonoy

Nonoy, Poch and the PilipinasForum Gang:

I've been following the exchanges on OILEX and I tell you these are some of my arguments against the measure. I would like to contribute my share but because of conflict of interest, I wouldn't want to dilute what PilipiasForum has stand for all this time. Presently, I am a government relations consultant to one of the players in the industry. I defer signing the petition due to this conflict but let me put it this way, you have my support because OILEX is untenable from a regulatory, administration, transparency and market reasons. What has to be answered is with OILEX, will it really lower the price of the oil. My answer is no.
Do a price simulation. Who are the 40 suppliers? Not unless we get oil from cheap sources such as Iraq, na wala tayong diplomatic relations and the continuing embargo by UN (under the food for oil program). Look at the committee report - it talks about putting the stock in Subic and Clark, there is no underground pipe from Subic and Clark to Pandacan, how would they distribute the oil? transaction cost will go up. As the product passes through one LGU to another, you have the potential of local tax being levied on the product such as the dressed chicken story of PCCI's Atty. Flores. OILEX determines supply, demand and even allocation. What is the criteria for allocation? market share? then patay ang new players! If it is ok to you guys, may I post some of my random thoughts on the matter? Not to convince you but just to add more information so that the Forum members could come up with their informed choice.
Regards.

- MAlou Tiquia

But on the issue of the Oil Exchange I agree with the reasons you have put forward for opposing the oil exchange. I would sign a statement to that effect.

I don't however agree with you and on the others' assessment that the best approach is to do nothing. This is your proposal, right?

My basic assertion is that while there are new players in the retail sector, the real competition has happened in the LPG and in the bulk sales for industrial fuel:

a) it will be a long transition to a competitive market in the retail sector, during which the three majors will continue to exercise significant market power. One reason for the long transition is the weakness of the economy itself. Another reason is preemption -- the ability of the old players to set up at least three new gas stations for every single one that the new players set up.

b) unlike in Thailand, we did not put in place the necessary conditions that would discourage the exercise of market power during the long transition. I contrast the Thai and the Philippine case. Then I have my proposals.

- Jude Esguerra

Noy,

Be careful also with what you say. You're putting oil, este words into my mouth. I did not say government should regulate the industry. I questioned (not even say) how come the government does not participate in this industry? or in the market of this industry? Regulation is not the only way the gov't can participate in the market. You should know that by now. (I shall not comment on your word "nationalize" because I cannot find any of that word in my previous message.)

Anyway, I just thought like any self-serving entity one should look out for one's interests. The government have a lot of interests in oil. It uses oil in implementing its projects and providing services. Would it be better for the government to find ways in securing its supply of oil? One is be an oil seller for profit. Not the typical subsidized state company breeding inefficiency and corruption and further extracting gov't resources. Another possibility is encouraging the public's participation in the industry. Some countries in Europe encourages consumers to participate in the market by putting up an oil company and compete as a supplier in the industry. By cornering a considerable percentage of the market (say 25%), they have a substantial role in influencing the prices and quality of services rendered. But of course, these consumer companies must strive to be profitable to be competitive and stay in the business.

About the increase in oil prices, I think we are beyond the "rollback" demand. We already know that nothing stays down forever, as more and more countries industrialize our need for oil also increases. Oil prices have to increase, not only because as the demand rises vis a vis supply makes prices go up but also because there are less entities who control the supply of oil in the world. Lucky are the countries that have oil in their backyard (like Norway) then they are fairly secure in their oil supply.

(work just interrupted my train of thought)

- Binky

Jude,
 thanks for this. I don't propose a "do nothing" though; my proposal is: instead of new regulation through an Oil Exchange, deregulate more, simply the rules more, level the playing field, give the new players more opportunity to challenge the "big 3". This includes talking to the PNCC, operator of the North and South expressways - even compelling it - to allow the new players to put up service stations along the 2 expressways. I don't know if there is an existing arrangement between the PNCC and the big 3 to "block" the expressways only to the 3 of them and exclude the new players.

Binky,
apologies for putting "regulation" into your mouth though you did not explicitly say so. But if govt. "joins the fray" and become an oil retailer too, like when it used to control 100% Petron, it's still one form of regulation. For instance, if govt. decides to sell at a lower price than the break-even level (palugi na bale) to "compel" Shell and Caltex to sell also at a lower price, then it's still regulation and govt. intervention. And what a lousy form of regulation: Govt. will rechannel some money from farm-to-market roads intended to help our car-less farmers, from basic  education budget, etc., to subsidize the oil sold by Petron to the middle class and rich car owners. Isn't this lousy, callous, inefficient, and stupid?

For many years, that was the policy under the OPSF. Every year, govt. sets aside several hundreds of millions, even billions, of pesos from the budget to subsidize oil prices, to pacify the noisy street demonstrators, and pamper the car-owners. In the process, depriving our farmers and fisherfolks and other poor people who have no cars, of the same amount of money that should have gone to rural infrastructure and basic services.

Nevertheless Binks, just continue writing, so we can clarify other points that may be in other people's minds too.

Malou,
 nice to hear that you're also working on this subject and also disagree with the Oilex. Please do share with us other info. and data that you have. You must have heard that Erap, through the recommendations of Sec. Tiaoqui and the Econ. Coordinating Council (ECC), plans to veto the proposal should it become a law. Which goes to show that somehow, sometimes, we can possibly reconcile our opposition to "Erap as a person" and our support to certain policies of the Erap govt.

Friends - we may never realize it, but some postings and discussions in this forum somehow manage to reach several key decision-makers of the country, both in the public and private sector. Poch for instance, works with Sen. Tatad, the present Senate Majority Floor leader. I would assume that Poch and his other officemates are able to convince his boss not to support Cong. Garcia's Oil Exchange proposal, even if Sen. Tatad is also running for re-election (?) next year. Unlike Speaker Villar – halatang desperado na maging Senador; paano, last March's SWS survey of the Senatoriables, #16 sya. Kasabay nya sa dulo si Jinggoy!

- Nonoy

Nonoy,

In economics, world supply is usually depicted with flatter slope than domestic supply. The reason is competition in world market is greater and also subsidy of some countries for industry with external economies.

In a sense, Oilex will open the domestic market to world supply and total supply curve is the sum of domestic and world. Expectedly, this will be a flatter supply curve.

In particular, if domestic supply is monopolistic (which is depicted in economics as a vertical line) then definitely Oilex will make supply curve to be even flatter. This is unambigous I think.

With flatter supply curve intersection of demand and supply would yield lower prices which will yield consumer surplus but will imply losses to domestic producers. Empirically we can estimate all this gains and losses in real and nominal terms.

Now we bring in issue of cost associated with Oilex. This cost either will have to be added to oil price or assumend by the government. If this cost eats up decline in price due to competitiveness effect then admin cost will exceed consumer surplus, and we're better off without Oilex. I guess we have to do some descent estimation rather than argue in terms of rhetorics. Cheers!

- James Villafuerte

James,

What can bring in more world oil supply into the domestic economy and hence, make the oil supply curve flatter, a government monopoly firm or dozens of local players with dozens of suppliers from around the world?

By blocking local players to directly source their oil supply from their suppliers abroad, this is explicit barriers to entry. Microeconomic theory says barriers to entry (technical or legal barriers) is the source of monopolistic power. And as you say, monopoly makes the otherwise upward-sloping supply curve vertical (i.e., regardless of the prices offered by different consumers, quantity is fixed).

The objective is to have a flatter supply curve. Oilex makes the supply curve more steep and near-vertical. More deregulation, more level playing field, more players, no govt. monopoly, will achieve a flatter supply curve than a govt. monopoly like the Oilex.

Now add the various costs of creating another govt. corporation - at the time where we are privatizing Napocor, Philphos Fertilizer, Phil. Postal Corp., PNB, Meralco and SMC shares, Channels 9 and 13, etc., and things follow the dreaded Murphy's law.

What are these costs?

1. From P17 to P25 billion of appropriation to set up a new layer of bureaucracy and bureaucrats. Since Cong. Garcia has not identified where to get the money, this could mean P3 billion will be deducted from DECS budget, P2 billion each from DPWH and DND budget; P1 billion each from DENR, DOH, DSWD, etc.

2. X billions of pesos of planned and potential investments that might/will be cancelled by existing and new oil players since it's back to regulation again.

3. X billion of pesos of potential privatization proceeds from buyers of Napocor and other state corporations. Why? If you're the potential buyer of Napocor, will you still go ahead knowing that rules can be changed mid-stream? That lousy politicians with short-term re-election or senatorial bids will suddenly reverse the law which just 1 or 2 years ago allowed them to come in?

If we go ahead with estimating the costs and benefit that this proposed Oilex will do, i can close my one eye and imagine a ratio of at least 3:1 in favor of costs and damages to the economy.

- Nonoy

Can we really arrive at an estimate? If the oilex will be depicted by the vertical line; with 11 competing firms the supply curve would be much flatter. With 11 firms, there is consumer surplus and losses to domestic producers but with oilex, there is a reduction in consumer surplus equivalent to oilex monopoly gains. Your estimate on losses consist of admin costs of P17-25 billion initially plus XX for items 2 and 3 add to this.

If we really need to quantify losses, add further XX for foregone foreign and domestic investment in every field as investors avoid potential changes in government policy within barely 2 years. Add also, XX for higher rates on new NG borrowing from private sources because privatization proceeds are less likely to come in while expenditures shoot up. In the long run, businessmen may tend to choose investment in government securities over investment in new capacity because of the prevailing uncertainty at a time when the government finds itself unable to tone down borrowing.

- Winnie Arceo

Nonoy,

Let's post a copy of the bill so we can examine issues/mechanisms carefully.

Regarding slope of supply curve - it will definitely be flatter since it's just a sum of present supply+whatever is coming from outside. This new supply from outside should quote lower price for it to qualify under Oilex. Are you expecting Oilex to buy more expensive oil?

Regarding Oilex as trading monopoly, I think Oilex is just a clearinghouse where bids for oil and gas requirements will be processed. Domestic suppliers will also submit their bids through this body. This is different from trading monopolies who decide on amount to be imported (say 30 T of sugars) and buy sugar abroad. There is room for individual companies to import directly through this clearinghouse, much like say way LC is processed. Advantage is that crude importation of Caltex/Shell/Petron can be sourced differently from parent company and we have the information on actual costs plus volume of purchase and inventory.

Regarding costs, we have to distinguish between fixed costs (acquisition of assets such as oil depository) as against administrative costs. Acquisition of hard assets or infrastructure are investments and generates stream of services into the future. Also acquisition is not the only model. There are other possible institutional arrangement.

Noy, remember theory of second best, when there are distortions in the market the 2nd best policy (in this case some form of regulation) is optimal. In the case, of the oil industry, this is a textbook example of monopolistic industry due to presence of economies of scale and large fixed cost. Here the barriers to entry are requirement for "minimum scale" and large start-up costs. Add to this product differentiation which will add another parameter greek character unto your price equation. I don't know why we want to push the competitive model in this industry.

Regarding price parity, it's indicative but we have to consider demand condition. In other countries, winter demand are primary source of escalation in prices. You can imagine supply curve being fixed (with steep slope) and demand shifting up resulting to higher prices. Countries with volatile oil and gas demand would have higher price volatility also.

Regarding privatization, what we're having now is a firesale of government corporation. Look at PAL, PNB and I'm sure it will happen to NAPOCOR. Price of gov't corporation should represent net present value of all future income stream plus some intangible price due to it being a strategic industry. What they are doing is to pass on liabilities of NAPOCOR to public and sell off assets at cheap price. This happened in Latin America also.

Noy, I think we have to examine the issues more carefully rather than making sweeping generalizations which more often are false. If you can post the bill, then we can propose significant changes. Lastly, a blind man's estimate is most dangerous. Cheers and I would gladly sit with you over a bottle os san miguel to discuss this thoroughly!

- James

Noy/James

forgive me for coming late into this discussion, but, I would like to know more about the supply mechanism of the Oilex as proposed in the bill (which I haven’t read thoroughly yet!).

from another vantage point, my sources (from Subic) told me that there is some grain of "crony cap" in the story of Oilex, and that the Subic and Clark depot are part of the equation. Anybody would like to do some sleuthing and piece that together? Thanks.

- Joven Balbosa

Joven,

Yes, I'm sure control will be an issue and clark and oil depots are very important in this game but theorywise it's not easy to dismiss thil Oilex outright.

- James

Hi James,

You can get a copy of the Oilex bill through this website:

http://www.philcongress.com/hbills/hb8710note.khtml

Unfortunately, the website does not yet contain the substitute bill to HB 8710, which was filed
last August 21 as HB 12052. One of the major differences is that, while the original bill authorizes the GOCC to take over and operate all terminals and depots for refined oil in the country, the substitute bill limits these only to "government-owned" terminals and depots at Subic and Clark "subject to the requirements of the Constitution and existing laws." Section 7 adds that "the refined petroleum products coming from winning local oil refineries may be maintained in their respective storage facilities, subject to the exclusive control and disposition of the Oilex."

Another difference is that the original bill required the ERB to set: the wholesale price based on the acquisition costs of the GOCC, and a formula setting the margins of the wholesalers, distributors and retailers. No such regulation is found in substitute bill.

I tend to agree with Nonoy. With the entry of the new players under the Oil Deregulation Act, aren't we basically facing the same supply curve as the one that would prevail under the Oilex? Can we also assume that a GOCC will be more efficient than the private sector?

You have a point about second-best policies, but I believe the Oilex proposal is inferior to, say, temporary subsidies to the small players in order to strengthen competition.

- Chichi Balbosa

Chi-chi,

Thanks for info. Here are my reply to your points!

Even, with oil deregulation, the big three, who controls sizeable chunk of the market, will source crude from parent company. Transfer pricing is a big possibility. Due to presence of scale economies, other prospective suppliers will not come in and only marginal players come in - additional world supply is quite limited.

With oilex, we are giving scale to anyone who can offer better prices - hopefully will generate larger world supply. It's like we are rationing out or bidding the "monopoly rent" that can be derived that "scale or maket share". Presently, the big three control that monopoly rent, what we can do with big three is to use oilex to hasten competitiveness effect. Of course, in practice the result could be different but what we have to do is to put enough safeguards.

In terms of efficiency, this is limited to managing oil importation and distribution and it can be done in partnership with the private sector. The only value added of Oilex is information and transparency whichis the spirit of the bill. Sana this bill can promote automatic pricing formula - parang rules over discretion. Presently, big three practice discretion in adjusting prices. I hope with oilex it will be rules that will prevail.

I think subsidy in the form of lower duties on refined petroleum has already been built into the present law but this is not enough. Also extent of subsidy can be large, kasi with monopolistic market structure they will practice marginal cost pricing and you have to subsidize the difference between average and marginal cost - this is if my recollection is correct about micro theory. This could be large right! Even large that P17-25B. Cheers!

-James

James,

I really appreciate the explanation you gave. I hope you will bear with me if I ask a few more questions.

If OPEC "manages" the bulk of world supply, would the presence of the Oilex make a difference? Won't we continue to be price-takers? I admit I don't have the figures to support this statement, but would it be reasonable to assume that the Philippine market as a whole is just a small drop in total demand?

You mentioned safeguards that need to be put in place. Perhaps we ought to focus on safeguards that directly address the undue market power of the 3 players, like anti-trust laws, rather than force government in the business of oil importation and distribution. Are there existing models of public-private partnerships that do not require special privileges from government?

You're correct about the lower duties- these are only 3%. But excise taxes could be further reduced to temporarily offset the increase in the exchange rate (although some would argue that this is the true level). Won't these measures be more transparent, and won't accountability be established more, here than under the Oilex?

I don't remember the 1970s oil crisis that well (he-he), but I think the OPEC was also the culprit then. I do remember though that the popular response then was to "conserve" energy.

Thanks for your patience!

- Chichi

I agree, transfer pricing is such a big possibility. But transfer pricing is just a benchmark of opportunity cost. Big oil firms are able to exercise it when the market allows them to sell to other buyers at the same price. The presence of scale economies allows them flexibility to sell at lower prices but if there's an agreement between oil producers to sell at high prices, why will they? Other prospective suppliers may always come in--and will more easily penetrate the market if they sell lower. Again, why will they sell low when other suppliers have already agreed to sell at high prices. In the end, the Philippines faces a horizontal supply curve for oil. That makes OilEx incapable of giving scale to anyone who can offer better prices. Transfer pricing becomes irrelevant--whether or not it exists. We're just 0.5% of the world market.
Dividing 91% of this among the big three yields an average of 0.15% for each of the three. The price remains the same whether or not one firm buys 0.5% or 0.15% of the market.

Domestically, if the big three can control monopoly rents, the OilEx can more easily do the same. A firm that is vested with the exclusive right to import petroleum and sell it domestically will not be transparent. The bill does not say how it will ensure transparency and inform the public that its decisions are correct. If its decisions are incorrect, what can the public do? Not even an automatic pricing formula would help. If corruption has set in during the negotiation of term contracts, that would just get into the pricing formula.

Subsidy is an option, but sources say this suggestion has already been shot down by the ECC.

- Winnie

dear james, just a couple of points regarding the OilEx...

Regarding slope of supply curve - it will definitely be flatter since it's just a sum of present supply+whatever is coming from outside. This new supply from outside should quote lower price for it to qualify under Oilex. Are you expecting Oilex to buy more expensive oil?

*** There are chances that OilEx may be "forced" to buy more expensive oil for the reason that there are instances where it may be cheaper to buy it a bit more expensive because it shall still be cheaper to refine quality higher priced crude from dirt cheap low quality crude. Also, take into consideration extraneous variables such as the air standards put under the Clean Air Act and its impact on the quality of crude oil requirements. Cheap isn't necesasrily better. Bottomline: Refining costs should be considered, as well.

Regarding Oilex as trading monopoly, I think Oilex is just a clearinghouse where bids for oil and gas requirements will be processed. Domestic suppliers will also submit their bids through this body. This is different from trading monopolies who decide on amount to be imported (say 30 T of sugars) and buy sugar abroad. There is room for individual companies to import directly through this clearinghouse, much like say way LC is processed. Advantage is that crude importation of Caltex/Shell/Petron can be sourced differently from parent company and we have the information on actual costs plus volume of purchase and inventory.

*** Actually, the OilEx is not a clearing house in the strictest sense as it shall engage in the direct importation, purchase, storage and distribution of the commodity. The Petroleum Electronic Price Exchange (PEPEX) and the California Power/ Electric Exchange (CELEX) neither SELLS nor BUYS electricity.

Regarding costs, we have to distinguish between fixed costs (acquisition of assets such as oil depository) as against administrative costs. Acquisition of hard assets or infrastructure are investments and generates stream of services into the future. Also acquisition is not the only model. There are other possible institutional arrangement.

*** True. But none so serious so far that merits attention. The Forum should try to make a sensible counter-proposal though that may not necessarily fall within the acquisition model.

Noy, remember theory of second best, when there are distortions in the market the 2nd best policy (in this case some form of regulation) is optimal. In the case, of the oil industry, this is a textbook example of monopolistic industry due to presence of economies of scale and large fixed cost. Here the barriers to entry are requirement for "minimum scale" and large start-up costs. Add to this product differentiation which will add another parameter greek character unto your price equation. I don't know why we want to push the competitive model in this industry.

*** The current Oil Deregulation Law has addressed this problem, actually by coming up with a P300 million fund (to be drawn from PAGCOR revenues) to allow more entrants into the industry. P300 million may be a "small" amount, but the idea is there.

Regarding price parity, it's indicative but we have to consider demand condition. In other countries, winter demand are primary source of escalation in prices. You can imagine supply curve being fixed (with steep slope) and demand shifting up resulting to higher prices. Countries with volatile oil and gas demand would have higher price volatility also.

*** The comparisons, I think, are only limited to the South/ South East Asian region. We should remember that Asian countries are levied a substantial "special tax" by the OPEC. Thailand has been appealing to the OPEC to abolish it.

- Poch

There's an interesting column by Mr. Rigoberto Tiglao of the Inquirer today re. Oilex. He says, "The big three - Jollibee, McDonald's and Burger King - make up a monopoly, and their competition is just for show... Year after year, the burger monopoly keeps raising its prices... The entry of new players in the past 2 years - Burger Brothers, Burger This and Burger That - hasn't pushed down burger prices...(So) Set up a Beef Exchange, exclusively authorized to buy beef patty and ever raw beef. The "BeefEx" will buy only from the cheapest beef patty in the world... If the Oilex bill is such a clever idea, we should set up a Tobacco Exchange, a Flour Exchange, maybe even a Computer Chip Exchange..."

Which makes us go back to the basic question: what justifies govt. intervention in the market? If it's "strategic" to the economy, some say. So, since mineral water, shipping, airlines, telecommunications, electricity, cement, food products, etc. are all "strategic", then govt. should intervene - regulate private firms' prices, or put up a govt. corp., or nationalize/monopolize importation. Wow, what a bright idea.

Theory has one simple criteria where govt. intervention is justified: if there is market failure, if it is a "public good" and hence, there are large externalities involved. Even then, the same theory cautions that "Market failure is a necesary but not sufficient condition for govt. intervention. Necessary because without market failure, then there is no need for govt. to come in. But not sufficient because it could be that govt. will also introduce its own inefficiencies in the market."

That's why we should go "hinay-hinay" in proposing that govt. should intervene here and there. Instead of proposing an Oilex, why not compel the PNCC to revoke its "no service stations allowed to new players in the North and South expressways" policy, thereby giving the big 3 exclusive access to these 2 important highways in the country. Meron pa nga silang regulation na "service stations should be at least 4 (or 3?) kms. away from each other".

Why not set up an Oil Information Commission or whatever name, whose only function is to inform the public of what's happening in the world demand and supply of oil, of possible unfair market practices by local players, and make such practices ground for prosecution before the courts or the DOE? This proposal comes from some economists like Dr. Clarete.

There are other options more workable than a state monopoly.

- Nonoy

Three points nonoy,

First, if we can create a body that can generate complete information that would make the market more efficient. Market fails due to incomplete information and economic remedies are either means to fill that information gap or create regulation due to limited information. In some markets though, it is very costly to generate complete information and the benefit is miniscule. In the fastfood industry, it's cheap to have complete information and I guess falling meal prices are a result of such occurrence. It's not farfetched, that with ICT this will happen in the near future though it may not be purely government initiative but also market driven.

Second, oil prices in constant dollar terms are not that high. What we are seeing is money illusion. Maybe we have to compare also price of air tickets, concert seats, etc. The irony though is that commodity prices of asian countries are also soft and this is a double whammy of some sort. Maybe, we are feeling the pressure not just because of oil price but because of adverse terms of trade effect and there are other better methods to cope with this.

Third, we should also bring back foreign exchange cover for oil imports so that we minimize volatility arising from exchange rate fluctuation.

I don't agree with monching that litigation is more efficient than the market mechanism. If you ask any lawyer, he would definitely propose that you opt for out of court settlement rather than pursue a long drawn court battle. In the courts, you only have one or few person deciding while in the marketplace you have a herd of agents.

- James

James,

The oil companies, in fact, had wanted the forex cover retained even with oil deregulation, but since the OPSF will have to be maintained as well to fund the cover, the government decided to remove it upon full deregulation.

The oil companies have to manage their foreign exchange transaction exposures because these have direct effect on costs and profitability. This is largely done via forward contracts for crude and product shipments. These contracts are priced by the banks using differential between US and RP interest rates (or otherwise there would be arbitrage). While the shipments are "hedged" in the sense that the oil company knows the actual peso amount it needs to set aside to pay the crude and product on maturity, it does not remove the cost due to the peso depreciation.

For instance, the oil company imports $50mn worth of crude today at P45.50/$. This will be paid only after the usual 30-day period of suppliers' credit, at which time the exchange rate will likely be different. If this is not hedged via forward or some other hedging products (i.e., have "open" position), the company will have to buy the dollars on maturity date at then prevailing spot price. The risk is that the exchange rate could be much higher than the contract rate and therefore have huge losses.

The buying of forward cover is essentially "defensive". In contrast, taking an open position may be seen as speculating. Buying forwards gives the assured peso equivalent for the imports. By buying forward today, the oil company will know with complete certainty that the dollars will be available from the bank at pre-agreed fx rate on maturity date, say at P45.80 (with the depreciation based on interest differential), even if the spot rate will be P46 or P44 on that date.

The point is that the effect of peso depreciation on oil company's cost is not washed away by the hedging through forward cover. The value of forward cover is to provide certainty.

Regarding transfer pricing, Shell purchases crude oil in line with prevailing international market prices based on the most competitive terms available in the market. Today, internationally traded oil are linked to market prices as reported by media services (e.g., Platts, Reuters, Telerate, etc.). The rise of market based price and trading systems, supported by highly accessible information systems, does not make it feasible to manipulate pricing. The oil industry remains highly monitored and there has not been a single finding over the years by any government agencies on the alleged crude oil transfer pricing.

In the East, the main reference crude oil for pricing purposes is Dubai. DOE records will show that the average acquisition cost of crude oil in the Philippines move in line with changes in Dubai spot price (although, being on average lighter than Dubai crude, it is slightly higher in price).

Details of all crude oil purchases by the oil companies are audited by internationally respected accounting and auditing companies. These are monitored by the DOE and are used as basis for local price setting. And like Petron, Shell has local shareholders (over 30%).

I agree with intensifying information access to remove information asymmetry and further improve transparency. The objective should be to promote/ensure contestability of the market.

Finally, we should remember that full deregulation will ensure COMPETITIVE prices, which is not necessarily equivalent to LOW prices (which only happens under subsidized environment). And PRICE IS NOT THE SAME AS PROFITS. Higher prices can coexist with negative profits when costs increase faster than revenues.

Cheers,
- Ronald

Thanks for drawing attention. Sounds like you're an economist. The Economist this week says even at $30 per barrel, this is in REAL prices about 1/3 of oil prices ten years ago. For RP , I computed that with base 1994 a P17 per liter price means real price of P11, nearly a third of 1984 gasoline real price of P30. Why can't we seem to adjust to 'higher oil prices'? I don't know how to compute it (maybe you could help me out), but I would guess that a P17 per liter price now in real terms is cheaper than the per liter price in 1970 (before OPEC moved) -- I vaguely remember then that gasolne per liter was P1. But how much is P1 worth today? P40? P50?

regards,
- Bobi Tiglao

Hello Bobi,

I don't have my CPI data at home, thus I cannot verify if your computation of P30 gasoline real price in 1984 (at 1994=100) is right. Granting that it's right, why can't we seem to adjust to 'higher oil prices'? Well, one, not only gas prices have not kept up with increases in real prices; wages too, have not.

Two, gas prices last year and in previous years have been low. Note that current prices are at around the same level as in 1991, during the Gulf War (Iraq invaded Kuwait, US and Allied Forces flushed out Saddam's army). If there was no inflation over the last 10 years, then we're as worse off as in 1991. But because there was inflation, then current prices are still "cheaper" compared to 1991 oil prices. That is, it should be "high 1991 oil prices + inflation rate last 10 yrs = even higher 2000 oil prices". But since the latter did not happen, then nakatipid pa tayo.

So, when we say that we're worse off now, our referrence period is 1999, 1998, etc. If we compare with 1991, then we're better off(!).

James, Ronald, others, tama ba ito? Correct me too if I have further confused Mr. Bobi Tiglao.


Hello friends,

You've heard at least one voice that expressed support for Oilex. James' ideas are a bit technical, but i'm sure you picked up the gist of his arguments. So, can we have your "willingness" to sign the statement which I and Poch drafted? As I said, it's still open for revisions (shorten it, clarify the vague statements, rearrange the flow, etc.). I myself will try to revise it, to incorporate the points raised by Winnie, Chi-Chi, Jane, James, and Ronald.

Cong. Tet Garcia has already delivered his sponsorship speech in Congress last week re. the Committee report on Oilex. Plenary discussions and debates will start when Congress resumes session on Sept. 18. This morning, he was bragging in the radio that "the nearly 190 Congressmen are solid in his bill, that almost 100% of Senators will support it, that they can enact the bill by October or November, and that Erap will sign the bill once it is enacted by Congress". HIndi nya alam nakumbinsi na nila Poch si boss
nila, Sen. Tatad, na hindi uubra ang Oilex.

James, continue raising issues giving oilex the "benefit of the doubt". That way, if we can find a way to dispute your arguments, then that will further strengthen our position; otherwise, then there is reason to think twice and indeed give oilex a second look.

Meanwhile, some corrections/comments:

James - Dr. Clarete's proposal to set up an "oil information commission" or whatever name is a "second best" proposal to the "first best" option, which is to let deregulation have more time and space to work. It is a reaction  to Speaker Villar's challenge that "unless the oppositors will come up with an alternative, we will pass the oilex into law very soon". Certainly, any economist who knows his/her theory will never substitute market mechanisms (with near-perfect information available in the market) for litigation.

Ronald - good that you pointed out how market-based price and trading systems can preempt any manipulative transfer pricing scheme. Though I doubt if those who charge "there is massive transfer pricing" like Cong. Garcia ever bother to check figures from Platts, Reuters, etc.

Friends - Ronald works with Shell; despite of this, I have no doubt whatsoever that he can't be intellectually dishonest when he wrote those things; he's more intellectually capable and morally upright than me, peks man, he-he.

Joven - if the infinite number of swindlers out there in the market know that there are an infinite number of them, and that I'm one of them, then by such knowledge, there'll be "balance of terror/swindling", ho-ho-ho.

- Nonoy

I reserve my judgment, and consequently, my signature on your proposed statement on Oilex. Not that I don't agree with your points and arguments (they are very persuasive), but so far, most that have been posted in the forum are against the Oilex (along with the Shell position paper, etc). I need more balanced information on the matter to form a strong opinion but I've been lazy and time-pressed to actually read the House Bill & other articles on the matter outside of what is posted in the forum.

From the basic Economics that I cursorily studied in UP, which is very rudimentary, I agree with the points you and Poch raised on government intervention vis-a-vis a free market. But, the Philippines is a peculiar creature. So, I am not certain how the application of these economic laws and theories will actually impact on the country's dilemma. Which leads me to think, armed with these theories and prognostications, why is the Philippines still lagging behind? Don't our policy-makers and congressmen have a retinue of economic consultants who will advise and "enlighten" them on the folly and pitfalls of the Oilex?

The discussions so far have been very technical that I feel excluded and not competent enough to opine on the issue much less sign a petition/position paper. Frankly, the discussion on Economics sometimes confounds me and at times, irritates me when it starts bordering on pedantry. (Ok, I should have paid more attention in my Economics, right?)

Pardon me if I defer signing the petition. I don't feel very comfortable with my lack of knowledge on the issue. For what it's worth, the discussions have been very informative.

- Elizabeth

Hello Elizabeth,

Four points on your note:

One, out of pilforum's 100 or so members, I expect at most 15 will sign the position paper against Oilex. Even so, this is still positive and reflects only the left hand side of the debate; the right hand side is the number of forum members (and those whom they have forwarded the postings on the issue) who could have been swayed by the popularity of the oilex proposal, but will stay neutral instead after reading the discussions.

Two, I think one reason why this country is still lagging behind its neighbors is because most of our policy-makers - from the Legislative, Executive, and Judicial branches (though more on the first 2), and strong political lobbyists - the big businessmen, the street demonstrators, the militant NGOs and media, MANY OF THEM, never believed in the market mechanisms to correct many of our economic problems. For every problem, people think govt. should ALWAYS come in. People think that govt. should subsidize not only elementary but college students as well; that govt. should protect domestic businessmen always, all the time; that govt. should own a corp. in oil, in postal, in fertilizers, in buses, in airlines, in telecomms, in water, in energy, in steel, in banks, etc. In short, we're not developed because of our predominantly protectionist, govt.-should-subsidize-always, anti-market mechanisms, thinking. (Thus, it's funny that the very rich families like the Concepcions and the militant workers like KMU sometimes mouth the same slogan).

Three, apologies for the sometimes technical discussions. Pilforum's membership is chop-suey: economists, lawyers, academicians, plain housewives, etc. But it's the technicality of discussions, the "back to theory" approach, that sometimes can help us better analyze issues. If you read the papers and magazines, or watch news on TV, you'll be drowned by facts and numbers, or by rhetorics. Framework is seldom offered, if not totally absent. Only theory - explicitly or implicitly stated, econ. or social or legal or scientific - provides framework.

Finally, nothing to apologize for not signing the position paper.. The fact that we infected you with some grain of doubt on the workability of the proposed Oilex, that in itself is an achievement of this forum. I'm sure by now, if someone tells you that Oilex is good and you should support it, you'll tell that person, "hey kiddo, you do not necessarily solve that problem by creating an outright govt. oil trading monopoly", or something to that effect. :-)

cheers!

- nonoy

Noy,

With the market expecting oil price to move-up, I think we have to tinker with other alternatives. Some thoughts I wish to share and also for you to shoot at:

If cost of oil price volatility is huge in terms macroeconomic stability we might wish to entertain some form of price control and rationing mechanism. In terms of price control, we can incorporate marginal cost pricing with non-uniform access fee. The idea is there is a basic price which everyone pays but then there is a premium that others will have to pay to ration or prioritize usage of oil. This idea can be implemented via changes in the structure of oil-tax (with zero net effect on total tax take) and not necessarily through meddling in the pump price. This should be complemented with rationing to cushion the effect of price volatility. Naalala ko before we shifted to DST to save on electricity, maybe we can propose some effective rationing devices that can be adopted on individual and aggregate scale.

We also have to examine pricing power of oil-firms. Pricing power basically reflects ability of firms to "pass" the costs to consumers. It would be interesting to see if pricing power has increased/decreased and also to design measures to control pricing power. Ronald is correct in saying that higher prices do not imply higher profits since costs might increase faster than revenue. However, we have to be careful since some costs can also be capitalized. This pricing power should be discussed in any new bill on oil as this would identify conditions wherein which oil firms sell at a price beyond what is reasonable.

From cursory surfing also, it's not true that pricing power will decline with participation of small players. In some countries, there are evidences that costs of small players are higher that costs of big players due to scale-effect. Hence they noticed that cases arise where small players quote higher than average market price. It's interesting because we saw this behavior the other day with small firms asking for larger increases than big-3. Kung sa layman kahit maliit yung tubo bastat malaki yung volume.

Cheers!

- james

Food for thought:

If there are "mega profits" in the oil industry, then the army of investor analysts (with access to sophisticated, state-of-the-art pricing monitors) reviewing Petron are blind by continuing to discount the stock heavily despite the super profitability of the industry. Petron used to trade as high as P26/share, now it is at around P1.20/share. (In contrast, these analysts have surprisingly "clear" vision with regards to reviewing tech stocks which offer nothing but promises.)

What is important is a) promote greater transparency in prices to remove perceived information asymmetry and b) ensure contestability of the market via level playing field.

Under the previous regulated environment, prices were based on cost recovery, thus ensuring that some positive level of margin is earned by the players. In contrast, under the current fully-deregulated environment, prices are based on demand and supply. This means that there is no assurance that all costs can be recovered, especially when there is excess supply of finished products in the market.

As long as imports can come freely into the country (as they do now), then the foreign oil companies can be viewed as direct competitors of the big 3 locally. One should stop thinking of national borders in defining the competitive environment. With low tariffs and real-time information and capital flows, the location of manufacturing capacity is no longer as important today.

- Ronald

People, before my reaction to James' posting, let me give some clarifications on some terms used by James and Ronald.

1. Information asymmetry - means information imbalanced between (or among) players in a transaction. For instance, the seller (owner) of a used car knows more the real "health" of the car than the prospective buyer, so the former knows how to price the car, espec. the "last price" or tawad. Because of information assymetry problem, the lack of (near) perfect information, the market does not function well, so inefficiencies, monopolistic pricing, price collusion, etc. could happen.

2. Contestable market - a market where entry and exit of players is relatively easy. Thus, a "perfectly contestable market" is one where entry and exit is free, no costs/expenditures involved; this hardly happens in real life. Nevertheless, policy-makers and players should aim for a contestable market so that more players will come in; also, incumbent players, like the big 3 in oil, will behave well since excessive profits will attract more new players to "have a slice" of the excessive profits in that industry.

3. Rationing - some will be granted (oil, credit, etc.) while others will not (or be "rationed out"), as in to be "credit rationed", meaning not granted credit by a bank despite willingness of the loan applicant/borower to pay higher interest rates. Joey Tan can explain this topic well even with his 2 eyes close.

James,

Di na ko komportable sa ilang proposals, o sa ilang terminologies mo ah. Price control with rationing mechanism. Maybe a more acceptable term based on your proposal is a "floating or flexible oil tax rate" instead of price control. "Energy conservation" or "demand reduction" instead of rationing mechanism.

I go with Ronald's proposals to (a) promote greater transparency to solve the information assymetry problem, and (b) ensure market contestability through level playing field. These measures, if done, will bring us to a more competitive market, both in the theoretical and practical sense.

(set natin ang tagay-diskusyon this weekend or next wk..)

Meanwhile friends, If we think that local oil prices are already high, we ain't seen the worse yet!

Crude oil prices (Dubai) in the first 7 months of this year was bet. $25-26/barrel; by August it has gone up to $27/barrel; Sept. 1-11 average price? $30.4/barrel! And it's climbing further.

Meanwhile, the peso in the first half of this year was P41+/$; July-August it was around P43/$; September is even worse, P44+/$. Around 2 pm today, it reached P44.7/$. Just these 2 factors alone, world crude price and further peso depreciation, then present gasoline prices of P17/liter could easily go up to P18/liter next month.

- nonoy

Noy,

Free market is not an end in itself. Not because someone subscribes to rationing and price discrimination mali na kaagad. Rationing and price discrimination are merely used to prioritize usage of scarce commodity and to cushion important sectors from excess price volatility.

Siguro most of us do not feel the pinch of oil hike and we can afford to pay. Other sectors has to be protected. With non-uniform access fee puwede mong idiscriminate yung sectors that can afford the volatility from sectors that cannot afford such gyration in prices. Sina maranan is also advocating price discrimination. Marami namang arrangement that we can use to discriminate between favored and non-favored sectors.

Imagine Nonoy if there is famine. If you let the market distribute the good then only the rich will survive, so you need to ration to ensure that everyone gets a little of something. In the case of transition economies, during early phase of deregulation they went all out for market mechanism but there as so many shortages and they have to resort to rationing and price discrimination. I think if this shock continue then price discrimination and rationing would be helpful. Cheers!

- James

OK James, got your idea.

I don't know how feasible this will be, but my gray matter plays around this thing as I read James' reply:

Govt. to subsidize diesel oil for public jeepneys and buses only in selected service stations around the country. Instead of P1.65/liter diesel oil tax, govt. raises this to P3/liter. So diesel price will increase further from the current P13.05/liter to P14.50/liter. But public jeepney and bus drivers will pay only say, P12.50 /liter, govt. pays the P2.00/liter differential to the service station. The money used to pay this differential or subsidy will be taken from the additional diesel oil taxes that govt. has collected. In exchange also, there will be no fare hike.

This mechanism, assuming it is feasible and workable, will achieve 3 objectives:

1. Sell diesel oil to public transport vehicles at low, subsidized rates; no more transport strikes.
2. No fare hike, benefitting the commuting public.
3. No additional taxes in other commodities or sectors; only the middle class and rich car owners whose cars/pick-ups/pajeros, etc. use diesel, will shoulder the burden.

- nonoy

Noy, James:

I think Malaysia had previously adopted (not sure if that is still in place) their so-called Automatic Pricing Mechanism (APM) where taxes/duties are automatically adjusted in order to keep the pump prices stable. However, I am not hopeful DOF would consider this since we have a growing budget deficit and this is actually no different to an OPSF system. On the other hand, the proposal to price discriminate looks difficult to implement, especially how to prevent corruption since dealers have discretion in classifying whether the vehicle is for public transport or private.

Perhaps, some more adjustment in specific taxes for petrol products can be made, with greater loading on gasolines to compensate for lowering of taxes on diesel (which unfortunately will also favor some luxury cars), kerosene and LPG. However, I suspect the increase in gasoline taxes will be much bigger than those for the socially-sensitive fuels if the government will try to maintain revenue-neutrality since gasolines only account for less than 19% of volumes, while diesel, kerosene and LPG account for combined 45%.

Cheers,
- Ronald

My **initial** reaction to subsidies - in all its forms - is always negative. About Nonoy's example/scenario, where gov't **receives** diesel tax of P3/liter and **gives** a subsidy of P2/liter – this sounds weird, parang paikot-ikot lang; in effect, gov't gets only P1 tax from the jeepney drivers. Pwede rin bang iba ang quantity tax depende sa buyer – how can we ensure that this subsidy will not be abused, i.e. that the buyers who will benefit from this subsidy are only the jeepney drivers and not the car owners? Also, if ever this subsidy is given now, one can imagine that when oil prices increase in the future **the jeepney drivers would again go on strike** - to ask for more subsidy... And there will be no end to this story of subsidies.

In the 1970s and 1980s, the farmers, vendors and even SMEs had been subsidized in terms of low imterest rates on their rural bank loans, courtesy of the gov't, and the costs to the gov't of these subsidies is great (DOF studies on directed credit programs, 1997 and 1998. (I think even the private rural banks **themselves**, and not the intended beneficiary, benefitted from the subsidies.)

I cannot cite many examples about the inefficiency of subsidies right now, but initially, my idea is that rationing and price discrimination should only be resorted to in case of market failure.

- Ces Cornejo

Nonoy, Ronald,

 Just to baffle your anti-oilex sentiment: According to an NBER study  entitled Sticky Prices, Inventories and Market Power in Wholesale Gasoline  Marketson, based on their study of 188 local wholesale gasoline markets,  greater market power leads to slowe output price adjustment. This suggests  that monopolistic market structure in gasoline market may have positive  welfare effect.

 What do you think?

-  James

James,

Just to baffle also your pro-oilex view, according to theory, 2 main causes of market failure: externality and market power. The latter is mainly due to monopoly, oligopoly and/or cartel, like OPEC. We already see how OPEC, acting like a monopoly, is spoiling all non-oil producing countries' economies. OPEC is a classic proof to show that monopolistic market structure in petroleum market has negative welfare effect.

Now, add a local monopoly through oilex, then we'll have a double-whammy. Rent extraction at the international level (opec) and domestic level (oilex). Countries can break opec rent-extraction by shifting to alternative energy sources, thereby reducing their demand for, and dependence on, opec's petroleum. Philippine economy can break a potential monopoly by shooting down the oilex proposal.

Additional points James, from my officemate, Bing Mongado:

"You're point is valid, i.e., that in a monopolistic environment price and output is slow to adjust due for example to an increase in world input prices. We can state further that when there is an increase in the cost of production (i.e., the marginal cost curve shifts upwards due for example to an increase in output tax or increase in world oil price) the increase in cost is not totally passed on to the consumers.

This is an outcome (from standard theory) when a firm faces a downward sloping demand curve (which is the case when there is monopoly power) rather than a perfectly horizontal demand curve (as in a perfectly competitive environment). You're point is valid up to here.

But if we conclude that this outcome leads to positive welfare effects is not valid. For we have all learned in standard welfare theory that efficiency and welfare of the economy is enhanced when we force the monopolist to produce up to the competitive level and bring down the price in doing so."

- nonoy

Nonoy,

That is not my view, but result of NBER study. I can't recall the shape of the demand curve would change depending on market structure. Supply curve is vertical for monopolistic and horizontal for competitive but demand curve remains downward sloping!

If you agree that price increase is much less with larger market power then consumer surplus would be higher. What NBER study is saying is that with smaller market power (more competitive market structure) price adjustment is much greater so consumer surplus is much less - this is source of welfare gain.

I don't disagree that OPEC has the opposite effect on price but it's difficult to say its purely due to monopoly. Slack in world supply is merely 4 percent and though this is managed supply maybe increase in price is due to dwindling world reserves and growing world demand due to recovery in North America, Europe, Russian and Asia. Maybe this non-renewable resourced is slowly being depleted.

But from the point of view of the study, the results for the local wholesale gasoline market show (at least within the scope of the study) that price adjustment is much less with growth in market power. Maybe, the reason gas prices have increased by lesser percentage in the Philippines as against say US is that we have monopolistic market - see this study can explain some local phenomena.

Don't be too defensive Nonoy, I'm just sharing an interesting study.
Cheers!

- James

James,

Haven't read or seen the NBER study you mentioned. Anyway, do you know if they defined competitive space in terms of territorial boundaries? If that is the case, the conclusion may not be accurate since it may be true that there are only 1,2 or just 3 players in a locality (number constrained by scale economies), but with full deregulation allowing easy entry of products from "outsiders", market is contestable thereby capping the ability of the "inside" players from raising prices.

I think it is not economically sensible to expect numerous oil refiners in a small economy, especially in absence of trade restrictions and other distortions. In this age of globalisation, having few domestic players that are exposed to international competition can provide efficiency, if not welfare gains, for most economies. Therefore not surprising to find lots of mergers and acquisitions even among the giants companies. What do you think?

- Ronald

Der friends,

This is the final draft of pilforum statement on oilex and the list of signatories (24). I think Poch sent an attachment of the statement which did not go through the egroups as Monching disabled attachments in pilforum for our protection.

This afternoon, I gave copies to Speaker Villar, Cong. Gullas (majority floor leader), Cong. Belmonte (minority floor leader), and 3 congressmen who didn't sign the oilex committee report, Cong. Acosta (bukidnon), Sandoval (malabon-navotas) and Teves (neg. or.). I also left a few copies at the House media center.

Thanks. Nonoy
PS: Jude, your comments are contained in paragraph 7.
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THE PROPOSED OIL EXCHANGE: MORE FLAWS THAN LOGIC

We are members and friends of pilipinasforum@egroups.com, a net-based discussion group, composed mostly of concerned Filipinos here and abroad, working as professionals and technical staff in various government, private sector NGO offices. We see the proposed National Oil Exchange Corporation (OilEx) as seriously flawed, untenable, and anti-competition in spirit and philosophy. We manifest below our reasons for saying so, and pose alternative proposals that Congress and the National Government can do.

I. UNMASKING OILEX’S THEORETICAL FLAWS

1. Deregulation not more regulation, and competition not monopolization, will ensure competitive prices and improved services. Barriers to entry of new players should be removed.

2. Deregulation will make the local oil industry a contestable market. A contestable market is one where entry and exit of players is easy. If there is “excessive profits” in the local oil industry, then new entrants will be encouraged, offer competitive prices and better services to eat into the share of the big 3. Over the long-run, such “excessive profits” will be gone.

3. A national oil trading monopoly cannot stop world oil price hikes. By law of supply and demand, world oil prices will increase and hence, local oil prices will increase. World demand increases every year due to the expanding population, increasing number of cars, factories, appliances, etc. Meanwhile, world supply is fixed, even dwindling because of expanding demand, and is cartelized. Oilex cannot stop OPEC from increasing oil prices.

4. With deregulation, competition not price collusion, explains for the similarity of prices among players. Since oil products are homogeneous (same quality and properties, like oil, bottled water, bangus, etc.), there are plenty of sellers and buyers, and there is (near) perfect information about alternative sellers and buyers, then there will be generally only one price for oil products across competitors. Retailer A cannot price its oil substantially high because motorists and customers know that retailers B, C and D are just a few blocks away.

5. Creation of a monopoly corporation will create more economic distortions. Putting up a state trading monopoly that will exclusively purchase, store, and distribute petroleum products will deprive local players to directly source oil from various suppliers abroad. The reason why we have been privatizing many losing government corporations is because we realize that government is a lousy business manager and has the incentives to be inefficient.

6. Complete transparency of oil prices worldwide will make manipulative transfer pricing difficult if not feasible. Internationally-traded oil are linked to market prices with other commodities (gold, rice, copper, etc.) and their prices are reported daily, even hourly, by media services (Platts, Reuters, etc.). Oil prices are highly monitored worldwide, and information is the greatest regulator.

7. Market power exists, but is part of the transition from an oligopolistic to a contestable market situation. Philippine retail prices have not moved up as fast as elsewhere in the world due to politicized oil pricing system. But this market power can certainly be exercised by oil companies when they try to recoup their so-called under-recoveries. But large market power is not a reason for reversing reforms. Rather, it is the most important reason for finding means to accelerate and encourage the entry of new players.

II. UNMASKING OILEX’S EMPIRICAL AND ADMINISTRATIVE FLAWS

8. Increases in world oil prices were faster, not slower, than local prices. While world crude oil prices rose by an average of 203% over the last 19 months, local oil prices have only risen by an average of 68%.

9. The Oil Downstream Deregulation Law has made slow but substantial gains. After nearly three years only, 61 new oil players have come in and captured some 10% of the oil market, even 24% of the LPG market.

10. Domestic prices are the lowest in the region, except for oil-producing countries like Indonesia and Malaysia. Prices in Thailand, the country which closely approximates our economy, have moved twenty times since March 1999 compared to 8 price adjustments in the country.

11. Oilex cannot guarantee that we will get from the lowest bidder. The Philippines comprises less than ½-percent of the world’s crude oil consumption. We may be at the bottom of the hierarchy of sellers’ importance. Europe, Japan and the US are the priority consumers and they can afford high oil prices.

12. Oilex can not exactly predict the country’s demand in the future. Oilex administrators are no Gods nor super-intelligent econometricians who can predict how many millions of premium gasoline, of diesel, etc. will be needed by the country next month, or in the next 3 months.

13. OilEx can not store the country’s monthly oil supply. This is due to the tremendous cost, expertise, and efficiency necessary to operate and maintain the needed storage facilities.

14. Government to spend $3-billion if it decides to purchase all the oil depots in the country. These are for the oil depots alone. It does not include any other facility that may be required by the Oilex , including the P17 billion which will have to be spent for the its carrying costs/inventory.

15. OilEx is not patterned after PEPEX. The Petroleum Electronic Price Exchange (PEPEX) in the internet only provides matching services between prospective retailers and suppliers, and not "buy and distribute" as Oilex seeks to accomplish on a monthly basis. PEPEX neither sells or buys oil.

16. CELEX is effective because it operates on a grid system. The California Electric Exchange (CELEX) buys its electricity anytime and in various quantities as transmission of their product throughout the state is possible by the press of a button, such that bidding may take place on a hourly basis and that delivery of the product after bids is ensured.

17. Oil cannot easily be transmitted instantaneously anywhere. Oil comes from different sources around the world, and it may take months before it reaches our shores. The bigger oil tankers are slow, such that a tanker leaving Venezuela could take three months to reach our shores.

18. There is no known existing exchange of its kind in the world. If government adopts this system, the Philippines shall be the first and only country in the world to operate such a corporation.

19. Oilex sends wrong signal that rules in this country can be reversed mid-stream. Foreign investors will think twice before coming into the country because liberalization and deregulation can be reversed anytime. Some P35 billion in programmed investments in import terminals, storage, distribution facilities and retail outlets by new players can be cancelled.

20. Oilex can be an instrument for corruption. Conservative estimates show that anyone in the proposed Oilex who would be "in the take," and would get a P0.10 "commission" for every barrel of crude oil it imports, stands to earn P48 million a month, or P586 million a year!

III. RECOMMENDATIONS

21. Stop the atmosphere of changing the rules mid-stream, facilitate the entry of more players into the oil industry. The more players, the more contestable the market, the more profits are suppressed as companies try to undercut each other’s prices (and/or improve their services) to increase their market share.

22. PNCC should allow the new players to put up service stations at the Expressways. The Philippine National Construction Corp. (PNCC) can help the new players further challenge the Big 3 simply by not excluding them to put up service stations at the North and Expressways.

23. Set up a Petroleum Competition and Transparency Commission instead. The creation of this Commission, together with the Office of the Petroleum Fair Trade Director, is contained in an alternative bill that will be filed in Congress. Their main function is to enforce the constitutional prohibition against any restraint of trade or unfair competition in the local petroleum industry.

24. Hasten construction and completion of rail-based mass transit system. This will effectively reduce people’s demand for cars, buses and jeepneys, thereby reducing local demand for oil products.

25. Governments can help private companies develop alternatives to oil and fuel-efficient engines. Governments around the world can help reduce our dependence and demand for oil by assisting companies that develop more affordable electric cars and solar-fueled vehicles. Also, cars that run on longer mileage per liter of oil.


Signatories:
1. Bienvenido S. Oplas, Jr.
Co-moderator, pilipinasforum@egroups.com
Think Tank, Inc., 136 Yakal St., Makati City
nonoy_thinktank@...

2. Paul Vincent Bermudez
Las PiƱas City
pochbermudez@...

3. Mark Octavio Agaloos
Ma. Orosa St., Malate, Manila

4. Rowena Arceo
Central District, QC

5. Carmencita Balbosa
Maginhawa St,, Teachers Village, QC

6. Joven Balbosa
Maginhawa St., Teachers Village, QC

7. Cristine Asinas-Cabrera
Los Banos, Laguna

8. Cecile A. Cornejo
Mapang-akit St., Pinyahan, QC

9. Jude Esguerra
Diliman, QC

10. Jane Febre
Makati City

11. Arlene Garces
University of Otago, Dunedin, New Zealand

12. Ma. Isabel Gonzales
East Fairview, QC

13. Glenn de Guzman
Kaimito ville, Valle Verde, Pasig City

14. Cynthia Hernandez
East Fairview, QC

15. Atty. Imelda Manalaysay
Manalaysay & Saulog Law Offices
2/F VAS Bldg., Taft Ave. Extension,
Pasay City

16. Dr. Romulo Emmanuel Miral, Jr.
Fairview, QC

17. Amenah Pangandaman
Congressional Labor Commission
Roxas Blvd., Pasay City

18. Luz Abogadie-Rose
Wellington, New Zealand

19. May M. Santos
Fort Bonifacio, Makati City

20. Joey Sescon
SSS Village, Marikina City

21. Rachel Reyes-Sescon
FSSI, QC

22. Malou Tiquia
George Washington Univ.,
Washington DC, USA

23. Ma. Luciana Tungala
Toronto, Ontario, Canada

24. Gloria M. Villanueva
Shaw Blvd., Mandaluyong City

25. Bebet Gozun
Quezon City

….

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