Champika calls for transparency in petroleum industry

The government is interested in developing an upstream petroleum industry using Sri Lanka's own gas and oil resources. But it is not an easy task as the country does not have the technology nor the huge capital investment needed for such a large scale project, Power and Energy Minister Patali Champika Ranawaka told a workshop on downstream petroleum industry organised by the Public Utilities Commission of Sri Lanka (PUCSL).

The workshop focused on supply, quality, pricing and regulatory issues.

Extracts from his speech.

"We need to regulate the downstream petroleum industry in a more transparent and logical manner which suits our needs. Today, our pricing mechanism and the regulatory environment of the industry is not satisfactory.

In the local context, petroleum plays a major role in energy supply in Sri Lanka and contributes 37% of the total primary energy supply. In 2013, Sri Lanka imported 1.75 MMt of crude oil and 2.36 MMT of refined petroleum products.

Petroleum imports take up approximately 25 percent of the import bill of the country and the proper management of this sector is vital for the economic well-being of the country.

If we continue to grow at the present rate I am sure our import earnings will not be sufficient to meet the demand for petroleum products.

It is evident that practices of the downstream industry needs careful study and improvements in many areas where the PUCSL can play a major role in making legislative and operational changes.

Imbalance

In the global context, petroleum contributes 33% of the total world energy consumption at 93.09 million barrels per day, while world oil production is at 94.16 MMbbl/d. according to US EIA data. The price of oil has dropped from around US $ 100 per barrel in early 2014 to about US $ 55 today.

This is mainly due to the imbalance between production and consumption. It is said that the production glut started with newly developed hydraulic fracking operations in the United States, which developed the so-called 'tight oil' trapped in shale rock formations.

In the past when supply exceeded demand, OPEC countries curtailed production to keep the prices steady. However, in this instance OPEC led by Saudi Arabia refused to cut production leading to the present oversupply.

It is generally believed that Saudi Arabia wants to retain its market share while discouraging fracking operations in US. New investments in fracking is not viable if oil is below US $ 80 per barrel and fracking operations already in progress become unviable below US $ 50 per barrel. OPEC currently produces 36.77 MMbbl per day, which exceeds demand by 2.07 MMbbl.

Until there is a substantial reduction in US oil production the oil prices may remain at current levels. Current low oil prices greatly benefit countries such as Sri Lanka dependent on imported fuel. However, we must prudently use this window of opportunity provided by low oil prices to develop other energy resources anticipating an upward swing in oil prices in the future.

Liberalisation

All indications are that this drop in world oil prices is a temporary phenomenon and prices will surge eventually dealing developing economies a brutal blow as developing nations such as Sri Lanka cannot control the world oil trade as we are not big-time producers or consumers.

The petroleum industry in Sri Lanka which was a State-owned monopoly, was gradually liberalised starting with LPG in 1993, followed by lubricants and bunker supply, ending with the partial liberalisation of the petroleum fuel market in 2003.

Today, besides the State-owned CPC there are number of players in the petroleum fuel, lubricant, bunker and LPG market. The industry is governed by the Ceylon Petroleum Corporation Act No 28 of 1961 and Petroleum Products (Special Provisions) Act No.33 of 2002.

The Acts formulated basically to govern a public sector monopoly is not equipped to regulate a liberalised industry involving a large number of market players.

Lack of a transparent pricing mechanism for petroleum products is a major shortcoming. Except for a short period in 2002, there has been no laid down pricing policy for petroleum products. Prices have

been arbitrarily fixed by the CPC or the Government, without taking into consideration the fluctuating oil prices in the international market.

While the upward movement of the international oil prices was passed on to the consumer if it is politically and economically beneficial, downward movement of prices was not passed on.

In 1986, when crude oil prices dropped to about US $ 10 per barrel, the Government imposed a Customs Duty of 45% on crude oil, compelling CPC to maintain high prices.

We must take appropriate action, so as not to burden the consumer with inflated costs. Yet, the utility must also generate sufficient revenue for investment in developing infrastructure such as refineries, storage facilities and pipeline systems. Hence, a transparent cost reflective pricing mechanism would benefit the consumer and the utility.

The government has taken action to reduce excessive taxes imposed on petroleum products. A cost reflective transparent pricing formula, based on international market prices will be introduced soon.

With the formula, consumers would be privy to breakdown of various cost components such as cost of product in the international market, freight and insurance costs, government taxes and marketing margin.

The marketing establishments would be unable to hide their inefficiencies in the future as every action and activity will be scrutinised by an independent regulatory body. No longer will the institutions pass unreasonable costs to the consumer.

In the infrastructure area we are today burdened with aging and inefficient facilities such as refinery, pipeline systems and storage facilities, the development and modernisation of which has been long overdue.

The Sapugaskande oil refinery was built in 1969. While it produced 100% of the country's need of refined petroleum products until about 1990, today it can supply only 30% of the refined products for consumption.

Modernisation

Due to the outdated process in the refinery, it cannot produce environment-friendly fuel needed modern vehicles. While the need to modernise and upgrade the refinery has been recognised for quite some time no action has been taken to implement it.

As per the energy sector development plan we are taking action to initiate refinery upgrading and modernisation project, at an estimated cost of US $ 1,300 million.

The configuration of the refinery will be changed from hydro-skimming type to a cracking type refinery, where low value furnace oil is upgraded into high value petrol and diesel. The project is due to be completed in about four years.

Once the project is completed the refinery would produce country's total need of refined products.

With modernisation, the refinery would produce more environmental-friendly fuel. Currently the refinery produces automotive diesel with a sulfur content of 2,500 parts per million (ppm). This would be reduced to 50 ppm after the modernisation.

Gasoline and diesel meeting EURO IV and EURO III quality standards will be introduced to the market.

Some of the pipeline systems are over 80-years-old and maintenance has been neglected leading to frequent leaks during operation causing large losses to the State.

Due to the reduced pumping speed on the pipelines, often demurrage is incurred during imports. A project has been initiated to rehabilitate pipelines from Kolonnawa to the port at an estimated cost of US $ 45 million.

Due to this scenario, we import 70% of our petroleum as refined products. There have been many shortcomings in the oil procurement process leading to corruption. Oil has been purchased on short-term basis on the spot market paying large premiums.

Action has been taken to streamline the oil procurement process with proper systems and procedures

in place making the process transparent. Serious issues have surfaced relating to product quality some of which are linked to shortcomings in the procurement process.

Quality

Action has been taken to improve the product procurement and upgrading of the refinery to ensure that quality products are marketed. Legally enforceable minimum quality standards for petroleum products need to be established. Lack of independent laboratory facilities for testing petroleum is also a major concern.

In the absence of a regulator, our consumers have no recourse if substandard products are marketed.

Petroleum will not play a dominant role in the future as envisaged by the recently launched ten-year development plan for the energy sector. The main emphasis of the plan is on developing indigenous renewable energy resources to reduce dependence on imported fossil fuel.

However, development of recently discovered natural gas resources in the Mannar basin is a priority. Two gas discoveries Dorado and Barracuda have been made in Mannar basin with a potential of two trillion cubic feet of gas.

Commercialisation of Dorado gas discovery has been planned. After gathering gas from the sea bed deposits, the gas will be sent to a processing facility to be constructed at Norochcholai and purified natural gas has to be transported via a pipeline to power plants. It is envisaged that natural gas will be available for use by thermal power plants by 2020.

The concept of a regulator for the petroleum sector was first initiated in 2003 with the setting up of the Energy Supply Committee (ESC), along with the partial liberalisation of the petroleum fuel market.

With the ESC and the Energy Supply (Temporary Provisions) Act of 2002 becoming defunct, no effort was made to appoint a regulator for the sector.

The legislature enacted to govern a public sector monopoly, is not adequate to govern a liberalised industry with many market players. Hence appointing a regulator to oversea the industry is an essential and timely need.