Zia Mian | Petrojam: The story that might help to make an informed decision

In the last column (Sunday Gleaner – February 3, 2019), I asked a few simple questions about the Kingston refinery. The first column in this series (Sunday Gleaner – January 27, 2019), provided some insight into the two basic questions that I summarise below:

a) Why did Esso build a refinery in Jamaica?

i. Esso owned the crude oil production in Venezuela.

ii. The Amway refinery in Venezuela provided intermediary products that were added to the crude oil before shipping it to Jamaica.

iii. Margins on crude oil and products it supplied from Venezuela were sufficient to support the financial viability of a simple downstream refining operation.

iv. Differentials in the freight rates for clean and dirty-oil tankers provided an incentive to ship spiked crude oil to process at a simple hydro-skimming refinery.

v. Esso would have the monopoly over the supply of petroleum products to the Jamaican market.

vi. A twenty-year tax holiday granted to Esso provided an additional financial incentive.

Under the agreed pricing formula, Esso was required to set the ex-refinery selling price for refined products based on a monthly average of the daily postings from the Caribbean refineries (Aruba, Curaçao, and Amway refinery in Venezuela).

b). Why did Esso request a small refinery differential and finally decided to sell the refinery to the government?

The refining cost of a small refinery in Jamaica was much higher than the cost of refining in the larger Caribbean refineries. As the Kingston refinery pricing formula was based on an average of the Caribbean postings, once crude oil margins disappeared, (owing to the nationalisation of the oil industry in Venezuela), the Kingston refinery was unable to recover its operating costs and was no more financially attractive.

A tax holiday alone did not provide enough incentive to continue the refining operations without additional financial support from the government. The tax holiday expired in 1982, and the government refused to extend it. as a result, the refinery’s bottom line became red.

The government was happy to oblige Esso by buying the refinery as it believed that it could turn the Kingston refinery into a commercially profitable operation. However, this could only be achieved through creative accounting, plus shifting the basis for the ex-refinery pricing formula from the Caribbean average to the US Gulf postings (a region that was a net importer of petroleum and petroleum products).

Esso, however, knew that even the larger refineries in the Caribbean were having financial difficulties and were likely to shut down (which they eventually did). Esso was happy to walk away with a cheque that was cashed in New York the very next day.

How do I know?

Because the man who carried the cheque to New York in a briefcase chained to his wrist told me when he was a member of my World Bank team that was developing the least-cost petroleum supply options for the small Pacific island countries.

I do recall offering to finance a similar study for the Caribbean island countries, but Jamaica would not have it, fearing that it might negatively affect the Kingston refinery.

In the last column, I briefly discussed the persistent operational losses that the refinery has sustained over the years and its management’s dexterity to explain such losses by blaming them on events beyond the control of the management!

The refinery was here to stay.

In today’s column, we take a look at Jamaica’s structural adjustment programme that was launched in the 1990s with the support of the World Bank and the IMF. This programme would have implications for the Kingston refinery.

STRUCTURAL ADJUSTMENT

The government had agreed with the World Bank and the IMF to restructure the economy and embark on an ambitious economic reform agenda. The reforms, among others, included an extensive privatisation programme covering public utilities and a large number of commercially oriented entities and services, together with the deregulation and privatisation of sugar, petroleum, and power sectors.

The immediate focus of this programme was to improve economic efficiency through trade policy reforms, deregulation, privatisation, and the establishment of a regulatory framework to provide comfort and predictability to potential private investors.

The creation of the Office of the Utilities Regulation – OUR, an umbrella regulatory agency – in 1995 was one such action for which I spearheaded the study that the World Bank financed.

In pursuance of this programme, most prices, marketing and distribution channels were deregulated. General subsidies on food were relaxed, and quantitative restrictions were lifted along with the shutting down of some trade monopolies.

One noteworthy element of this programme was to adjust tariffs to conform to CARICOM’s Common External Tariffs (CET). This development would have profound implications for the Kingston refinery.

DEREGULATION OF THE PETROLEUM SECTOR

Prior to the start of the liberalisation process, all aspects of the petroleum industry were regulated. A government appointed commission played a key role in fixing prices and trade margins. The commission’s members had no expertise in the petroleum industry. However, it determined and approved operating margins for haulage contractors, gasolene retail outlets, and margins for marketing companies.

There were frequent complaints from marketers and union actions and strikes (by haulage contractors, pump attendants, and sometimes retailers). Under this framework, the Kingston refinery enjoyed a defacto monopoly for the import of petroleum and petroleum products.

Following the purchase by the government, the ex-refinery pricing formula had been restructured to reflect “so-called opportunity cost”. It was designed to provide operating margins to the refinery and keep it profitable.

By virtue that the refinery collected taxes on petroleum products, and sent a hefty monthly cheque to the treasury, the ministry of finance was happy with the arrangements, a situation the refinery used to its advantage.

As the refinery had persistent operational issues (and ran at below its capacity – it made up for total product demand in Jamaica by direct import of refined products, thus controlling about 95 per cent of the domestic market. Marketers’ main role was limited to being wholesalers, with some ownership of retail outlets.

As part of the reform programme, the Government of Jamaica (GOJ) launched a phased deregulation of the petroleum industry, first by decontrolling the domestic petroleum prices (except for kerosene for domestic use, which was subsidised for environmental and social reasons!), and allowing a full pass-through of the higher international oil prices, including devaluation effects, to the consumer.

IMPOSITION OF COMMON EXTERNAL TARIFFS

In 1993, the GOJ implemented the second phase of the deregulation by removing the de facto monopoly of the Kingston refinery to import petroleum and petroleum products through the imposition of Common External Tariffs on refined petroleum products.

But the ability of other marketers to import products was constrained due to a lack of terminalling/storage facilities. More and more, the refinery was operating as an oil-import terminal rather than a strict refining unit.

The harmonisation of CET granted to the Kingston refinery a 10 per cent protection on its refining operations. A CET of five per cent was imposed on refinery feedstock (crude oil and semi-finished products that the refinery imported) and 15 per cent on the refined products.

There was an understanding that if the refinery could not make a product, the direct importation of that product by any approved importer could receive a tax waiver. The issue of tax waiver on unleaded gasolene granted to a marketing company was a result of this proviso.

However, the refinery claimed that it could make unleaded gasolene, and no such waiver should have been granted. But the reality is a different story!

In the meanwhile, the refinery was continuously receiving tax waivers (sometimes retroactively) and used the system to its advantage.

It is good to be owned by the government!

- Zia Mian, a retired senior World Bank official and former director general of the OUR, is an international consultant on energy and information technology. He writes on issues of national, regional, and international interest. Email feedback to mian_zia@hotmail.com or columns@gleanerjm.com