The pass-on costs of oil deregulation

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“We agree that retail
competition accounts for similarities in pump prices,
the difference being little
red toy cars and
free sodas.”

Seeking both transparency and accountability, our energy officials are pushing for the unbundling of oil company costs. This is in light of unprecedented runaway inflation following a chemistry of government-initiated incremental excise taxes on petroleum products and global highs in oil prices.

This move to unbundle the controversial fuel pricing is not new. Seventeen years ago, power rates were unbundled, the proposal then was likewise plagued with pushbacks and divisive debate.

The unbundling of major costs was an issue when the Electric Power Industry Reform Act was being debated. The industry is partly regulated, partly deregulated. The unbundling addressed by the law was “vertical” unbundling that differentiated costs attributable to the major links in the electricity value chain from generation, through to transmission, and finally to distribution.

“Horizontal” unbundling refers to cost breakouts among major costs identified on the vertical cost column.

Only the distribution sector fully complied with both vertical and horizontal unbundling, not so much because it was the law, but because consumer billing is left to distributors to handle.

Today, the impetus to unbundle oil prices is different.

Transparency is compelled by a developing economy with one of the highest energy rates in the region, where electricity, a critical input, is still generated from imported, foreign-currency depleting, dollar-denominated, oil-based fuels like diesel and Bunker C. Given the contribution of fuel to transportation costs, we can assume comparative costs, inclusive of fuel and lubricants, to likewise be prohibitive.

The Department of Energy (DoE) wanted such notoriety erased and accountability imposed given the deregulated license to pass on costs of oil companies. The oil companies, however, claim it is precisely deregulation that makes unbundling unnecessary.

Deregulation supposedly yields to competitive forces that temper price swings. Moreover, requiring unbundling is itself regulation.

We disagree. Let us cite several realities where hidden costs charged to the public require transparency even in a deregulated market.

One, there is no real competition between refiners. Deregulation did not only fail to induce investments in additional refineries, it reduced the number to two. Refineries increase employment and cut import costs. Two, refining inefficiencies are also charged to consumers and rather than cut costs to compete, both share the fruits of high prices by being price leaders.

Two, there is no Return-on-Rate-Base price mechanism that says only earning assets are allowed returns on capital. Thus, non-performing assets are included in the pricing, allowing oil companies to run inefficiently, disregarding extraneous, passed-on costs. With only two competing, the company with the higher refining cost tends to be the price leader and generates extraneous profits for others. While the behavior is not strictly collusion, this employs the same intra-corporate catalyst of cartels. Laymen call it greed.

Three, the high price leader paradigm works even among numerous small oil players and traders. Monkey see, monkey do. Mimicking the high price leader benefits all vendors as the product is basically homogeneous, marketing gimmickry and branding notwithstanding.

Even where pricing is benchmarked against the Mean of Platts Singapore, note where different sources, reserves, tank farm capacities, tariffs and duties, capital assets and costs of debt and capital should create different economic efficiencies enough to widen cost differences. In contrast, while small players pay higher costs absent economies of scale, they benefit from the price leader’s higher margins.

We agree that retail competition accounts for similarities in pump prices, the difference being little red toy cars and free sodas. Unfortunately, their kind of competition compels following the higher price that large oil companies set in a deregulated regime where price gouging is allowed and even shared, and where systemic underlying greed means profit.