Crude solution

Business World
Introspective

Acouple of weeks ago, President Gloria Macapagal-Arroyo issued an executive order that turned back oil prices in Luzon, which has been placed under a state of calamity, to where they were on October 15 as relief to typhoon victims. This added to an already long list of price controls temporarily placed in typhoon-stricken areas on items ranging from rice to sardines to funeral services.

The cap on fuel prices unleashed the sharpest response from the business sector, largely because of the history behind oil price controls. The industry was deregulated only in the late 1990s, and memories of shortages such a policy produced remained fresh in people's minds, not to mention the enormous subsidy cost of trying to stabilize prices.

Local business groups and foreign chambers of commerce have railed against the imposed measure. Their arguments were hard to refute - price controls would only distort supply, spur shortages, create a black market (and black market prices), lead to profit losses for oil firms, and discourage investment. Those who showed some support for the wielding of state powers highlighted the need for it to be used sparingly and within a very limited time.

Even the central bank has spoken up on the issue. A deputy governor of the Bangko Sentral ng Pilipinas (BSP) warned the public on the dangers of price controls, which he said created market distortions and affected availability of supply in the long run. A Palace economic adviser has also weighed in on the issue, arguing how price caps on petroleum products disproportionately benefited the well-to-do and resulted in revenue losses of as much as P4.5 billion (from VAT and income taxes), while opining how it was much sounder for the government to just target help to typhoon victims (e.g., through diesel discounts, discounted fuel access cards for lower-to-middle- income families, and income transfers to the poor).

But the President has kept distance from the debates, leaving it to a task force led by the energy and justice departments to decide whether or not price controls should be lifted. The task force has been meeting with the private sector but says it will need to wait for the verdict of the National Disaster Coordinating Council (NDCC) on how soon the emergency situation can be expected to end. With its hands-off policy, the Palace will also likely let the courts defuse tension, as one of the Big Three (Pilipinas Shell Petroleum Corp.) has questioned the legality of EO 839 and asked for its lifting.

The capping of oil prices may be perceived as merely a well- intentioned but wrong-headed policy designed to ease the plight of calamity victims. However, the lack of a clear effort toward consensus-building hints at a less straightforward agenda, not the first time that the country's leader would play to the gallery (e.g., less than full recovery of power costs until 2004, brief suspension of automatic indexation of water tariffs, and freezing of toll fees).
Apart from failure to confer with industry players, only a few Cabinet officials had apparently been closely consulted in crafting the measure, with the puzzling omission of the secretaries of energy, finance and economic planning and the central bank governor.

At the moment, there is a battle of wills between oil companies and government. Oil companies threaten shortages and shutdowns, while government officials and administration lawmakers warn of the full force of the law. One Palace insider describes the mood in the corridors of power as pregnant with petulance.
The danger is, the longer this is allowed to drag, the messier it becomes for the local fuel market, the harder to unwind, and the worse for the economy in general. Already, arbitrage and shortages are being reported in certain areas in Luzon where oil firms allege they have to sell at a loss, while complaints have been made about escalating prices elsewhere in the country.

The sector to watch out for is LPG (also used for household cooking), a sensitive market that will likely be the first to take a hit because of the weak financial muscle and low profit buffers of independent players who together hold more than a fifth of market share. LPG retailers have threatened to stop sales if price caps continue until December.

Inflation also becomes harder for monetary authorities to manage if the present situation continues, explaining BSP's timely take on the issue. As one central bank official cryptically confided to friends, maybe [the] measure is temporary but caution ensures it will not be permanent. Local pump prices have kept relatively steady despite the rise in world prices purportedly as a result of price wars, but will later have to follow global trends. Keeping rates below market level for a long time will only lead to price surges when ceilings are removed.

For the longer term, the present episode could mean a dilution of the oil deregulation law which the Ramos government took pains to establish. Already, Congress is looking for ways to amend the law and widen the powers of the state to correct abuses especially during special circumstances (e.g., by raising the transparency of price-setting, spurring competition by building up smaller players, or bringing back some form of price regulation).

The quickest break to the impasse would be if both government and oil players agree on a compromise - a discount for typhoon victims perhaps, as what seems to be the emerging consensus, or limiting the measure to highly distressed areas with an agreement to gradually phase in price increases elsewhere in Luzon. The NDCC could also decide that a state of calamity no longer holds, making any court case against the freezing of oil prices academic. Otherwise, oil firms could simply wait for the court system to grant a restraining order on the measure which should not be too long though the relief will be temporary.

The above scenarios still offer the administration a graceful exit from the self-inflicted dilemma.
Government trumpeters have repeatedly assured that price measures will generally be geographically, temporally, and legally bound, but the truth is how long caps on oil prices in particular can last depends entirely on the President. In the meantime, inventories have been dropping as oil importers begin to cancel scheduled purchases - from the usual three weeks to less than two, according to the energy secretary - creating a possible backdrop, some speculate, for a state-led fuel allocation plan. Listening to industry experts, one gets the feel that the longest major players can survive this game is two months and the smaller players maybe just one. Government could of course try to maximize brownie points and stretch oil firms to their limits before it finally folds its cards, but this would be at a great cost ultimately.

(This column is based on a GlobalSource report written for international fund managers entitled Crude Solution, co-authored by Margarita D. Gonzales.)
Romeo Bernardo is board member of The Institute for Development and Econometric Analysis and is managing director of Lazaro, Bernardo, Tiu and Associates, Inc.