Petroleum Products Amendment Bill: briefing; Report on Petroleum Pipelines Bill: adoption

Meeting report

MINERALS AND ENERGY PORTFOLIO COMMITTEE
13 August 2003
PETROLEUM PRODUCTS AMENDMENT BILL: BRIEFING; PETROLEUM PIPELINES BILL: ADOPTION

Chairperson: Mr M Goniwe (ANC)

Documents handed out:
Petroleum Products Amendment Bill [B25-2003]
Petroleum Pipelines Bill as amended by the Committee (final version)
PowerPoint presentation on Petroleum Products Amendment Bill (document awaited)


SUMMARY
The Department explained that the amendment Bill was intended to deal with practical problems in the current system. It would seek to promote an efficient industry, investment, advancement of the historically disadvantaged, employment and small business, and ensure petroleum product supply at competitive prices. The Bill would give the Minister wide scope for regulation to match the wide scope of the industry players' imaginations. Regulations would seek to eliminate activities that placed upward pressure on the fuel price, such as promotions and a proliferation of marginal retail sites.

Committee members raised concerns that the regulations would interfere with market forces. The Department explained that market efficiency was not the only policy objective; further the regulator did not have the resources for the sort of fine-tuned regulation that would be necessary to separate out costs such as for promotions.

MINUTES
Briefing by Department
Dr R Crompton (Deputy Director General: Hydrocarbons and Energy Planning, Department) briefed the Committee. He stated that the Bill was responding to practical situations in the industry. As an amendment Bill, it was merely renovating the system and not a complete redesign. The Bill was for a transitional period - the Government intend that the activities it covers will be moved to the single energy regulator in due course. They are following a path of managed liberalisation.

He outlined the background to the Bill as follows. Existing regulations prohibit vertical integration and regulate full service in the industry. The Service Station Rationalisation Plan had been introduced in the 1940s to deal with cut-throat competition, and exempted the industry from the Competition Act. After the White Paper on energy, the amended Competition Act required an application for the renewal of this exemption. Lack of consensus in the industry in 2000 resulted in no application being made. This should give the Committee some insight into the difficulties they would face with the Bill - there are many interest groups, with fractured interest patterns amongst them.

SASOL would end their part in the upliftment agreement. At least one oil company had given notice that they were withdrawing from the upliftment agreement with PetroSA. SASOL has few retail outlets, PetroSA none. Against this background, there was market positioning going on in the industry in anticipation of the coming changes. The Bill would thus seek to ensure fair competition and deal with related problems in the industry.

There is a perception that retail sites are a source of wealth. This has led to there being too many retail sites, though there is no agreement on how many too many. The situation leads to many marginal sites, which places upward pressure on the petrol price due to consequent demands to increase the retail margin.

There are allegations of 'hidden cross-subsidies' in the industry. Dr Crompton stressed that these allegations are as yet unproven and had to be investigated. The Department is against such subsidies and would like to rule them out in the regulatory framework.

Several niggling issues were frequently raised and consumed much of the regulator's resources. The Department wished to deal with this in a manner which would save resources. Fuel specifications were not prescribed, which had led to diseconomies. The Department thus wished to standardise specifications. A study on optimum octane levels had just been delivered to the Department. Standardised specification would also prevent anticipated dumping of low specification fuels as the move to clean fuels continued. Forecourt promotions, used to attract custom and build brand-loyalty, led to upward pressure on prices. The Department wished to prevent this. Dr Crompton noted that the Department was faced with the considerable imagination of companies in the industry and so proposed giving the Minister wide powers of regulation to be able to deal with the wide scope of imagination. The Minister and Department were constantly called on to intervene in the relationship between wholesalers and retailers. The Department thus proposed a quick, cheap arbitration mechanism. Stock outs (where fuel supplies ran dry or low) caused economic disruption. Much hard work had been done to prevent such situations. The Department proposed minimum commercial levels of stock to be held to prevent stock outs.

Environmental degradation was at times a problem when sites were abandoned. New site licences would require financial security for environmental rehabilitation should they be abandoned. This measure would not apply retrospectively. Fuel blending, such as the spiking of diesel with paraffin, led to tax losses and engine damage. The Department wished to try to eliminate this.

Dr Crompton stressed that his slide on Pricing Imperatives should not be taken literally. It merely illustrated the imperative to lower the costs of petrol and diesel as inputs to the economy and of paraffin and LPG to aid poverty alleviation.

The Petroleum Products Amendment Bill was intended to ensure that governance of the liquid fuels sector was in line with Government policy objectives. It would do so chiefly through the licensing dispensation. The Amendment Bill deletes obsolete provisions in the Petroleum Products Act and provides the framework for licensing for refining, wholesaling and retailing. The licensing objectives would seek to promote an efficient industry, facilitate an environment conducive to investment, promote advancement of historically disadvantaged South Africans, create employment opportunities and develop small businesses, and ensure the countrywide availability of petroleum products at competitive prices.

The Minister would be given wide scope for regulation, in order to deal with the wide scope of the industry's imagination. Under the Bill, the Minister may regulate to disallow behaviour that undermines price regulation, to enhance market transparency as part of the route to managed liberalisation, to ensure minimum stocks, and regulate the efficient and safe use of petroleum products.

The Bill would prohibit wholesale/retail vertical integration and require full service. This would simply entrench the current Regulations in the Bill. It creates the basis for a system for retail sites for use in a transition of up to ten years linked to the size of the market - this system would have to be published for comment before adoption. It obliges the controller of petroleum products to administer the licensing system, modernises the offences and penalties and introduces an appeal procedure. To deal with relations in the industry, it introduces arbitration for 'unfair & unreasonable contractual practice' between wholesalers and retailers. This would benefit small businesses especially by providing a faster, easier, cheaper route to settle such problems. The Bill would enable the Minister to regulate on: licensing conditions and restrictions, prohibition of certain business practices, the advancement of historically disadvantaged South Africans, furnishing information and record-keeping, security of supply, fuel specifications, prohibition of blending to avoid tax, and financial security for site rehabilitation.

Dr Crompton noted that there were many groups that wished to introduce their interests to the debate. The Department would comment on these views when they were presented.

Discussion
Mr A Blaas (ACDP) asked about the regulation of fuel specifications to prevent upward pressure on prices. Market forces would deal with an over-proliferation of new types of fuel.

Dr Crompton replied that he did not think he had stated that the introduction of new products led to price distortions. In a small economy, one had to look at costs. Problems could arise if there was a large range of fuels - for example, some fuels could not be stored in tanks that had been used for other fuels. Thus one needed different kinds of storage, transport, and so on. This led to higher costs.

Mr I Davidson (DA) asked who ended up with higher costs - the consumer or the oil industry? Ultimately, oil companies must look to their own margins. As long as the fuel price was regulated at a maximum level, if the companies wished to incur costs, they should be allowed to.

Dr Cromption replied that there were other aspects to this. For example, if oil companies introduced additives with negative health implications, surely this should be regulated? One had to consider the environmental and health implications. The Department worked with the Department for Environmental Affairs and Tourism on this. The intention was not to restrict innovation, but ceilings had to be set for pollutants such as sulphur. Regarding the economics of the matter - there were a number of components to the regulated price, one of which is the wholesale margin, which considered return on assets. If companies built many storage tanks, for example, they would need a higher wholesale margin to get a return on these assets. Thus having many tanks would feed through to a higher petrol price.

Mr Blaas asked about the role of the motor industry in the setting of fuel specifications.

Dr Crompton replied that the motor industry had views on fuel specifications. He noted that newer vehicles self-adjusted to various fuel specifications. The intention is to find the optimum number of fuels, though this is not easy. The Department would consult with the motor and fuel industries and try to find the correct balance between their views.

Mr Blaas stated that promotions were simply a part of the free market. Why did the Department wish to intervene?

Dr Crompton replied that the number of cars and amount of petrol bought in South Africa was pretty constant. If one petrol station used a promotion to gain market share, this was at the expense of others. The others would then use promotions to regain their share. There was thus consumer movement back and forth. This was all very well in a free market, but in a regulated market this led to higher petrol prices. Retail margins depend on their costs, so the margin has to be increased to deal with higher costs leading to higher prices. Promotions thus had little effect on market share given counter-promotions and led only to an increase in price.

The Chair responded that with a regulated price, the retailers had to recover their promotion costs from the regulated margin. Since retailers did not decide the price, how did their promotion costs affect it?

Dr Crompton replied that the costs related to promotions were captured when the overall cost was captured to calculate the retail margin. Promotion costs thus effectively increased the petrol price when the retail margin was calculated each year.

Mr Davidson responded that if the price was regulated, the costs went to the retailer, not the consumer. He did not understand why the Department was building in the increase. The Department did not have to give in to pressure to increase the margin to recover promotion costs. Why was it protecting the petrol industry from cutting its own throat?

The Chair added that retail sites might not always incur significant costs in promotions. For example, a site might buy cola in bulk at reduced prices and offset that saving against the cost of giving away free cola when people bought petrol from the site.

Dr Crompton replied that the Chair's point helped to illustrate the problem. There were approximately 4900 petrol stations. When measuring the retail margin, the Department would need to do a forensic audit on each to establish where the cost of promotions started and ended. Experts reported that a high percentage of stations lacked proper books, though they could relate their overall costs. The regulator did not have the resources to perform the investigations that would be necessary to separate out such costs.

Mr Davidson responded that he could not see Dr Crompton's argument. He stated that there should be a regulated maximum price, not minimum. If fuel companies could maximise efficiency and sell petrol more cheaply, they should be allowed to. He accepted the argument that there were too many fuel stations - their numbers needed to be reduced which would lead to more profit. Why not allow retailers and oil companies to maximise efficiency and pass along the savings? If the object of the Bill was to ensure competitive prices, it was contradictory to allow regulations against practices that undermine price regulation. Only the maximum price should be regulated.

Dr Crompton replied that matter would be much simpler if economic efficiency were the only policy objective. However, there were other objectives, such as maintaining jobs. Forecourt attendants were in a vulnerable position.

Mr Davidson interjected to suggest that the Department require full service in legislation.

Dr Crompton responded that it would be difficult to define 'full service'. If one applied one's imagination, there could be many interpretations. For example, is it still full service if the customer has to get out of his/her car to pay for the fuel at a cash window? It would be difficult to regulate. The Department had to consider objectives such as the promotion of small and medium enterprise, the promotion of the historically disadvantaged. It could not single-mindedly go for efficiency.

Mr Blaas asked if the minimum stocks proposed would apply to wholesalers only or also to retailers. If it requirements applied to retailers too, they would result in additional costs, which placed more pressure on retailers, especially marginal sites.

Mr E Lucas (IFP) noted that petrol companies lease service stations to individuals to get round the prohibition on vertical integration between wholesalers and retails.

Mr Lucas stated that larger margins benefited bigger dealers more than smaller dealers and the latter were often outside of urban areas.

Dr Crompton responded that one would make more money on greater sales volumes. There were certain fixed overhead basics which any retailer had to have. It was more difficult for smaller retailers to manage and they complained to the Minister about this, asking for an increase. However, as the margin increased, this created space for new marginal retailers. This could lead to upward pressure on the petrol price.

Mr Lucas asked what the costs were for producing diesel, paraffin and petrol. The Department should address the cost of paraffin.

Dr Crompton replied that the cost of fuels varied from producer to producer. The question would be better addressed to the producers. The Department did not monitor the costs of production, it monitored the fuel regulatory system, which used a formula that stood in for the basic cost.

Mr Davidson asked Dr Crompton to explain the allegations of hidden cross subsidies.

Dr Crompton gave two scenarios that had been alleged. Diesel was sold mainly to commercial customers directly, not through the forecourt. The price of bulk diesel to commercial customers is lower than that at the forecourt. There had been suggestions that companies may be using prices at the forecourt to subsidise commercial prices. Oil companies had introduced electronic gadgets to allow automatic deduction of the cost of commercial diesel bought on the forecourt from the account at the oil company. It was alleged that retailers suffer through this since certain oil companies reduced what the retailers received per litre on the basis that they were doing less for the oil company with the electronic system in place. Again, ordinary diesel consumers would be subsidising commercial consumers. The Department was investigating these allegations.

Mr G Oliphant (ANC) stated that the fuel industry was very complex. It was not as easy as it might sound to regulate it. There had been security of supply and this should be maintained. He stated that he could not recall a situation in South Africa where people had gone to a service station and found that it had no petrol.

Mr Oliphant asked what had been done to promote the advancement of the historically disadvantaged. Legislation should encourage the implementation of the liquid fuels charter.

Dr Crompton responded that the Bill did not include reference to the liquid fuels empowerment charter. This was because at the time of its drafting, there was still uncertainty about the legislation on empowerment. It was mentioned in the objectives of the Bill and could be regulated by the Minister. There was a problem in that the signatories to the charter did not cover all the constituencies covered by the Bill. This would have to be considered if the Bill was to refer to the charter.

The Chair asked if there was a way forward on this. There was pride in the pioneering work of the petroleum industry in empowerment. The Department should consider formulations that give space for the charter.

Dr Crompton responded that the Department would do this.

Mr J Nash (ANC) stated that Dr Crompton had covered most of his points. He stated that in the pricing of petrol, retailers and wholesalers each have a margin. Every year retailers asked that their margin be increased based on their costs, which led to an increase in the petrol price. The formula to work out the margin included the overheads.

Mr Lucas stated that members understood what regulation and deregulation was all about. Regulation had worked and had brought the industry to its current position. Greater clarity is needed. Extra costs vary from area to area. Promotions were conducted to get more customers, which led to greater profits and so could be afforded by retailers. Smaller retailers suffered however. Having a system where only the maximum price was regulated, as suggested by Mr Davidson, would work only in urban areas. In more rural areas, the maximum price would always be charged. This would disadvantage the poor, who would end up subsidising urban customers.

Mr H Gumede (Chief Director: Hydrocarbons, Department) replied that on the system of setting margins, the cost of promotions was passed through to the consumer. The previous year's costs were considered in setting the margin for the coming year, so promotions one year are part of the cost-base for the following year. So the Department wished to avoid them. The use of credit cards had the same effect given the costs of banking for the retailer. The objective was to promote an efficient, viable supply network, to minimise costs and maintain a reasonable margin. This should increase the survival rate of retailers.

Mr Baas stated that there was a contradiction in the Bill. It sought to protect retailers, but there was an oversupply of retailers. If basic costs were fixed, there must be a break-even volume. Marginal retail sites should not exist. If the Department protected retailers, they should expect prices to rise. If they wished to rationalise the industry, they had to allow the market to have its effect.

Mr Gumede replied that the Bill sought to protect both retailers and motorists. In a free market, some stations would close. The Department intended to take this into consideration. The aim was to reduce the number of retailers without economic bloodletting. The process had to be managed to avoid closures in areas where stations were needed.

Dr Crompton added that the Department was pursuing several policy objectives.

Mr Davidson asked about the use of credit cards to purchase fuel. He noted that the matter was not addressed in the Bill and wondered where it should be addressed. He asked where the investigation into their use for petrol purchases was.

Mr T Burger (Director: Petroleum & Gas Regulation, Department) replied that the annual margin determination was based on costs, including banking costs. If the use of credit cards was allowed, one would have to take into account the costs - at 5% this was 20c per litre at a price of R4 per litre. This would lead to an increase in the cost of petrol. Since most buyers did not have credit cards, this would mean an increase in the price for a small percentage of consumers. The Department was engaging with the banking industry on the matter, but international credit card rules prohibit allowing the buyer to accept credit card costs.

Dr Crompton added that the matter could only be addressed by banking legislation that forced banks to allow credit card holders to bear the costs of transactions.

The Chair noted that there was considerable pre-negotiation between the Department and stakeholders in developing Bills. The work done involved compromise. He hoped for this sort of outcome with the current Bill. South Africans have demonstrated an ability to find solutions to complex problems.

Adoption of report on Petroleum Pipelines Bill
The Committee adopted the report approving the Petroleum Pipelines Bill and reporting it to Parliament with amendments.

The meeting was adjourned.