Why aren’t we paying R5.29 for fuel?
The US government (and popular media) has a long history of blaming oil companies for “excessive profits” when the oil price is high. They don’t particularly care that when the oil price is low, oil companies risk huge losses, or that massive, long-term industrial investment projects can only be justified by future profits. No, every time Americans suffer at the pump, or think they do, oil companies are hauled before Congress to testify about their “price gouging”.
Turns out that they make less profit than you’d think, as Sterling T. Terrell shows eloquently in an article here. It’s a must-read, because it makes the price of fuel at the pump really, really simple. Taking into account inflation and tax, and despite higher demand from growing economies, higher demand from countries buying in currencies other than dollars, and restricted supply because of draconian environmental restrictions on exploiting domestic oil resources in the US, it turns out Americans aren’t paying all that much at all. Of the excess over base costs, two thirds goes to the government in the form of taxes. The “record profits” of billions of dollars that you hear about on TV might sound like a lot, but once you work it out in terms of the value of a typical oil company’s asset base, the volumes of product supplied, the cost base, and total revenues, they’re not “record profits” at all. Even water utilities make more profit, as do many other industries.
He argues, correctly, that price caps will lead, inevitably, to shortages. But that doesn’t stop politicians, here and abroad, from expressing grave concern about the impact of the high oil price on consumers. Smoothing the political path for intervention, no doubt.
I did a crude (haha) calculation myself, using various data obtained from Stats SA and the Department of Minerals and Energy Affairs. Starting with a 1998 base price of R2.28, which is what a litre of 91-octane unleaded used to cost inland, I compared the actual price to the inflation-adjusted price. For actual price I stuck to the highest octane available, as new levels (93 and 95) were introduced. If R2.28 is adjusted by inflation (average annual CPIX), the average fuel price in 2007 would have been R4.45. The average price in 2007 was actually R6.75. For the sake of simplicity, let’s put all of that disparity down to the steep oil price rise of recent years.
But we are a global leader in the production of synthetic fuel from coal. Sorry, says Sasol, we can’t give it to you cheaper than the government price. As a result, Sasol’s after-tax net profit margins, at 17%, are much higher than the 9.5% profit margin of US oil companies. Synfuel, however, accounts for only 30% or so of its business, but generates about 55% of the company’s profits. So the profit margin of the synfuels division alone is almost twice as high again, just because its costs are independent of the oil price, but its prices are determined by government and rise as the oil price goes up. So in reality, Sasol’s synfuel makes 3.3 times the profit that a typical US oil company makes. And the US companies are the ones being hauled before public hearings!
Profits would not be an issue in a free market, but they are an issue when they are made by a private monopoly in a highly-regulated, price-controlled sector. Worse than government-sponsored profits for Sasol, however, is that more than 20% of the fuel price goes towards unnecessary taxes (as opposed to the Road Accident Fund, which for all its bureaucratic chaos and mismanagement, is a more defensible levy). Take that arbitrary tax away, and the inflation-adjusted fuel price at the end of 2007 could have been R3.73, or if you account for the disparity between the inflation-adjusted price and the actual price — reflecting, in my simplification, the recent oil price rise — it could have been R5.29. (Disclaimer: So says the back of my envelope; corrections or refinements to this rough calculation would be welcome.)
Instead of R6.75 on average for 2007, we could have paid R5.29, and that’s without any change to the Sasol price policy or reduction in the price of oil. What effect might such a massive saving in transport cost have on food prices and general price inflation? Why does the government think it’s a good idea to tax fuel, and to keep raising those taxes?
Some might argue that fuel taxes discourage consumption, and therefore they are good for the environment. But fuel demand is notoriously inflexible. Face it, you’ve got to get to work, and producers have got to get bread and milk to the supermarket, no matter what the fuel price is. So the effect of taxation on demand is fractional. If you’re going to incur costs in the economy by using the fiscus to fund environmental improvement, almost any other investment would get you higher returns than fuel taxes.
So we have the absurd situation that on one hand, the US is holding hearings in populist efforts to claw back money from companies whose prices aren’t regulated, whose operations are bound by a myriad laws, and whose profits are by no means excessive. On the other, South Africa is doing nothing about sky-high monopoly profits that are a direct gift from the government, and which raise costs for every industry sector, limit economic growth, reduce our ability to alleviate poverty and create jobs, and limit our options in dealing with the energy crisis. And neither country has considered that of all the idiotic tax ideas a rapacious government can think of, slapping 20% taxes on fuel is possibly the worst. [Correction: that should read “27.2% taxes”. 27.2% tax results in a 21.4% share of tax in the final price, which I rounded to 20% here.]
Some economists say that South Africa is not headed for recession, despite the worldwide financial crisis, the weakening global economy, the critical shortage of electricity, and the rising oil price. I’m fairly pessimistic, however. I think the electricity crisis alone will be enough to cause a recession, because its effects permeate the economy. But even if the Bolt Effect, as I like to call it, is not as bad as I surmise, I’d be far more inclined to believe the optimists if the government were less keen to skim the cream off what’s left of the economy by taxing a basic commodity such as fuel.
Meanwhile, you have until this Friday, 25 April 2008, to comment on price cap proposals (Government Gazette link in PDF) on liquified petroleum gas. I’ve written about this before. If you want to know why you can’t find that nice cheap LPG at your local petrol station, look no further than government’s insistence on regulating every price in sight.
And every time we get shortages, or price inflation, or both, we wonder why. It’s because (and Mandy de Waal’s comment yesterday is a case in point) we simply don’t trust the profit motive as a driver of efficient capital allocation. We simply don’t trust the price mechanism to regulate supply and demand. In the end, we don’t trust our people with their freedom.
But really, do go read Terrell’s article. Evidence once more that Economics 101 is, well, elementary.
You are quite right about Sasol except for one thing — that is the amount of Foreign Exchange ie US dollars, its saves South Africa by producing liquid fuel from local resources (gas to-liquid or coal-to-liquids). That is not to denyy that Sasol makes large profits but then, why not? Sasol is owned by shareholders who knew a good thing when they saw it> And, don’t forget that many South Africans have pension funds that benefit from Sasol profits too.
Other than this, I could not agree more with you, and your views generally. I wish there were more of you in the local media which seems to me, more and more these days, written by ill-informed teenagers or, if not written by them entirely, then sub-edited by them.
Economics 101 is not part of the school curriculum in SA and I suspect that once you get to university the subject is dominated by crypto-Marxists. What else explains the blind ignorance of how successful economies work?
Econ 101 is certainly no prerequisite for becoming either a politician or a journalist, sadly. On Sasol, allow me to make the fine distinction that I don’t blame its shareholders for exploiting the playing field, but I do blame the government you and I pay for, for creating it.
Thanks for the compliments.
Gah!
Nice for Sasol’s shareholders.
I speak under correction but it costs SASOL about $25 to produce an equivalent “barrel” of fuel and it is in govt’s remit to pass that on to you and me. but ole Thabo “What crisis?” Mbeki is too busy telling George Dubbya and Japan off to pay attention to this Eskom-scale cock up. Argh!
$25 per barrel? That would be nice.
(btw great piece Ivo)
Let’s just discover WMD’s in the Middle East. Go to war and claim their oil. If it’s a lot we’ll be better off than others and getting it cheaper. Ah, forgot the US got their first. And it didn’t end up cheaper at all: billions spent with more to come.
This whole spike in oil prices was seen a long, long time ago and simply ignored as the pickings were good - large profits made. Story of mankind. Long term consequences vs short term gain. Hell, what’s oil when we’ve no planet left to live on? (Or one where we’re swimming in an ocean due to a rising sea-level. At least there’ll be no sharks as they will too will have been eradicated for shark-fin soup).
Ah yes, and after glimpsing back on the article, now I know why Sasol have the slickest ads on the block what with their 17% net profit margins. Makes you sick, doesn’t it?
@ Paul: Thanks :-)
@ Andrew: You’re not making much sense, I’m afraid. The “war for oil” to “get it cheaper” makes no sense. Spending thousands of lives, hundreds of billions in cash, and who knows how much political capital to “claim their oil”, when Saddam was a common gangster with whom an unprincipled state could (and some did) do business, when the UN wanted to lift sanctions against him, when Iraq has less than a tenth of OPEC’s 40% global market share (less than, say, Venezuela or Iran), when post-war oil ended up costing four times what it costs now and the US is a net importer of oil, makes no sense.
That oil prices were “simply ignored as the pickings were good — large profits made” makes no sense. Profits were low when the oil price was low, and they’re very high now. So high, in fact, that every second politician is trying for a cash-in-transit heist by levying “windfall” taxes, as if the “windfall” isn’t the result of capital invested and risk taken even when the oil price was in the dumps. Makes no sense.
“Long term consequences vs short term gain” makes no sense. If that’s true, why do investors not sell their shares in oil companies? Why does the stock market keep rising over the long term? Why do GDP, income, and asset values, keep rising? Why is the world, including with a few socialist or corrupt exceptions the poor world, been getting more prosperous and populated over the long term? Makes no sense.
And it makes no sense to decry the profit margins of a regulated monopoly whose prices are set by the state.
All in all, your response appears to be less a rational argument than an unhinged rant repeating the economics-free, paranoid, apocalyptic and populist preaching of the anti-capitalist left. It makes no sense at all.
But thanks for your comments. They’re always appreciated.
Sorry, don’t have time to read all of this - feel free to point me in the right direction. My simplistic view is that a) the DME could allow Sasol to sell synfuel at a lower cost, if b) it forces Sasol so sell the same petrol to other local oil companies, who can then all compete on the same footing and pass the joy to consumers. Everybody wins, Sasol probably most of all, by producing much more of it and getting out of the fossil fuel business, at the same time alleviating the shortage. Right?
The DME could do so simply by deregulating the fuel price. Who Sasol sells it to is immaterial. It would be wise to sell to any customers, however, to profit from higher sales volumes. It wouldn’t get out of the fossil fuel business, because coal is just as much a fossil fuel as oil, but it would help alleviate the shortage, and it would push prices down by providing an alternative to high-priced oil-derived fuel, yes.
Differ on two points: It does matter who Sasol sells it to, because otherwise its synfuel advantage would blow the others out of the water. But then, the rabid libertarian would say so be it, and why must Sasol be faulted for its enterprise?
Is there a less simplistic answer to the problem? Why didn’t anybody else take the opportunity?
The other thing is, should government see the point of forcing Sasol to share the spoils, thus avoiding a de facto monopoly, it won’t force it to do so by deregulating the industry and letting it do what it wants.
Thanks for putting me straight about coal coming from fossils, haha!
What is rabid about wanting to see the most efficient suppliers succeed, in the interest of consumers? What is rabid about not wanting consumers to pay the price of inefficiency? What is rabid about arguing that the government has no right to use legislative force to coerce someone into entering into transactions against their own will and interests?
The only problem, of course, is whatever legal rights Sasol might have that a competitor does not have. I doubt it still does have such rights, but if Sasol’s behaviour leaves room for competition such competition must be able to arise. The only argument in favour of regulating Sasol is that it was able to invest capital in synfuel technology under monopoly protection and government price controls. Whether this outweighs the disadvantages, risks and unintended consequences of such regulation, however, is disputable. One should be very cautious about advocating regulation as the cure for perceived ills in the market. Sacrificing liberty so freely has heavy costs, both in principle and in practice.
I can think of unintended consequences of deregulation resulting in unfair competition too. Let me see: a clean coastline, kids without respiratory illnesses in Table View, compounded fuel shortages (Sasol can only manage sunfuel at 30%-something of its total production), debilitating lawsuits against the government and billions going back to the US and Malyasia.
None of those are likely consequences of removing price controls on fuel, none of those are likely consequences of deregulating Sasol, and none of those wouldn’t have remedies in a free market. I wasn’t proposing abolishing the judiciary.
Would you advocate pro ante limitations on what business you may engage in, just because there is a risk you’re a bad person and may commit fraud? Surely you’d say, if I do, charge me after the fact or sue me for your losses? What happened to presumption of innocence? And how far would you take regulation designed to prevent any behaviour that might turn out to infringe on someone else’s person or property?
On your financial xenophobia, Sasol is a South African company, so why would billions be repatriated elsewhere? The other oil companies are foreign, but how would permitting price competition substantially change what they repatriate?
If you buy something from someone, why would you care what the seller does with the proceeds? Even if they do repatriate it, surely you have obtained more value from the money than you would have obtained from not entering into the transaction? Otherwise, why did you enter into the transaction? Why not close the borders altogether and try achieve PW Botha’s self-sufficiency dream?
If you do get a cheaper or better product from a foreign company, that leaves you richer in real terms than you would have been if you’d been forced by regulation to subsidise a less efficient local firm. That extra wealth on the part of consumers — more money left over to spend or invest, lower production costs, better value from their purchases — makes it desirable to buy from foreign companies if local companies cannot compete.
Anyway, the point is that Sasol, a local company, should be able to compete. Unshackled by regulation that forces it to charge uncompetitive prices for its product, it — or any putative synfuel competitor — should be able to thrive on increased volumes, strengthening our economy not only by their own success but by reducing costs and oil price shocks throughout the economy.
Sounds like a pretty decent consequence to me.
So you’re saying letting Sasol charge R5.29/litre when no-one else can, and it being able to do so based on an unfair advantage would not blow the other oil companies out of the water? Are you saying Sasol, which cannot match its own refined-crude fuel output with synfuel, will somehow and of its own accord sell its cheaper fuel to EVERYONE, including the other oil companies, because it’s wise to up its volumes and extract more profit? You’re saying it won’t use its unfair advantage, a la Microsoft, to strangle its competitors? You can presume its innocence if you want. I don’t trust any profit-driven animal to think of the greater good unless he’s told to. Else why do we have BBBEE, environmental, HSEQ, competition and governance regs?
I think there’s a fair case to be made for restricting a hacker’s Internet access until he’s “rehabilitated”, or at least so rich from lecture tours and books signings that he sees the point of repackaging his recidivism in respectability. Academic example, nothing to do with Sasol.
I don’t think you got my point about repatriation of - not Sasol’s profits, but the others’ investments, if they cannot cut it in some double-dog regulate-unfairly-till-you-can-deregulate-unfairly protectionist or at least criminally unthinking backwater.
Anyhow, lovely as this has been, we both have work to do.
No, no profit-driven animal considers the greater good. That not their purpose. They consider their own interest, and when pursued within the law, this is a perfectly moral pursuit. In fact, that they seek profit is the greater good in and of itself. They can only profit by supplying something somebody considers sufficiently valuable to pay for. (Unless, of course, they’re guaranteed profits by state price controls…)
As for your “academic” example, it is only valid for convicted criminals. What you proposed earlier was more akin to blocking everybody’s internet access in advance, or permitting them only the access they can prove they need for business purposes, because of the risk that they might use it to make kiddie porn or send 419 scams.
But that’s the first time I’ve heard someone defending high fuel prices to save the poor threatened oil companies from alt-fuel competition. Nice one.
Oh dear. I want the price of fuel to be R5.29 too, only the accompanying tactic, I’m suggesting, should be to require Sasol to supply synfuel to other oil companies. Kind of a staged liberalisation, while they get their stuff together. Oh bugger, that opens up another can of worms.
That sounds ominously like “managed liberalisation”, which you’ll surely agree isn’t all it’s cracked up to be. We’re likely to be better off without the “managed” part.
But admittedly, it that’s all I can get, I’ll take it.