Fuel supply and oily politics
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File picture of a fuel station.
A few days ago, we were told that Cabinet approval has been granted to open up Sri Lanka’s domestic fuel market for more players – companies which wish to import fuel and carry out domestic sales. In principle, the entry of multiple players in the domestic fuel trade would improve the market competition in terms of price, quality and efficiency. However, the outcome of the Cabinet decision would be shaped by the forthcoming regulatory mechanism under which the fuel market would operate.
History
For the past 20 years, Sri Lanka’s fuel supply has been a “duopoly market” in which there are two major players – the government-owned Ceylon Petroleum Corporation (CPC) and the Indian Oil Corporation (IOC) subsidiary, Lanka IOC. Prior to that for about 40 years it was a “monopoly market” owned exclusively by the state-owned CPC.
Whether the “duopoly market” with CPC and LIOC makes it better than the previous “monopoly market” remains a question to ponder! While the fuel crisis batters the domestic market, both the CPC and the LIOC are equally helpless in capitalising the opportunity (of rising demand).
At the time that a share of the domestic fuel market was handed over to the LIOC in 2002, there was another international company to enter the Sri Lankan fuel market; that is Sinopec Company established as a subsidiary of the China Petroleum and Chemical Corporation.
The political authorities at that time might explain it better, why the Sinopec Company was rejected a market share from Sri Lanka’s fuel trade. If it had been granted a stake, today we would have three suppliers. So, even if CPC fails in meeting the fuel demand, other two players would have been competitive. There is no need to mention that a market structure with three players, which is known to be an “oligopoly” would have been more competitive than a duopoly.
State monopoly
What was there before the CPC was established by a Parliamentary Act in 1961? It was a competitive private business operated by a couple of international oil companies. The CPC commenced business in 1962, competing with these international oil companies.
The nationalisation of the oil trade and handing it over to the CPC made it a state-monopoly. With this, all the international oil companies had to leave the country. The CPC took over the entire business of import, sales and distribution of fuel. In addition, the Kolonnawa oil installation, regional bulk depots and retail outlets which were operating under three different oil companies were also unified as one entity under the CPC, further strengthening its monopoly market powers.
With the commencement of the oil refinery facility in 1969, bunkering operations in 1971 and entering the production of other petroleum products, the CPC grew in strength and capacity as a state-monopoly. Even after the entry of the LIOC in 2003, its monopoly status changed only marginally because of its overwhelming market share and the regulatory mechanism which was not challenged by the duopoly status.
By the way, Royal Dutch Shell Company – known as “Shell” – was one of the multinational oil companies operating in Sri Lanka since colonial times; it too had to leave the business after the nationalisation of oil companies. However, as the government offered a 51 per cent stake of Colombo Gas Company in 1996, Shell came into the Sri Lankan market again by purchasing it for US$37 million.
This time, Shell did not remain for more than 10 years. As part of Sri Lanka’s “re-nationalisation policy” after 2005, Shell Company terminated its operations and handed over its stake back to the government for US$63 million; with this re-nationalisation activity, the government established its own Litro Gas Company, which has also failed today to keep up its business mandate of gas supply.
Failed models
The state-monopoly model in Sri Lanka has failed today, so much so that the state monopolies such as the CPC have collapsed in delivering their supplies to the domestic market. This failure is critical, because it would obviously push Sri Lanka’s “crippled economy from the pan to the fire” as we discussed last week.
But why did they fail? Someone can put forward an argument that they don’t fail everywhere; I agree, because state enterprises have grown globally and become multinational corporations competing well with private multinational companies. An OECD research publication in 2013 on state-owned enterprises identified that out of the world’s 2000 largest listed companies, 204 were state-owned enterprises originating from 37 countries, mostly from Asia.
Then, I must refine my question to ask why at least the state-owned enterprises in many countries failed; apparently, there is no dispute that Sri Lanka is one of them.
The political slogan that the state enterprises are “people’s assets” bears little sense in a political economic environment that they operate in Sri Lanka. As we debate the “principal-agent problem” in economics and management studies, the “ownership” of an enterprise matters; identifying the real ownership of a state enterprise is complicated; so who holds the responsibility and the accountability for their performance is vague. Agents are those who run the business, while principals are the owners.
Who owns it?
There are multiple monitoring bodies for the state enterprises, as the general public, elected politicians, non-elected bureaucracy, and the management, but ultimately the questions melts down into who is accountable for what. The environment in which a state enterprise operates, the objective of public interest could also be displaced by the interests of the influential stakeholders, whose vested interests can guide decision-making.
In general, state enterprises face distinct challenges of corporate governance as reflected by the evidence from around the world:
- They suffer from undue hands-on and politically motivated ownership interference
- They are protected from two major business threats: Takeovers and bankruptcies.
- There is a complex chain of agents – management, director board, ownership entities, ministries, and the government – without clearly identifiable principals.
As a result, business losses don’t matter, as the losses are transferred to the taxpayers through the government budget. There is no incentive for efficiency in the absence of competition in a monopoly market. They can borrow money as the government provides bank guarantees. On top of all the above, the director board, the management and the employees all have got hold of the “spoon” with which they can “help themselves” without accountability.
Obstacles to reform
All in all, at one point they were bound to fail. The leaders, who understand it in advance, must take corrective measures to reform the state enterprises, a process which includes liberalisation and privatisation, opening up for competition, and introducing accountable management systems.
There could be obstacles to reforms emanating from various parties: (a) the politicians who seek popular gains, (b) trade unions of employees who enjoy the status-quo of perks with the “spoon” in hand, (c) public lobbying groups which have been misguided by others with vested interests and, (d) finally corruption of the politicians, bureaucrats and the deal-makers who seek bribes, commissions and other undue advantages from the deals.
Unbelievably, Sri Lanka still has about 400 state enterprises, while their exact number is not known to anybody. I found difficulties to understand even why some of them exist, draining the budget. The biggest state enterprises by their turnover as well by their annual losses are the CPC, Ceylon Electricity Board, SriLankan Airlines, Water Board, Sri Lanka Transport Board and, the Railway.
Reform is not a choice but a mandate irrespective of the ownership; neither is it inconclusive, but continuous. If it is taken seriously, economic crises also provide unprecedented opportunity to reform not only the CPC, but review and reform all the state enterprises; it would help to achieve economic recovery as well as macroeconomic stability and growth momentum.
(The writer is a Professor of Economics at the University of Colombo and can be reached at sirimal@econ.cmb.ac.lk
and follow on Twitter @SirimalAshoka).
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