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Philippine Oil Pump Price Calculation Model and Oil Company Gross Margin – Executive Summary

September 11th, 2012 Posted in Oil Pricing Formula

Philippine Oil Pump Price Calculation Model and Oil Company Gross Margin – Executive Summary

 An Independent Oil Price Review Committee (IOPRC) recently completed its study and submitted its findings to the Philippine Department of Energy (DOE), the print and broadcast media, and conducted a public consultation at the UP School of Economics to interested parties such as NGOs, oil company associations, academe.

The IOPRC concluded that domestic oil prices of gasoline and diesel tracked changes in the international price of oil (Mean of Platts Singapore or MOPS) based on statistical and regression analysis. It also found that the return on equity (ROE) and internal rate of return (IRR) of the oil companies (refiners, importers) on an annual average are reasonable and lower when compared to returns of other utilities and industries such as power generation, telecom, mining and that the oil company gross margin (in % and absolute Pesos per Liter) which was computed by subtracting from the pump price all taxes and government fees, logistical costs, dealers margin and cost of the imported oil were not excessive as generally alleged.

Executive Summary

By going into each value adding step in the oil supply chain, either thru refining of crude oil or direct importation of finished petroleum products such as gasoline and diesel and then marketing, transporting, storing and blending in depots with biofuels such as ETHANOL and CME BIODIESEL, then hauling and retailing at dealer’s pumps, it is possible to calculate the oil company gross margin (also known as oil company take) by subtracting from the actual pump price all the intervening costs arising from its importation, unloading, processing, marketing, transporting and retailing.

This residual value or oil company gross margin takes care of the oil company’s costs and provides also a profit margin that serves as the economic incentive or driver for importing, refining, processing, marketing, distributing and retailing of petroleum products.

And applying the exact science of accounting, engineering and economics, a mathematical formula could be developed to model and represent each importation value adding activities to arrive at the Duty Paid Landed Cost (DPLC).

Once the DPLC is known, all other local value adding activities such as refining, processing, transshipment, pipeline, depot operation and biofuels addition, hauling and retailing will lead to the determination of the pump price.

Using precise accounting tools is by far the best method of calculating the reasonable pump price rather than ratio and proportion methods proposed by other government agencies as well as so called rule of thumb formulas.

The pump price is calculated using the model below:

PP =DPLC * (1 – % biofuel) + [DPLC * (1 - % biofuel) * %GM + (TS + PL + DE) * (1 – % biofuel) + BIO + HF + DM] * (1 + %VAT2) + OPSF

To calibrate this model, the % gross margin (GM) is derived algebraically as follows:

%GM = {[PP - OPSF - DPLC * (1 - % biofuel)] / (1 + VAT2) – [(TS + PL + DE) * (1 - % biofuel) + BIO + HF + DM]} / {DPLC * (1 – % biofuel)}

Finally, after we have calibrated the model by determining the economic behavior of the oil company as exemplified by its % GM appetite, the absolute oil company gross margin in Pesos per Liter is calculated:

OCGM (P/L) = DPLC * (1 – % biofuel) * %GM

The above formulas were applied on data supplied by the DOE and the oil companies from Jan 1973 – May 2012 (the data consist of average pump price, exchange rate, Dubai and MOPS, customs duty, excise tax and value added tax, BOC imposts, transshipment, pipeline, depot operation, hauling fee and dealer’s margin). Recent data (2005-2012) were supplied by the oil companies while earlier data (1984-2004) were supplied by the DOE, and very early data (1974-1983) were culled from other sources such as the DOE and the data base of Engr. Marcial Ocampo, formerly Section Chief for Transport, Buildings and Machineries at the Conservation Division of the Bureau of Energy Utilization (BEU) of the Department of Energy.

Main Findings:

The main findings from applying the above formulas on the historical data are summarized below:

1)    The DPLC and Oil Pump Price Formulas have calculated % OCGM as well as absolute Pesos per Liter gross margin that are no larger than 7.300 P/L in 2011 for gasoline and 1.437 P/L in 1985 for diesel.

2)    In 2012 (January-June average), the difference between the gasoline pump price and its DPLC includes costs for transshipment, pipeline, depot, biofuels, hauling and dealer’s margin which totals 5.053 P/L and the gross margin is 6.863 P/L. Hence, there is no over pricing of the order of 8.0 P/L as manifested by other government agencies, consumer groups and NGOs.

3)    As of June 2012, the average OCGM is 16.96% of DPLC for gasoline (6.863 P/L) and 2.17% of DPLC for diesel (0.885 P/L). This indicates that the oil companies are heavily subsidizing diesel used mainly for public transport thru the larger margins of gasoline used mainly for private motoring. It is for this reason that small retail outlets with mainly diesel pumps have gone out of business or suffering from financial difficulty because of the low gross margin from diesel retailing.

4)    Based on the ratio of gross margin to pump price of 12.33% and 1.93% for gasoline and diesel, respectively, an estimate of the oil industry profitability will be in the order of 5.39% return on sales assuming that sales proportion are in the order of 1 part gasoline sales to 2 parts diesel sales. The reader is advised to refer to the other TWG report on profitability that utilized the oil company financial statements submitted to the SEC.

5)    The OCGM for gasoline during the regulated periods (63.93% of DPLC from 1973-1983; 31.93% of DPLC from 1984-1997) were much larger than that during the deregulated period (11.38% of DPLC in 1998; 6.74% of DPLC from 1999-2005; 11.57% of DPLC from 2006-June 2012), indicating that the level of competition arising from the oil industry deregulation law. It appears that the regulated period assures profit to the least efficient operating refinery or marketer.

6)    On the other hand, the OCGM for diesel during the regulated periods (-17.84% of DPLC from 1973-1983; 7.26% of DPLC from 1984-1997) as well as during the deregulated period (13.89% of DPLC in 1998; 1.38% of DPLC from 1999-2005; 0.79% of DPLC from 2006-June 2012) were consistently lower compared to gasoline, indicating that oil companies are cross-subsidizing diesel from their higher gasoline margins to sustain their operations.

7)    The behavior of the oil industry is characterized today by series of weekly price adjustments to approximate but not equal the calculated price increase in the international markets (Dubai, MOPS) based on current prices vs. last week’s average cost inputs. Likewise, downward price adjustments do not reflect immediately the calculated price decrease in the international markets as there are under recoveries arising from the earlier moderate price increase that needs to be recovered to sustain their operations.

Conclusions:

There may be isolated instances of larger than normal gross margins on a daily or weekly basis as the oil companies adjust their gross margins to recoup spikes in international crude oil and product prices. But the IOPRC can not rely on transient short-term adjustments to conclude that there is deliberate overpricing as this will constitute cherry-picking of data such as when using ratio and proportion when ratio of pump price to MOPS is lower in previous period when compared to current period with an international price spike where the ratio of pump price to MOPS is extraordinarily high; hence, the predicted price using ratio and proportion would also be abnormally high and some NGOs and government agency therefore conclude that there was overpricing.

With today’s 10% ETHANOL gasoline blend, it is expected that oil companies will adjust upward domestic prices up to 90% or less (less because of competition) of the increase in the peso per liter equivalent value of gasoline MOPS and also 90% or less (less because of any previous under recoveries) of the decrease in the MOPS of gasoline. This is because the gasoline blend consists of only 90% pure gasoline component.

For diesel with 2% CME biodiesel blend, the oil companies will adjust upward domestic prices up to 98% or less of the increase in diesel MOPS and also 98% or less of the decrease in diesel MOPS. Aside from the level of adjustment, the upward price adjustments are effective immediately while downward price adjustments are implemented immediately but held for a longer period of time as oil companies recover any previous under recoveries.

On a monthly and annual average basis, however, can it be concluded that there is overpricing for gasoline and diesel? THE ANSWER IS NONE.

Using an oil pump price calculation model developed by the Committee — wherein the retail prices of gasoline and diesel are built up from import costs to transport and distribution including all taxes — there is no evidence of overpricing:

  • Using the OPPC model developed by the IOPRC, no evidence was found of overpricing of some P8 per liter for diesel and P16 per liter for unleaded gasoline, as claimed by some consumer groups. The largest annual average gross margin was 7.300 P/L in 2011 and 1.437 P/L in 1985 for gasoline and diesel, respectively.
  • As of June 2012, the average OCGM was estimated at 16.92% of Duty Paid Landed Cost (DPLC) for gasoline and 2.20% of DPLC for diesel.
  • In June 2012, the average OCGM as percentage of pump price is 12.3% (6.86 P/L) for gasoline and 1.9% (0.88 P/L) for diesel. This gives a weighted average of 5.4% (2.88 P/L), assuming that sales proportion are in the order of one-third gasoline sales to two-thirds diesel sales.
  • The OCGM for gasoline during the regulated periods were much larger than that during the deregulated period, indicating the level of competition arising from the oil industry deregulation law.
  • On the other hand, the OCGM for diesel during the regulated period, as well as during the deregulated period, were consistently lower compared to gasoline. This suggests that oil companies are cross-subsidizing diesel from their higher gasoline margins to sustain their operations.

Recommendations:

The TWG for Oil Pump Price Model and Oil Company Gross Margin therefore recommends the following:

1)    The DOE should adopt the Oil Pump Price Calculation (OPPC) model for calculating the DPLC and the Pump Price to consider accurately the effect of biofuels addition and other logistical costs Other approximate methods such as Ratio and Proportion (such as pump price to MOPS ratio) and Rule of Thumb (such as 3 US$/bbl MOPS change per 1 PhP/L or 1 PhP/US$ FOREX change per 1 PhP/L) are at best approximations and may not be able to predict accurately absolute pump price in Pesos per Liter or price adjustments and are not recommended for regulatory use and monitoring by the DOE.

2)    The DOE should make available through its website the OPPC Model for DPLC and Pump Prices to regulators, the academe, and other interested parties.

The power point presentation in ppt format, full document report in pdf format, and the OPPC model in xls format may be download from the DOE website.

A second installment of the technical paper on Oil Pump Price Calcualtion Model and Oil Company Gross Margin will follow shortly on this same blog.

If you need advise to understand further oil pricing, you may contact us at energydataexpert@gmail.com.

 

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