Spotlight

India's stranglehold of Lanka's economy

Dr. P.B. Jayasundera

By Frederica jansz Having destabilised Sri Lanka in the early 1980's using the Tamil ethnic issue and training Tamil militants, India is now trying to systematically strangle Sri Lanka on an economic level. In a stealthy, but focused plan the Indian government is steadily taking control of Sri Lanka's oil and gas industry which will in the long term create turmoil and havoc for the Ceylon Petroleum Corporation (CPC) and may even result in the closure of its refinery.

India's monopoly of the oil, petroleum and gas industry in Sri Lanka has already been agreed to by Treasury Secretary Dr. P. B Jayasundera at a high level discussion he had on July 5 this year with India's Finance Secretary, Shri D. C. Gupta.

The issues discussed between Dr. Jayasundera and Gupta at this meeting in New Delhi and agreed upon by Dr. Jayasundera includes a pact that India would offer a new line of credit of US$ 150 million for the purchase of petroleum products from Indian public sector oil marketing companies on term contracts. This would be in the form of an Exim Bank Line of Credit. It entails a fast disbursing loan, with the first installment to be made available in about two months from the time of release. The total repayment period would be seven years, including a moratorium of one year. Dr. Jayasundera has agreed that the government of Sri Lanka would consider creating an escrow account to take care of repayments.

Discussions in India

In the long term, the result of this agreement would mean that this new Indian Line of Credit would ensure that the decision making process in Sri Lanka's petroleum sector - like pricing and supplies - will be made not in Colombo but in New Delhi!

Indian sources further revealed that Dr. Jayasundera also agreed the government of Sri Lanka will begin settlement of a subsidy claim submitted by Indian Oil Company (IOC) to the tune of about US$ 14.1 million (approximately Rs. 1.4 billion), while it makes no pledge to honour subsidies due to the CPC to the tune of Rs. 10 billion.

Dr. Jayasundera has additionally agreed that the government of Sri Lanka "will consider favourably" India's Oil Natural Gas Company's (ONGC) request for allocation of blocks for oil and gas exploration in Sri Lanka.

He also promised that the government of Sri Lanka will take an early decision on the bids invited for retail marketing of Indian oil products in Sri Lanka. This means Dr. Jayasundera has pledged to speedily push for a conclusion in negotiations with another Indian oil firm which has made a bid to be the third player in Sri Lanka's petroleum industry.

At this discussion, Gupta had brought to the notice of the Sri Lankan side the abnormal increase in the export of pepper and copper rods often exceeding the production capacity of Sri Lanka. D. C. Gupta informed Dr. Jayasundera that India anticipated similar problems regarding the export of vegetable oils and vanasapti from Sri Lanka. Dr. Jayasundera offered full cooperation in curbing third country exports through Sri Lanka particularly in the agriculture sector and verification of rules of origin in other sectors.

It was agreed that the customs authorities of both sides would meet in the near future to work out how this cooperation can be given a formal shape.

Dr. Jayasundera also promised the government of Sri Lanka will reiterate its instructions to the CPC to undertake oil purchases through term contracts, in view of the significantly lower cost of a term contract as against a spot purchase. To purchase through term contracts certainly makes better economic sense. But there is a catch here. This clause means that the CPC would have to buy oil only from a state oil company in India which is the Indian Oil Company and would not be able to purchase on a tender basis from other Indian suppliers on a long term contract that would be more cost effective and cheaper in price.

Chairman, CPC, Jaliya Medagama said he knew nothing of this discussion and agreement with India.  Medagama expressed deep misgivings, asserting that if indeed this be the case, then Dr. Jayasundera's agreement with India will bear very serious consequences for the existence of the CPC.

"I haven't seen this agreement so it is premature for me to comment," he said, asserting however that if it is so, "then it is a matter bearing very negative connotations to the CPC and one to worry about."

Medagama agreed that the entry of Lanka Indian Oil Company (LIOC) into Sri Lanka has caused concern to the extent that unions within the CPC are charging that LIOC has become a serious threat to the existence of the CPC. "I think these unions are somewhat justified in their concerns," Medagama said, adding union heads have already detailed the crisis issues and concerns to President Chandrika Kumaratunga.

The consequences of the present privatisation plan of the CPC as it is will result finally in the CPC being left with a market share of only 17%. Medagama too conceded this fact. At present, CPC owns 300 filling stations which entails 50% of the retail market. Separately, 600 dealer filling stations dominate the balance 50% of the retail market. The retail petroleum market share is directly related to the number of filling stations.

Crisis

In all probability, under the present terms and conditions being negotiated by the government with the third player and the entry of a third player will result in a breakdown of market share. Out of the 300 filling stations owned by the CPC - which is 50% of the retail market - 100 have already been given to LIOC. Another 107 have been earmarked for release to the third player. This means both LIOC and the third player will possess one third each or 17% of the market share. Collectively they would control 35% of the retail market while CPC would be left with only 17%. The balance 50% of the retail market is controlled by dealer owned filling stations.

And in the backdrop of the present financial crisis within the CPC - its debt is estimated to be in the region of Rs. 25 billion or US$ 250 million - there is every possibility that all 600 dealer owned filling stations which possess a total market share of 50% would be finally owned by the two competitors. Dealers who spoke on conditions of anonymity said this would be because LIOC is offering better facilities than the CPC could offer. They claim that LIOC is offering "under hand commissions to dealers" as well as additional discounts on sales.

As a result, dealers are now refusing to sign agreements with the state corporation unless the CPC agrees to demands for free equipment, interest free loans, grants, etc., all of which are now way beyond the economically strangled corporation. In fact, dealers confessed they are waiting for the third player to enter the scene so that competition would be stiff and dealers would stand to gain substantially.

Even Medagama agreed the end result would be that finally the CPC could be left with less than a 20% market share which will gradually reduce even further due to the present internal weaknesses within the CPC and its financial crisis.

The danger

What is of significance here is the refinery which produces about 60% of the market share. In the now realistic scenario whereby the CPC will have less than a 20% market share with the entry of a third player, the refinery would face possible closure.  Medagama maintained that competitors are not bound to purchase the local production even of better quality and cheaper than the imported product. This would effectively give full control of the petroleum industry to the two competitors.

The unions have made a strong plea for expansion of the refinery which has been running at 100% capacity. The refinery during its 40 years and more of existence has been profitable every single year except one. Union heads maintain that the CPC's losses and the country's losses today are due to imports of diesel and kerosene to meet the country's increasing demand.

Now, we come to the real danger in this setup. And that is that both competitors are going to be Indian companies. One is, Indian Oil Company which is already in the country, while the other proposed third player is Bharath Petroleum Limited in India. The Treasury is already negotiating terms and conditions with Bharath. And this was discussed at the meeting in New Delhi between Dr.  Jayasundera and D. C. Gupta where Dr. Jayasundera agreed the government of Sri Lanka will take an early decision on the bids invited for retail marketing of oil products in the island. He was referring to ongoing talks with Bharath making a promise to reach an early conclusion.

During the regime of the United National Front (UNF) government a tender was called for a third player to offer for a one third market share in the Ceylon Petroleum Storage Terminal Limited (CPSTL) which is the infrastructure company of CPC where ownership is to be divided between three players.

Early decision

When the UNF mooted a tender to this effect the best price on offer was by the Chinese oil giant SINOPEC. They offered US$ 88 million for a one third market share in CPSTL. The deal included ownership of 107 filling stations plus the right to entice or persuade dealer owned outlets into their network.

A cabinet paper was prepared to this effect, but never submitted as political turmoil broke out and Sri Lanka faced yet another general election. When the government changed in April this year, the new United People's Freedom Alliance (UPFA) altered the goal posts and refused the Chinese full ownership of the 107 filling station. The UPFA insisted the government must retain a 51% ownership of the stations. The Chinese were not interested and pulled out of the deal. However, the Indian company Bharath expressed an interest and the government is expected to soon conclude negotiations with this company. This is what Dr. Jayasundera meant when he met with Gupta and promised to take an early decision on bids invited for retail marketing of oil products in Sri Lanka.

LIOC already fully owns China Bay for import and delivery of oil products. This is where the future of the refinery and the CPC is balanced on a tight rope and whether they will make it to the end of the line already seems shaky.

This is why the entry of LIOC has already become a serious threat to the existence of the CPC. When questioned, Medagama admitted that it has been rumoured that a long term plan of LIOC is to get control of all CPC owned filling stations in lieu of government subsidies to be paid to them. Medagama however maintained he had no evidence that this is true, but speculation to this effect is rife.

Green light?

Medagama meantime voiced concern that the refinery cannot operate with a 60% production in the event CPC market share is reduced to less than 20%. "This will in all probability result in the closure of the refinery," he said.

While the market share of CPC has reduced drastically after the entry of LIOC, its overhead costs have increased as a result of benefits being given to dealers as CPC continues to strive to retain their outlets with the corporation. Some of these benefits have included filling stations being upgraded, CPC incurring high interest payments for bank overdrafts given to dealers, unpaid subsidy claims exceeding Rs. 6.3 billion owed by the Treasury, unpaid monies from the state sector exceeding Rs. 4.8 billion and an exchange loss of more than Rs. 1.2 billion when the rupee depreciated from 98 to 102 against the dollars.

Deliveries from Sapugaskanda terminal have already been suspended wasting a huge investment while CPC continues to pay back the loan. The overhead costs of CPSTL has already gone up where the 'throughout' charges have been increased beyond amounts allocated in the price adjustment formula.

Meanwhile, LIOC has already spoken with the government to obtain approval to supply islandwide from China Bay at a cheaper cost. They are in a position to do this by using excessive concessions given to them in the agreement. Going by Dr. Jayasundera's discussions in New Delhi it looks like LIOC will definitely secure the necessary green light. What would then happen to CPSTL and its staff is the multi million dollar question which even CPC Chief, Jaliya Medagama has no answer to.

Recovering profits

Bharath Petroleum Limited (BPL) will buy a one third share in CPSTL. Valued at US$ 45 million this share allocation is presently owned by the Treasury. The government has already agreed that BPL will have total freedom to negotiate and own the 600 dealer owned filling stations which possesses a 50% market share in the retail marketing sector. BPL has purportedly agreed that the Treasury may retain 51% ownership of the 107 filling stations to be allocated to them. However, the Treasury will not have any control over the business or be entitled for any profits other than 51% of the lease rental for the 107 filling stations.

Informed sources revealed the third player will function as a subsidiary of BPL and probably be named 'Lanka BPL.' Lanka BPL, they said, will own a one third share of CPSTL, and will buy or lease as many dealer owner filling stations as possible. They will in addition own via a lease agreement 107 filling stations at present owned by Modern Petroleum Marketing Limited (an arm of the CPC) and partly owned by the Treasury.

As pointed out by a financial analyst what is noteworthy here is the value of the third player in the petroleum sector lies in the petroleum business itself and not in the lands of the 107 filling stations. The total investment by BPL of an estimated US$ 65 million can easily be recovered within a year through the profits of this business.

Growing debts

Asked for his views on the current controversy regarding entry of the third player and future of the CPC, Daham Wimalasena, its former chairman said, "five months ago entry of a third player was justified.  SINOPEC which offered US$ 88 million to be the third player would have helped wipe off an appreciable part of the debt incurred by the CPC during the years 2000 and 2001. The debt position if CPC received US$ 88 million would have been adequate and manageable in early 2004." Wimalasena however asserted that at present the financial and competitive position of the CPC has deteriorated drastically to, "A hopeless position. In this context the entry of a third player must be reviewed," he asserted.

In this backdrop, the tragedy for CPC is that it made a Rs. 9 billion profit in the year 2002 with the old pricing formula. The current revised formula has additional profit of about Rs. 4.6 billion per year as guaranteed profits for the marketing companies through the privatisation process.

CPC may well be in a position provided it holds a two third share to pay back debts in two or three years if the government is able to restructure its debts to a long term loan through the government.

A major reason for CPC's growing debt has been the government's refusal to adjust prices to be in line with international prices. So far it is the CPC which has been subsidising the consumer. The Treasury and state agencies owe CPC an estimated Rs. 10 billion while the overall debt is in the region of Rs. 25 billion.

No value

Additionally, the CPC has paid the Treasury about Rs. 25 billion every single year without default or delay as taxes and duties. In 2001, when the Treasury did not approve a price increase, CPC losses amounted to Rs. 16 billion. Yet, the Treasury took its pound of flesh - as much as Rs. 22.5 billion.

In 2004, the Treasury is expected to do even better. The "Treasury Take" could be around Rs. 30 billion irrespective of whether CPC has a profit or loss. The truth of the matter is that with every price increase the consumer suffers, but the Treasury gains. Even much of the sales proceeds of its assets were retained by the Treasury when it should have been given to the CPC to offset its debt.

Wimalasena pointed out CPC's financial, operational and administrative costs are soaring with misuse of its resources and a breakdown in discipline. "Conversion of the CPC to a fully government owned company with professional management devoid of political tinkering is the answer," he said, adding "CPC is a Rs. 100 billion turnover organisation - the only one in Sri Lanka. CPC can be resurrected within two years if there is no political interference in pricing and administration. Also there should be no further downsising or disintegration of its existing market share," he said.

Bringing in a third player at this juncture appears to be more damaging than of any real benefit. The total revenue from the third player is to be in the region of about US$ 65 million. This is while the monthly fuel import bill at the CPC is about US $ 90 million. So is there any value in this sale for Sri Lanka in the long term?

Private companies such as LIOC and BPL will earn back their investment in a matter of two to three years and profits will be taken out of Sri Lanka in US dollars from the island's own local market.

And to cap it all is now Sri Lanka's blanket approval to India to allocate blocks for the Indians to conduct oil and gas exploration in the island. This is what Dr. Jayasundera has agreed to when he met with Gupta in New Delhi this year. He has done so ignoring the fact that bids should be called and ensuring Sri Lanka's natural resources are protected and not exploited.

To quote Medagama on this issue, he said, "This is a very serious aspect if indeed the Treasury has already entered into some kind of an agreement with India." Medagama reiterated that government officials early this year were hosted in Houston where it was explained in great detail that if oil and gas exploration is to begin in Sri Lanka it must do so under a transparent bidding process which will also ensure the sites are protected and not exploited by foreign parties.